Market Report: June 2008

A few months ago I mentioned that I was forming an opportunity fund to purchase a block of distressed residences. Unfortunately, our group was not able to secure an appropriate financing vehicle for this project in spite of the good economics. This is illustrative of the credit problems plaguing the real estate marketplace today; banks loved the idea and the principals involved but are loathe to loan any money from their own capital base. Yes we have no money to loan. Fortunately for those looking for an investment, our group now offering a limited partnership in a senior mobile home park in California. It will cash flow immediately. Call me for details.

The Tail and the Trunk

The spring rally, now fading into the summer lull, was both predictable and consistent with past patterns. Citing this seasonal rally as evidence, industry flaks have been gleefully touting the end of the residential recession. But if reality is your preference, I would look elsewhere for information. The evidence is clear that the fall in prices has not yet been arrested. Happy-speak will not change that fact.

Here is how I see the landscape. First, the housing recessionary cycle is about one-third to one-half completed. Second, some form of Federal intervention to assist troubled homeowners will be required to avert a deeper recession. Third, the Federal Reserve Board will not be lowering rates anytime soon. Fourth, there will be a continuation of the current economic slowdown until housing prices are stabilized.

Using the formal definition, there is neither a national nor local recession. The sour mood of consumers suggests there is one. The traditional governmental measurements of the economy are suffering from a credibility gap. Only those whose purchases do not include the 'volatile food and energy sectors' can embrace the current fairy tale concerning inflation. The effects of this recession, unlike the past, are more affecting the bottom half of the economic food chain. In any case, the invisible hand is still relevant as evidenced by the dramatic reduction in housing sales.

People will not and have not responded to jawboning from real estate professionals. Buyers and the talking heads have collectively decided that the bottom of the market has not been reached. Because of this, the pace of sales will surely continue to decline over the second half. Prices usually follow demand although there is probably not much more room on the downside baring unforeseen outside events. The usually reliable fall rally, which has been AWOL since 2005, may or may not materialize later this year. That will depend a lot on the pricing behavior of sellers and on the courage of buyers.

There is little question that consumers remain keen on buying homes and condominiums. They swarm over every new listing, eagerly opening closet doors and peering into crawlspaces. Home shopping is one of our local sports and it seems as popular as ever. The problem is getting buyers to pull out their wallets. This reluctance is not so much based on affordability but on fear itself. Buyers are not alone in trying to describe the elephant; they want to know how much more are prices going to fall. That answer can vary depending on the exact sub-market. The pain of this downturn has not been shared equally.

A Tale of Two Neighborhoods

Good homes at fair prices can be ignored and bank sales attract twenty offers in one day. The home markets in Eastlake and Mission Hills best illustrate this duality. The former is a newer community peopled by average wage earners. Real estate transactions are dominated and driven by fallout from the sub-prime mortgage crisis. In Mission Hills nearly all sellers are financially able to service their debt and have substantial equity in their homes, unlike owners in Eastlake. It is an older established neighborhood and most homes were purchased with conventional loans and real down payments, unlike in Eastlake whose sales success was based on the concept of no down payment. Put another way, this is also a story about class and economic power. Owners in upscale neighborhoods have the net worth to weather the storm. The tail is not wagging the dog in the upper reaches of the real estate world.

This can all change if related markets start to implode or if the Fed completely loses control of inflation. Thanks to the credit crisis, the ship of commercial real estate has sprung a few leaks but is not sinking as of yet. Banks are not only their own worst enemy but are doing much harm to investment real estate. Inflation, which if not reined in soon, has the potential to create even more mischief. Given stagflation or worse, sellers in upscale markets could suffer loses in their financial portfolio as even bonds will take a drubbing.

Career Buyers waiting for the killer deal in Mission Hills or its ilk are going to disappointed if the general economy continues to limp along. There is a political consensus that if the mortgage crisis in Peoria is not contained, Chevy Chase will eventually be in trouble. The idea that market cycles must run their course with minimal interference from governments has fallen into disfavor. Washington knows they must break with historical precedent and step onto the slippery slope of forcing a government-dictated modification on a private contract. This concept is ideologically repulsive to most pols and to the business community. But the risk of a serious and deep recession poses a far greater danger to their political careers. No one knows the exact extent and future impact of the mortgage and credit crisis. Unless that becomes clear or the government acts, buyers will tend to remain on the sidelines.

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