25 comments to “Prediction — Let’s Review — How ‘Bout Now? The Real Estate Correction”

Robert Coté on August 29th, 2008 at 7:40 am said:

• I have nothing much to add to my Jan comments. I will pat my own back for my call of a stairstep in prices late spring/early summer. That happened.

  With mortgage spreads widening and increasing inflation we may not see “prices” even holding current levels while at the same time we as investors may be exposed to rising costs.

  I know rising inflation should be good for asset nominal prices but this time inflation will flush out a great many of those homebuyers who find themselves trapped in ARMs as they reset higher.

  May we live in interesting times.

BawldGuy on August 29th, 2008 at 10:04 am said:

• Oh no!! Not the ‘interesting times’ wish.

Another Investor on August 29th, 2008 at 10:43 am said:

• In Phoenix, according to the two lenders I spoke to this week, approximately 60 percent of their business is FHA-DPA (seller down payment assistance). These are no money down, no closing cost loans, which means houses are still being bought by people that cannot really afford them and will have no equity in them. The seller DPA goes away for FHA loans closing on or after October 1st. Both lenders expect residential inventory to rise and prices to fall over the next several quarters because of the lack of buyers.

  Vacancies are rising quickly on the commercial side, and everywhere you look you see shell retail centers, multi-tenant office buildings, and flex industrial space. When the borrowers can’t roll the construction loans into mortgages or they default on the mortgages that have closed, the banks will be in serious trouble. There is no Fannie/Freddie safety net for commercial real estate loans.

  Add in the rising unemployment, the ARM resets, and you have a recipe for disaster. I can’t say this will happen for sure, but I expect to start buying in 18 to 24 months, once real distress washes most “investors” out of the market and wholesale capitulation begins.

BawldGuy on August 29th, 2008 at 12:10 pm said:

• Investor — Thanks for your thoughtful comment.

  Phoenix will rise later than others. That said, investors may choose to invest in markets better positioned presently.

  Again, thanks, and don’t be a stranger.

Michael Cook on August 29th, 2008 at 12:27 pm said:

• Jeff,

  I think you have always been too optimist with your real estate predictions. I remember us “talking” in the blog space a year or more ago about the impending doom and you were fairly optimistic. I would almost call you the anti-economist, though I wouldnt go as far as calling you an NAR economist.

  Personally, I think you are underselling the problem. Real Estate moves as fast as a turtle with two bad legs. Once it gets going in the wrong direction it seems to keep going for years. In this case you have a lot of bad fundamentals coming together all at once. A slow economic, very tight credit markets, housing inventory at record peaks and pricing declining like a rock (supply and demand at its finest).

  My only question is what will be the next shoe to drop? Fannie and Freddie, a major bankruptcy from a mega bank or a mega builder, a state bankruptcy (my money is on Alabama because of their aggressive derivatives investments, perhaps even New York since the tax revenues will be slash by 30% or more for the next five years or so), etc.

  Sometimes a CD is the best investment. It would seem to me the wisest play in this market is to save liquidity for a year (or two) and then buy like crazy.

BawldGuy on August 29th, 2008 at 1:05 pm said:

• Knew I could count on ya, Michael. Long time no see. Good to see you at BHB too. Your thoughts there were appreciated.

  We’ve been waiting for the predicted, so-called kill shot now for two years in real estate. Then there’s the recession that never was. The Bears have been having their season a bit, but they can’t seem to close the sale.

  Now they’re sayin’ 3.3% growth for the 2nd quarter is just a blip nobody should pay heed to. And our solid export picture should be ignored also. It never ends.

  Also, I’ve said next year we’ll possibly be lookin’ back on these days saying it was when it started to visibly begin to steady itself.

  Don’t be gone so long next time, OK?

Michael Cook on August 29th, 2008 at 1:52 pm said:

• “Now they’re sayin’ 3.3% growth for the 2nd quarter is just a blip nobody should pay heed to. And our solid export picture should be ignored also. It never ends.”

  This is actually interesting. This actually ties into the inflation data. The 3.3% growth is not real growth, but rather less goods being sold at inflationary prices. The people who take a broader look at these indictators are very nervous because their was actually significant real decline ex. inflation. The export picture also speaks to our declining consumption and confidence towards the future.

  My predicition… Next year we might be saying that we are finally hitting bottom and laughing at all of those who predicted bottoms in 2008. It will be sad laughter, but laughter never the less.

  Also note that in my hiring class 1 out of 2 have left the company or been asked to leave. I am working twice as hard and in investment banking that is saying something. Sleep is a luxury, so I often read, but rarely comment. I will be talking to you around bonus time. Perhaps you can help me invest the $1.50 I get thanks to this terrible market.

BawldGuy on August 29th, 2008 at 2:01 pm said:

• Michael — That’s harsh.

  Don’t laugh too hard, OK? You must be killin’ yourself at work. Not surprised you’ve survived the herd thinning though.

  I’m predicting we’ll look back to 2008 as the year we began U-Turn. The absolute bottom is another story. Could be same, or not.

  Take a nap, OK?

Another Investor on August 29th, 2008 at 4:54 pm said:

• I just drove the round trip from the Bay Area to Phoenix, and I saw significant vacancies in every major market along the way. The overbuilding is most obvious in retail, where new centers on the edges of growth areas and in infill locations are really struggling. Every second tier location seemed to have a new and often poorly designed strip center sitting on it. I was very much reminded of the beginning of the S&L meltdown.

  I can’t say if there overbuilding in Texas, the Carolinas or Kansas City, because I haven’t been in those places recently, if at all. However, I’m pretty sure lenders lent as indiscriminately there as they did here. When their economies soften, they will be faced with the same issues.

  I don’t pay that much attention to the heavily massaged government growth numbers. Anecdotally, business in general seemed to pick up around February, but things have gotten much worse in the last 60 days. The spring may have brought that “dead cat bounce,” at least in small business and employment.

  The key to any significant economic growth is capitalization. Neither the traditional banking system nor the Wall Street companies that have been trying to peel off the most profitable pieces of banking through securitization and direct lending over the last 15 to 20 years are in good enough shape to provide that capitalization. As the commercial real estate market rolls over, banks will fail in significant numbers and the availability of capital will decline quickly and dramatically. I suspect we are looking at a long and unpleasant economic contraction.

  I would have to agree with Mr. Cook aoout the CD’s. Sometimes the preservation of capital trumps investment for growth. Maybe you can’t spot the bottom, but I would rather stay out until I see the upturn.

BawldGuy on August 29th, 2008 at 5:03 pm said:

• Thanks Investor — I love the way these occasional ‘we’re all not gonna die’ posts bring out the Bears big time.

  So far every single death knell prediction has died a very lonely death. Has it been bad? Of course it has. Are we all financially floatin’ down the river face down? Not even close.

  This too shall pass. The true power players are making their moves.

Another Investor on August 29th, 2008 at 5:47 pm said:

• I’m neither a bear nor a bull. I’m an investor. I try to make money and to preserve what I have. I buy when it makes sense to buy and I keep my cash in my wallet when it doesn’t.

  Even the big guys make mistakes. While in Phoenix, I heard a third generation Phoenix land banker and developer interviewed on the radio. He said he could find plenty of deals right now at 50 percent off the selling price two years ago. However, even at 50 percent off, he could not find anything that would pencil out when he worked backwards from what tenants could afford to pay. He expects to find real opportunities in 24 to 36 months. Meanwhile, the privately held family company is focusing on its other business interests.

  However, there is a lot of private investment capital out there chasing those 50 percent off deals. That does not mean land values have hit bottom. Without development capital and tenants who can pay the rent required to make development feasible, these buyers will have to hold for years or sell at an even lower price if they can’t hold on.

  Are we headed for economic disaster? I don’t know. The “expert economists” certainly don’t know. As long as employment is strong, most folks will not be “financially floating down the river face down.” However, a lot of these folks are at risk of being pulled under by their debt loads, and a job loss will drown them.

  As a small investor, I’m not big enough to afford a serious mistake. I know I can hold on if my rents decline 25 percent and vacancy shoots up to 25 percent. I will wait to buy until I’m sure the economy and the market have turned.

BawldGuy on August 29th, 2008 at 5:57 pm said:

• We’re sure in agreement about ‘expert’ economists. I’m not saying Phoenix is the place to go now by any stretch. Also, wasn’t my intention to call you a Bear.

  Phoenix, this year, took over ‘first place’ as #1 job producing county in the country. It’s population has never stopped growing during the entire correction.

  I’m talkin’ strictly the big picture, with real estate as a huge segment, obviously. The last two ‘blackest days in history’ have been survived without as much as a news special on TV the last 12 months.

  I maintain we’re very near feeling the squishy mud in our toes.

David Shafer on August 31st, 2008 at 9:28 am said:

• Gotta laugh at the CD investment advice at the same time these folks are claiming many banks are going down. Depending on the government to back those banks through the FDIC I guess….

  Funny how people are still making money, even in real estate, through all the gloom and doom. Yep capitalization is tough in this market, I am involved in trying to get money right now for a real estate development firm, but there is still much money running around the globe trying to find a home. And of course the smart ones are buying (Warren Buffett) while the others are running around decrying the “bad” economy!

BawldGuy on August 31st, 2008 at 1:15 pm said:

• Thanks for injecting some facts on the other side of the coin, Dave. I’ve felt lately like asking some of these Bears — Hey! Pick a lane, willya?!

Michael Cook on September 1st, 2008 at 6:08 pm said:

• To be considered an expert investor you need to be right more than you are wrong or just be very right one time. Seeing as how I work for a bank, I have seen many so called experts getting burned in Florida calling for bottoms. Recently I heard about a deal being marketed in Florida where a developer was selling condos for less than his building costs and get this, the land value was zero!

  Banks are extremely gun shy, so I think we will be hard pressed to see a recovery in markets where banks just dont want to lend. Jeff, I know you and Brian always say a lender has to lend, but the costs of funds and the availability of funds in the hardest hit markets is almost nil.

  People who bought “deals” three or four months ago are losing their shirts. Speaking of shirt losers, what about all those people that called bottoms in the financial markets? Soverign wealth funds, Citigroup buying Country Wide, heck, Wachovia buying Golden West. So many “expert” lost Billions not millions. Experts are overrated and common sense and caution are some times underrated.

BawldGuy on September 1st, 2008 at 6:21 pm said:

• Michael — Those getting burned attempted to buy in the bottom of crummy markets. You mentioned Florida — a state I’ve avoided from Day 1.

  Those who ‘call’ bottoms are idiots, a statement with which I know we agree. I’ve never called a bottom, and think those trying need to get a grip. I’ve written many posts solely to ensure folks know the foolishness of ‘bottom predicting’.

  What I’ve done in the past, and am doing now, is pointing out the common denominators which have shown up in last few ‘innings’ of past corrections. They’re happening now.

  Common sense is still what rules the day. Part of that includes taking advice from Wall Street with a wheel barrel of salt. I’m with you on the common sense train, we just view some things differently. For example, WS has predicted recessions at about a 3:1 rate of their actual occurrence. Another obvious example is the NAR who could by now predict the sun settin’ in the west, and be challenged.

Chris Lengquist on September 1st, 2008 at 11:09 pm said:

• “However, even at 50 percent off, he could not find anything that would pencil out when he worked backwards from what tenants could afford to pay.”

  BINGO!!!!!!!!

  I’ve been watching this conversation. And why people buy property that won’t pencil with whatever numerical input they would like is completely beyond me. You ablsolutely must start where the tenant starts.

  Quite simply, there are markets where the pencil doesn’t work. And there are markets you can throw away the pencil and use a pen. Even within markets there are markets.

  Opportunity is still there. But pay heed all ye that enter…Beware. Know your game and how to play.

BawldGuy on September 1st, 2008 at 11:29 pm said:

• That comment is truth in almost pristine form.

  Adding/subtracting from it would only diminish its value.

Another Investor on September 2nd, 2008 at 7:11 am said:

• I see one of Warren Buffett’s companies is out buying up local residential real estate brokerage companies.

  http://www.bloomberg.com/apps/news?pid=20601109&sid=aswAkIWAiJtk&refer=home

  The fellow that runs this company believes the downturn is slowing. Never known a broker who wasn’t an optimist, but this one has to answer to Buffett if his optimism does not turn into profits. However, Berkshire Hathaway takes a very long term view when they buy businesses, so years may be the time frame used to judge.

  The interesting thing about the developer from Phoenix is that the company invests in all kinds of real estate projects and other businesses in the very same markets that The Hairless One prefers. They do not restrict themselves to Phoenix - they like Texas, Boise, and North Carolina (www.cardon.com). And they still are not finding much that pencils out.

  I think the risk of a liquidity squeeze for real estate as debt capital goes away and unemployment rises is just too high to take. It’s not like prices are going to suddenly rebound tomorrow even if the squeeze is avoided. I will wait until the excess capital that is overpaying for property is gone and I have confidence my capital will be effectively deployed.

BawldGuy on September 2nd, 2008 at 9:45 am said:

• Investor — Your take doesn’t make you the Lone Ranger. You’re not alone.

  When it comes to Buffett, before he makes the first move towards acquiring any business, real estate brokerages or not, he and his team have researched, analyzed, projected, and made their decisions on that industry. When Berkshire makes an acquisition, they’re confident it’s gonna be a long term producer.

  I know you can’t possibly mean to imply Buffett asked a broker what he thought, then said, “Sounds good to me, give me six!” I’m guessin’ he didn’t ask NAR for advice on the future of real estate and brokerages as part of his research, and if he did, it was for comic relief. Does anyone really think Warren took a broker’s opinion as fact and acted upon it?

  Builders will once again build when they flush their current inventories, take a breath, and are able to move forward. This time isn’t gonna be any different on that topic, than past corrections.

  The builders I’m talking with are tellin’ me they’re finding all kinds of dirt making sense. It’s just not for huge projects, or high priced projects. In other words, they’re payin’ attention to the market. What a concept.

  The hundreds of millions pouring into markets which are employment magnets are not coming from ill informed rookies. They simply see a different picture emerging than those agreeing with your outlook.

  They are plenty of folks in both camps. They’re both legitimate views. I prefer the Buffett outlook.

David Shafer on September 2nd, 2008 at 10:02 am said:

• Capital has for decades and will for the foreseeable future been landing in real estate. When I say capital I mean pensions funds, oil rich nations, private equity, etc. They are only looking for mid single digit returns (6-8%). They find this in large scale commercial buildings, large residential developments, etc. Financing doesn’t effect them because they are looking for a place to park their cash, not a place to maximize their wealth creation. This is where you get the “Japanese (Saudi’s, Chinese) are buying up our country hand wringing! Frankly, they could care less about the problems of credit. There only concern is that the rents keep coming in to give them their return. Recessions are part of the environment and only effects them to the degree they think they can get better returns elsewhere. Then they stop deploying their capital. Hasn’t happened yet to any large degree.

  The rest of us are working at at much lower level trying to maximize our returns with leverage. I don’t really see the current credit environment hurting folks that know what they are doing. If rents decrease as they have in Florida, then property that was barely cash flowing could turn negative, but one should have enough reserves to cover it until it reverses itself. And if you can’t find properties that make financial sense, then you don’t buy. Up until now, there has been pockets of places in which the numbers do make sense, so why worry?

BawldGuy on September 2nd, 2008 at 10:19 am said:

• There’s nothing like common sense to start the week of with a bang!

Another Investor on September 2nd, 2008 at 10:52 am said:

• Jeff:

  I would guessthe builders you are talking to are the ones building the product your clients are buying, i.e. builders of 1 to 4 unit properties in places like Texas, where the employment picture is still relatively healthy. I don’t know any major builder out optioning dirt anywhere nor can I think of anyone I know on the commercial/industrial side who thinks it’s a great time to buy and build.

  Of course, Buffett and his people did their homework before buying the company. However, one of their secrets to success is letting the people who ran the business before they bought it continue to run the business, with the backing of Berkshire’s capital. Peltier is out buying deeply discounted brokerage businesses. These businesses work today because of the low acquisition prices and the capital support Berkshire can provide. When the market recovers, the lack of debt will turn them into cash flow cows.

  With regard to David’s comments, capitalization rates and yield rates have been at historic lows for several years now. Pension funds, insurance companies, REITs, private equity, and all the other players David mentions accept the lower yields because there is no alternative investment with a better yield. As soon as excess capital is removed, inflation increases, greater risk is perceived, or some combination of these and other factors occurs, investors will demand a higher rate of return.

  In addition, the smart money isn’t always smart. I still remember Prudential Insurance selling off all their land out in Pleasanton for around $2.00 per square foot at the bottom of the last cycle. And I don’t see the sovereign wealth funds making more large investments in Citigroup or the like.

  I think we all agree real estate is cyclical. Long term, especially with prudent leverage, it’s a good investment. I’m just not ready to agree with the bulls that the tangent to the value curve at this point is positive.

David Shafer on September 2nd, 2008 at 12:20 pm said:

• Cap rates for institutional re investments is 6.75%, having risen .24% in the last year. This is normal as investors demand a risk adjustment. Speaking of risk adjustments, the risk premium (comparing cap rates to treasuries)is over 1% below its historical average. Bottom line is we should expect cap rates to continue to rise pushing prices down. Rents and vacancy rates become more critical during these declining value environments. Keep in mind that the institutional world is a very different playground than the world of individual investors!

Proper Fundamentals Trump Economy When Buying Your Rental Property « Kansas City Real Estate Investing on September 3rd, 2008 at 6:11 am said:

• […] Fundamentals Trump Economy When Buying Your Rental Property Jump to Comments There has been quite a discussion over at BawldGuy as to the shape and direction of the economy. Jeff maintains that the recovery is starting or at least poised to.  At least one experienced real estate investor and one investment banker disagree thinking we are at least one to two years away.  Both point to evidence supporting their suppositions.  Both sides making excellent points.  (Make sure to read the comments!) […]

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