Saturday, October 31, 2009

Our Ownership Society:

There is something very Orwellian about how over the last 20 years the government has created policy toward an "ownership society". People are being strong armed by the government to buy houses so they can become "owners". Today, a more accurate definition would be the "inverse ownership society" where about a quarter of home owners are underwater in their mortgages. Home equity for our country's housing stock is at 40%, by far and away an all time low. Before the 1980's it was always the goal to pay off one's mortgage. This changed during the Reagan years when a house became "a payment". It's all part of the "trickle down" economic theory: give wealth to the rich elite and maybe some will trickle down to the masses. Presently, the goal of the government appears to be to get people to buy houses and become debt slaves to Wall Street even when they can rent and save a substantial amount of money.

The government's ownership policy propaganda worked well until our country's housing values were driven up in price beyond what people could afford to pay. This house of cards ended in 2007 but the government is still pushing ownership. I can think of no reason why a citizen owning an overvalued home does anything to help our economy. It just enriches Wall Street, impoverishes the financially uneducated and brings more speculation and volatility into the market. In a normal world I would hope that a benign government would reward saving and prudent living. Our present government's "ministry of saving"(Orwellian Reference) is creating a mountain of debt to reward people for getting into more debt. I agree with Bill Gross of Pimco. He says that asset values in our country are $15 trillion overvalued. I believe that a big part of this problem is bad government policy.

Presently our government is poring trillions of dollars into subsidies for housing:

  1. Reduced mortgage rates: The Federal Funds Rate is at zero and the GSE's are guaranteeing most of the mortgage market. The Fed is buying mortgage backed securities and also buying treasuries thus pumping trillion of dollars into the banking system. The mortgage market is on life support from the government. It has ceased to function normally. It is a two step program back to normal. First, the government must stop injecting liquidity into the banking system. Second, the government must back out of the financial markets. I believe that someday it might be possible for the government to complete step one and to stop pouring trillions of dollars into Wall Street and the banking system. Maybe in 5 or 10 years. But it will never be possible for the government to complete step two. The housing market is addicted to government money through the GSEs. For taxpayers to extricate themselves from this largess would take a revolution. This will always be a hidden tax on taxpayers to prop up home values.
  2. Embedded tax breaks: This is mainly the deductions for home ownership at tax time. Our country must gift homeowners a portion of the interest and real estate tax that is paid for a primary residence. The second gift that is given is the untaxed profit that a homeowner gains with the $500,000 tax exemption. Another gift is one given to investors in the fantasy depreciation of the property. An example would be the $36,000 expense for depreciation that the owner of a $1,000,000 property gets to claim every year. In the real world there is no loss on the $1,000,000 property. That is why I call it fantasy depreciation. In theory it is required to be paid back when the rental property is sold. But if you have a good tax person this fantasy depreciation will never be paid back to our country.
  3. Fun new tax breaks: This would be the homeowner tax credit. The government is giving $8,000 to new home buyers. It has immediately increased the value of all lower end homes sold and therefore it will probably become embedded into the tax code. I will be very surprised if it is eliminated in April, 2010.

Tax breaks are a big driver of overpriced housing. There are also many other factors that created this inverse ownership society. The Interest Rate Mega Bubble, The peak of the baby boomers, women joining the workforce, The Greenspan Put and the weak dollar are just a few other examples. All of these events raised the price of housing to where it is today. None of these events will occur again and some will reverse to create a drag on housing prices. There is nothing in the future that can artificially drive housing values higher except the speculative nature of The Herd. I sold my home in 2007 with the intent of buying again in 2010 but I am starting to rethink my thesis. I am happily renting and saving a substantial amount of money(against the government's wishes) and see a lot of market volatility in the future due to massive temporary government intervention. I am tempted to use my "house down payment" money to hedge the markets instead of becoming a part of the "ownership society". This may seem crazy but in this totally dysfunctional market betting against The Herd could be more prudent than betting that the government can create prosperity with more debt. My major concern is that The Herd is totally clueless to the "New Normal" that the government has imposed on our future. Our generation has forgotten how to save. We are propping up asset values above fair value with temporary strong armed government intervention. In my opinion it is impossible for these asset values to hold up in the long run. We have been through a period of prosperity unequaled in history and all we have to show for it is debt. We are trying to hang on to this prosperity by using more debt. This will only create volatility and dysfunctional markets in the short run. It will not change the final result in the long run. This will be the "New Normal".

During the stock bubble of the late 90's I remember many people telling me that they were going to retire early and live off the gains from their stocks. During the housing bubble not only were people going to retire early from selling their home for "millions" but also people were using their homes as ATM's to supplement their household income. It was mass hysteria. The new hysteria is the present thinking that if our country creates enough debt we will spur ourselves out of the doldrums that has been created by the record leverage and debt that we already incurred. Today we have much more debt than anytime in our nation's history. The government is trying to keep this Ponzi finance scheme going but it will just create more bubbles and dysfunction.

The present bubble is in long term US treasuries. When this bubble pops it could drive interest rates up and home prices down. Unfortunately long term savers could be directly brutalized by the spike in interest rates and indirectly by inflation. Therefore a prudent saver must hedge against bad government policy. The direct hedge would be shorting long term treasuries. Indirect hedges could be short plays on the dollar, interest rate ladders or just trying to time the markets. Market timing has been my strategy for the most recent stock and housing bubbles. This is not a perfect strategy but it has worked up till now. I think this zero sum game pitting winners against losers will become more complicated in the future. At this point I have no idea what the "New Normal" will look like. It depends on the government, The Financial Elite and The Herd. I will definitely purchase a home in the future but I believe there is no hurry to do so. The Japanese "lost decade" has been continuing for a generation with asset values still trending downward. The Great Depression lasted over a decade and had pretty high interest rates in a contracting economy. Our government seems dead set on implementing the same policy as these two monetary and fiscal fiascos. Yes we can have interest rate inflation but asset inflation seems very far off on the horizon. Maybe I will opt out of the "ownership society" for a little while longer.

Tuesday, October 27, 2009

Absolutely Amazing Antioch:

The real estate market is always fun to follow. Presently I am tracking the action in Antioch. Investors are coming into the market with conviction. In my opinion maybe a little to much conviction but there is profit in the short run for the investors and that's whats driving this mini bubble. At these prices I also see profit in the long run but I think there is a lot of unrealistic expectations by some of the less savvy investors. The frenzy is letting the banks unload a lot of inventory. This is very good for the short run. Eventually the market will come to some sort of equilibrium between home prices and market rents. Rents will be an important driver of prices in the future because this boom is predicated on a large influx of investors renting their homes out at cash flow positive and flipping in 5 years for a profit. Many economists are saying that first time home buyers are fueling this rally. I see the main focus of this frenzy in Antioch being provided by investors.

The Antioch housing market has not made an appreciable increase in pricing since it slammed into a bottom last year. Homes are still selling at $125 a square foot for normal sales, $100 a square foot for Distressed Sales(REO and short sales) and $90 a square foot for foreclosures. The only thing that has changed is that investors are pouring into the market. One investor will buy a home at a foreclosure sale($90 sqft.) or an REO($100$ sqft.), fix up the home and sell to another investor for $125 a square foot. The original investor seems to make about $20,000 to $40,000 for their effort after all the costs. It appears that the second investor is looking to rent the home for 5 years and sell for a significant profit, at least this is what I have heard second hand. Of course some of the second sales are to first time home buyers but it really appears that this market is being driven by investors.

Here are some observations:

Home 1:
Purchased in 1997 for $41,500
Purchased in 1998 for $102,000
Purchased in 2006 for $405,000, lost to bank in 2009
Trustee's sale 2009 to investor for $77,200
Sale to second buyer 3 months later(10/16/09) for $155,000

Home 2:
Purchased in 2004 for $527,000
Purchased in 2006 for $680,000, lost to bank in 2009
Trustee's sale 2009 to investor for $177,100
Sale to second buyer 3 months later(10/16/09) for $283,000

Home 3:
Purchased in 1994 for $157,000
Purchased in 2004 for $441,000, lost to bank in 2009
Trustee's sale 2009 to investor for $149,900
Sale to second buyer 3 months later(10/20/09) for $220,000

Home 4:
Home purchased in 2005 for $650,000, lost to bank in 2009
REO purchase in 2009 for $206,000
Sale to second buyer 2 months later(10/16/09( for $260,000)

There are hundreds and hundreds of examples. Eventually the profit from the spread from the Distressed purchases of the First Investor to the Second Investor will diminish to the point where it is not worth the risk. Once that happens this will take away about 30% of the sales in Antioch. Because of the herd mentality of the Second Investors I am guessing that they will not make the 5 year gains that they are expecting. Once the investors make this realization the sales will be reduced even more. These same Second Investors instead of just reducing purchases could bolt from the market with the double dip in the economy in 2011. Either way this dynamic is extremely interesting and I will keep tracking the Antioch market for the next few years.

Friday, October 23, 2009

Market Neutral with a Vengeance:

Since the start of this rally in March I have only taken 55% of the 60% gain of the S and P. I have prudently forgone the last gasps of this uptrend and I am happily backing away from the table with my gains. I have gone market neutral in my retirement account. This means that my 50 stock positions are hedged equally against generic short positions in the market. I have accumulated quite a bit of cash so if the market goes up some more I could be tempted to go "net short" in a few sectors, such as finance and real estate. In my "house equity account" I have taken some of my cash and I am tactically shorting individual stocks. Presently all stocks appear to be rising evenly. In my opinion the rise in some sectors is premature. One solid example would be hotels which have rising vacancy rates. I have shorted Mariott and Starwood hotels and will sell quickly if I can get a little profit. I will dollar cost average down if the hotel sector rises more. I also have a short on oil. I just sold my short on long term treasuries but that is not to say that I believe that yields will go down in the future. I am just picking some low hanging fruit in this dysfunctional market. Trading on volatility seems to be the only prudent way to invest now that the stock market is above fair value and the government and The Herd are dead set on creating another bubble and thereafter another economic downturn.

Lafayette Housing Market:

The Lafayette housing market has started to trend down from the high in late 2008. Like most high end markets Lafayette peaked much later than lower end markets such as Pittsburg and Antioch. Where Pittsburg and Antioch are pretty close to reaching a bottom, Lafayette is still a few years away. Adding to the problem of a late start is the raw stubbornness of high end markets. Presently Lafayette has a median listing price of $1.4 million and a median pending sale price of $820,000. This is why the Days on Market numbers are going through the roof, from around 10 days for sales during the bubble to 80 days presently. The median final sales figures for October and November should easily finish under $800,000. People trying to sell at $1.4 million and finally selling 80 days later at $800,000. It is frustrating to watch a home that comes on the market at $300,000 over market price stay on the market for 9 months and sell for $1 million under list. In this kind of market a house has to be priced perfectly. I have watched hundreds of homes in the Sacramento market that were priced just a little over market value in 2006 ride the wave for years and sell hundreds of thousands of dollars less. A very bad tactical move but that is just the downward stubborness of the housing market. Unlike the stock market that can move down like a greased roller coaster.

Lower End Housing Markets:

There are some incredible things going on in the Antioch and Pittsburg housing markets. The less expensive fixer uppers are selling like hotcakes. Many of them are being fixed and sold again for a profit in a just a few months. This is a very interesting game, but it does make me question the market participant's motives. If this is just another rendition of musical chairs for home speculators, what is going to happen when we go into the 2011 economic slowdown? The good news is that most of the purchases by investors are for cash, so the government will not have to bail them out after this round.