Showing posts with label Housing. Show all posts
Showing posts with label Housing. Show all posts

Tuesday, February 06, 2007

Timeless advice on lifetime home purchasing from iTulip

Earlier, I wrote about how the stocks of home builders and mortgage lenders are diverging from the actual weakness in the residential market. In this post, I want to concentrate on the “real” aspect of the residential real estate market. I’ll start off by commenting on a lifetime home purchasing plan from iTulip and discuss my own view of housing valuations afterward.

For those of you familiar with Eric Jansen or his iTulip website, advice on buying homes is probably the last thing you expect. Indeed, iTulip first made its name by calling the tech bubble correctly. More recently, it has been calling for a popping of the housing bubble, such as this article in 2005. To me this actually makes them more credible as the source is free of the usual biases and ulterior motives. At any rate, I found the advice practical, prudent and well thought out. Here is an excerpt:

Step 1: Buying your first home*. Buy a modest house as soon as you can. That means a house that's not as nice as the one you grew up in, and one that needs some work. But you're young and smart. Swing a hammer. Slop some paint. It's one that you can afford using the 20/28/36 mortgage rule… Consider a variable rate mortgage that doesn't adjust for seven years. You may find it cheaper than a fixed rate 30 year mortgage. You're going to move in four to six years anyway–this house is just a way to get to the house you want but can't afford yet. No, not some suicide loan with a teaser rate that adjusts after the second full moon in the first year of the dog or whatever. If you are smart enough to be reading this but can't understand a loan you're offered then it's garbage. Don't buy it. Good loans are easy to understand.

Buy in a town with a good school system if you can because the price will tend to hold up better during inevitable real estate downturns. Don't buy a house at the top of the market in a lousy neighborhood…

Step 2: Buying your second home. Four to six years later, sell the modest house and use the profit as a down-payment on your first good house. Again, look into an adjustable mortgage that stays fixed for seven years.

Step 3: Buying your third home. Four to six years later, sell the good house and use the profit as a down-payment on a great house. Take out a 15 year fixed rate mortgage and pay if off in ten years.

Using this method, by age 50 you'll own a great home free and clear, while riding the real estate cycle up and down and without having to win the lottery.

What not to do:

  • Nothing. Wait for money to fall out of the sky. As you can see, the process takes time. Starting a 20 plus year process works better when you're 25 than when you're 40. (See caveat*, below.)
  • Buy more house than you can afford using the 20/28/36 mortgage rule…
  • Purchase a suicide loan, liar loan or other horrific loan product. (These are soon to be nixed by regulators, anyway.) If you can't afford a home with a fixed rate mortgage or a seven year adjustable on the 20/28/36 rule, look for a smaller house or condo or wait until you've saved more money and your income is higher.
  • Consume your home equity…
Just as there is no more ludicrous form of slavery than the one we can impose on ourselves using unsecured debt to purchase depreciating assets like cars, there is no greater freedom than owning a home clear of a mortgage. Getting there isn't rocket science.

Housing Bubble?

Of course this being the iTulip, there is a caveat:

* Note on Step 1, Buying your first home. We are early innings in a real estate bust cycle. These tend to last five to seven years but this one may last as long as (ugh) fifteen years, due to the extreme of the housing bubble. This boom peaked around the middle of 2005, and may not bottom until 2010 or even 2015.

Obviously, iTulip believe we’re still in the early aftermath of a housing bubble. Whether to call housing a “bubble” is just semantics, but it’s plain as day that prices have increased significantly in many coastal markets. The following article contains a table of 5-year (to Q1 2006) appreciation rates for 275 metro areas compiled by the Office of Federal Housing Enterprise Oversight (OFHEO). The gains range from a meager 8.32% for Lafayette, IN to a blistering 146.4% for Madera, CA.

The key question to ask at this juncture is what kind of appreciation is reasonable? I use a simple rule of thumb based on Robert Schiller’s work that in the very long term, home values only keeps up with inflation. For inflation, one can assume 3% per year if one wants to used the government CPI number; 5% per year is probably more reasonable if true living cost like food, energy or insurance are included; or one can use 7% based on M3 growth. I’m feeling generous so let’s use 7% for now. In five years, it gives an “in-line” appreciation rate of 1.07^5 -1 = 40.2%.

To appreciate how much home value have increased across the country, note that if we rank the 5-yr appreciation rates as compiled by OFHEO from the lowest to the highest, 40.2% (my in-line figure) corresponds to 151/275, 80.4% (2x in-line figure, getting warmer) to 213/275, and 120.6% (3x in-line figure, hot, hot, hot) to 255/275. 12 of the top 20 gainers are in California, the rest in Florida. Although more than half of the nations market appreciated less than the “in-line” figure of 40.2%, the value of the homes in the hottest areas are much higher. Consequently, the mortgage backed security market is dominated by issues from those areas.

If I were in California or Florida, would I start the long term home purchasing program as outlined by iTulip? No way! Had I been in one of the cheap locals? Absolutely! How about something in-between? As an example, let's consider the city of Philadelphia that had a 5-yr appreciation rate of 74.29%. My quick rule of thumb says it was 1.7429/1.402 = 24.75% overvalued as of Q1 2006 as opposed to over 70% overvalued in Madera, CA by the same methodology. The answer here is not so clear cut. There are a number of other factors to consider:

  • House values can revert to the mean via a combination of price decline and inflation.
  • There are tangible psychological benefits to being an owner provided household finances are not stretched.
  • Price and availability of rentals
  • The length of time one intends to stay in the home

In the end, I can see a rational person going either way.

Obviously my rule of thumb is just that: a quick estimate based on a single variable. It assumes all housing markets are fairly valued five years ago and doesn’t take into account housing quality or other specifics. The OFHEO data paints a bleak picture for RE in the formerly hot markets in California, Florida and possibly Arizona and Las Vegas. Lenders and builders in those markets will be under pressure but the majority of markets across the nation will not be affected much. While it’s too early to call for a housing bottom or a soft lending, we will not have a great depression either.


Sunday, November 19, 2006

Foreclosures from Yahoo! Real Estate

I just discovered that you can search for foreclosures in addition to regular MLS listings on Yahoo! Real Estate. It was completely new to me.

For example, in my zip code, when searching for a 3+/2+ single house, I got 44 MLS listings between $350k and $450k. Checking for foreclosures, I got 6 entries, all entered on Oct. 11-12. Half of the entries had auction dates prior to October so I suspect the foreclosure feature wasn't available till then or it wouldn't be very useful. Looking at other zip codes, I found houses in all stages of the foreclosure process, from "notice of default" to "foreclosure sale".

Each of the 6 foreclosures has an associated price that varies wildly from $129k to $423k. Further investigation indicates they are merely "estimated bid amounts". The "More information" button leads to RealtyTrac which offers a 7-day free trial. The membership gets you the standard property information plus detailed loan information including the default amount, the last payment and the name of the owner (see the screen shot below).

Not knowing much about the foreclosure process I'm not sure if the average home buyer can really take advantage of this information (Would someone at the NOD stage be a "motivated" seller? More likely they are in default in the first place because they are "under water" on the mortgage.) On the other hand, the number of foreclosures is an indication of the health of the local housing market (e.g. 305 listings in Sarasota, FL).

If you know more about foreclosures or how to take advantage of this information please leave a comment. TIA.


Friday, September 01, 2006

Unobvious obviousness

Watching the market in the past week, the saying kept coming to my mind was, “the market will do the most obvious thing in the most unobvious way”. I have subscribed to the thesis of a housing-led slow down or recession for sometime, and have never been more convinced of its veracity. Yet the market has merrily chugged higher. Does it really know better or is it just doing the “unobvious”?

This blog embraces the “Middle Way” that is a judicious compromise between extremes. While I have always respected market action especially in the short term, a rigid rule like “the market is always right” goes too far in my opinion. After all, the market reflects the perceptions of its participants who are far from infallible. Below, I reflect on two examples of “spin” in the financial media. Things like that convince me the downside risks have not been properly priced in.

Dropping bond yields to save the home owners
This has been the mantra of the bulls when confronted with the prospect of the looming 2 trillion ARM re-set. But a look as the historic fixed rate and ARM rates from HSH Associates reveals that even if home owners were able to refi into another loan, they will still be looking at a large increase in monthly payments. According to, the current average 30-yr FRM is at 5.94%, while the 5/1 ARM is at 5.69%. The current spread betwen 1, 3 and 5-yr ARMs are negligible. Compared with the lows of 3.56% for 1-yr ARM in the spring of 2004 (my guess the 3-yr ARM was about 4% then) or 4.6% in last summer, the increase is still significant. Note that March-June 2004 was the peak of sales in much of California, and last summer was probably the peak in housing overall.

Of course as pointed out by Frugal in this article, someone sitting on a lot of equity can do a cash-out refi to sustain the increased monthly payments. However, in addition to it making absolutely no economic sense (unless they can get an after tax return greater than the mortgage rate), it assumes the home owner hasn’t already tapped the equity in some way. Given the amount of MEW and HELOC loans in the past two years (compare the % cash out and increase in house prices: Freddie Mac), it’s an assumption I’m not willing to make.

National Monthly Averages
Date 15-Year FRM 30-Year FRM 1-Year ARM
Jan-04 5.20% 5.88% 3.83%
Feb-04 5.10% 5.76% 3.72%
Mar-04 4.91% 5.59% 3.56%
Apr-04 5.29% 5.96% 3.77%
May-04 5.77% 6.40% 4.09%
Jun-04 5.81% 6.42% 4.25%
Jul-04 5.61% 6.20% 4.22%
Aug-04 5.41% 6.01% 4.14%
Sep-04 5.28% 5.88% 4.08%
Oct-04 5.25% 5.84% 4.05%
Nov-04 5.26% 5.83% 4.18%
Dec-04 5.27% 5.83% 4.23%
Jan-05 5.27% 5.80% 4.35%
Feb-05 5.26% 5.72% 4.36%
Mar-05 5.54% 6.01% 4.51%
Apr-05 5.58% 6.02% 4.60%
May-05 5.43% 5.87% 4.53%
Jun-05 5.35% 5.77% 4.57%
Jul-05 5.41% 5.84% 4.73%
Aug-05 5.58% 6.00% 4.89%
Sep-05 5.52% 5.94% 4.89%
Oct-05 5.77% 6.21% 5.11%
Nov-05 5.99% 6.44% 5.30%
Dec-05 5.95% 6.39% 5.37%
Jan-06 5.86% 6.28% 5.38%
Feb-06 6.02% 6.40% 5.47%
Mar-06 6.12% 6.47% 5.65%
Apr-06 6.28% 6.63% 5.82%
May-06 6.37% 6.75% 5.92%
Jun-06 6.38% 6.83% 6.03%
Jul-06 6.53% 6.88% 6.16%

Many home owners are in trouble because

  • They overextended themselves and tapped the home ATM to finance their life stle. If they couldn’t afford the fixed rate mortgages last summer or much of 2004 when the rates were about the same or lower than right now, how will they afford them now?
  • Because the short term rates have risen, the ARMs are just as unaffordable as the fixed rate mortgages.
  • This is all assuming the home owner would qualify for the new loan. I haven’t even started on falling comps and tightening lending standards here.

Moreover, current low mortgage rates shouldn’t be taken for granted. As Barry Ritholtz from the Big Picture pointed out, the bond rally is looking tired. In addition, the Yen index has declined from 91.7 in mid May to 85 and change. So part of the rally in the 10-year may be due to the resumption of the yen carry trade on top of the bond traders getting a whiff of a slowing economy. The yen index should have some support just below 85, so a rebound in rates is very likely. Falling oil prices and reconstruction in Lebanon may also translate to less money going into bonds.

Consumer spending
Consumer spending is 70% of the economy and is represented by the Personal Consumption Expenditure index (PCE). July’s 0.8% MoM increase in PCE was much ballyhooed in the main stream financial media. It gives a rather rosy picture of the American consumer, right? How does that jive with the thesis of a housing-led slowdown? Instead of focusing on the Mom change, I looked at the data the same way as in Ahead of the Curve by Joseph Ellis. The YoY %change in the real PCE (inflation adjusted) was used to filter out the seasonal effects. The trailing three-month average was used to smooth out the data series. A different picture emerges: the rate of change including July has clearly been on a downward path. If one examines the spending by category, the slow down in expenditure on durable goods is even more dramatic. In other words, the American consumers may be finally tapping out.

What now
So what do I do if I truly believe the market hasn’t fully priced in the downside risks? My bearish bets have not fared well in the past month although my total portfolio was still up. I’ll respect the current market action by not betting the farm, but I’m stubborn enough to continue placing small bets while waiting for the return of sanity. Labor Day is finally here and I’ll be on the look out for high volume moves in either direction next week. There are some who say this market is manipulated and the powers that be won’t allow it to drop till after the election. Let’s see what the market thinks.

This is not investment advice; please do your own due diligence. Good luck and be safe!


Sunday, May 14, 2006

S&P CME Housing Futures and Options

John at MightyBargainHunter is talking about these new housing futures that according to this MSN article are to debut tomorrow. John was not so warm about them as they were obviously not intended for the average home owner. I agree with that 100%. I further predict that mortgate lenders with overexteded loan portfolios and large MBS investors will be among the ones most interested in these products early on.

After a little more thought and asking myself who's going to take the other side of the trade, my mind has changed to, like, "oh my god, what were they thinking!". You see, home buying is a terribly inefficient process, even more so in a slow market like today's. Buyers are still hopeful for the price their neighbors got six months ago; sellers are eyeing the growing inventory; and inbetween the agent is waiting for a large commission. Obviously, futures and options have none of that, which means the "price discovery" mechanism works much faster. In a down market, it will not change the terminal price per se, but will certainly accelerated the bottoming process. I just don't know if our present system can take this jolt.

If LA home owners wake up tomorrow to find a 15% home price reduction in 1 year baked in the cake, how will they react?

Last time I looked at BZH (Beazer Homes) which I'm shorting, I thought a short term target would be in the $52 range. I was planning on covering and re-entering later. It seems I need to rethink that strategy.


Sunday, May 07, 2006

House of Cards

This week saw a number of earnings reports from home builders. Although still tryng to paint a rosy picture, they all fessed up to what we already knew: either profits are already down or orders for the current quarter are down significantly while inventory levels are rising:

Of course, all this has been expected for anyone up to date with the websites that keep track of the progress of the housing bubble, e.g., My short position in Beazer Homes (200 sh @ $66.59) has so far gained 12% at Friday's close of $58.50. I have not talked much about the fundamental picture of any company in this blog as that kind of analysis is not one of my strengths. But if one takes a look at the cash flow of Beazer, one will see that despite its record profits, the cash flow is acutally consistently negative as the company not only spent all its earnings, but also issued debt in order to purchase more land. This is the modus operandi of all home builders, of which Beazer is just one of the most egregious. For its leverage, Beazer was rewarded with one of the highest P/E multiples among the home builders. But leverage is a double-edged sword. Now it's time to pay the piper, so to speak.

Despite Toll Brothers finally coming clean with some atrocious outlook, the home builders actually rallied with the market on Friday. The trigger was probably the below-expection payroll number that was perceived to reduce the pressure on the Fed to raise interest rates. I see this bounce from deeply oversold conditions as mostly technical. Due to the large short position in Beazer, it always had the most violent short squeezes. The 200 dma at $64.48 may be tested in a worst case scenario. My short position in Beazer is both a directional play and a hedge to my general market exposure. I refrain from short term trades, but I may add more when this latest move tops out.

One important internet resource is the Housing Tracker which monitors the asking price and inventory levels from the MLS data base. In addition, I check the following blogs daily:

  • Mish's Global Economic Analysis Mish covers global economic trends in depth. There is an excellent article on why the most recent mortgage application showed a month-to-month increase. He has been making arguments for a deflationary scenario as a consequence of the collapse of the housing bubble. I can't say I fully agree because the outcome depends largely on the Fed's and global central banks' collective response, but I always hold his views in high esteem.
  • Calculated Risk This is another excellent blog which keeps track of the new and existing home sales figure, as well as the mortgage application index.
The $64k question is whether the housing market will drag down the entire US economy. The firing of 3,800 workers at Ameriquest Mortgage will not be the last, I fear. On the other hand, the market is making new highs and I'm lousy at calling tops, so my strategy remains reactionary rathan anticipatory.

My wife and I don't own a house. We are currently "house-sitting" for my mother-in-law. The house is paid for so we are only responsible for the upkeep and property taxes. I have largely missed the real estate boom since I have had a "real" job for only five years, but I have no regrets. There is always a bull market somewhere, they say. I'm blessed with a wife who doesn't want one of those 4000 sq ft homes, so we will be more than able to afford our own place when the time comes. We live in an area where plenty of "McMansions" had gone up in the past five years. There has been appreciation but it was nothing like California or Florida. So far there is no obvious decrease in prices either. Toll Brothers reported 45% lower orders in this region so there may be some bargains in the coming months/years. More than anything else, our buy decision will be determined by when my mother-in-law comes back. How's this for a change: housing demand driven by actual need rather than speculative fervor?


Thursday, March 23, 2006

February existing home sales

Home builders had a good day today. Beazer (BZH) went up 4.77% to end at $67.60, putting my short position in the red. One catalyst might have been the earnings report from KB Homes (KBH). Traders seemed to have concentrated on their stellar earnings, even though orders were down by double digits.

The other catalyst might have been the February existing home sales that were higher than expected. Headlines were touting the YoY price appreciation of 10.6%. The actual report paints a different picture. The sales volume was just under the year ago level. The inventory level increased to 5.3 months of supply from 4 months a year ago. Both the median and mean prices logged their fifth consecutive monthly decline. At the current pace, we will likely see YoY price declines starting in April when even the most rose colored glasses will not hide the fact that the nation's housing market is in full retreat.

The regional housing markets are not moving in sync. The Northeast seems the strongest and the West and Midwest weakest. A good resource for tracking the asking prices in various metropolitan markets can be found here.

The existing home sales figure is a lagging indicator: the sales are registered after the closing. Tomorrow is the release of the new home sales figure which is a leading indicator: sales are registered after signing the contract. We will have a clearer picture then. As for BZH, it was tempting to short more today. I didn't only because I strictly adhere to the rule of not adding to a losing position.