Housing: Are We Near the Bottom?
by John Mauldin
September 13, 2008
Housing: Are We at the Bottom?
The short answer is no, but let’s look at the data from one of the most knowledgeable sources on that topic. John Burns of John Burns Real Estate Consulting consults with over 2000 of the largest banks and homebuilders in the country (his client list is a who’s who of banks, builders, and hedge funds). He has a reputation for solid research and pulling no punches. Some of his hedge fund clients were the ones you read about who made billions. (He wishes he had negotiated a percentage!) He is deeply involved in analyzing trends in the housing market. His web site is
www.realestateconsulting.com. He has graciously sent me the executive summary of his latest posting (a 27-page executive summary) that we will be looking at for the next few pages.
Let’s start with a quote from John at the beginning of his report: “The prospects for the U.S. housing market have changed for the worse. It has become increasingly clear that the U.S. economy is on the brink of recession, as overall job growth has slowed to zero and retailers are reporting abysmal results. New home sales, traffic and pricing are all heading down according to the results of our survey of over 300 builder executives. Resale [existing home] sales are starting to plateau in some markets, but pricing continues to fall as distressed sales dominate the market. The new housing bill will help in some ways, but will first serve a devastating blow to homebuilders, with the elimination of seller-funded down payment assistance, which accounts for 17% of new home demand by one estimate.”
How far along are we? Burns thinks that home prices will drop by 22%, 12% of which has already occurred. His analysis differs from that of the Case-Shiller Indices, which suggests a much steeper decline. Note in the graph below that the Case-Shiller Index shows home prices rising more than does Burns’ work. Part of it is different methodology and part of it is that the CS index focuses on major markets and Burns’ work is more broadly based.
However you slice it, there has been a lot of pain. Shiller’s work shows home prices in the areas he measures to be down about 17%. He said last week that he does not think it unlikely that we sill see home prices drop by as much as 30%, or about the same as during the Depression of the '30s. Burns sees less of a drop, but from not as high a point, so they both end up close to the same end point.
The graph above shows Burns’ projection for the next few years. He thinks it will be 2011 before housing prices begin to turn back up on a nationwide basis, with national prices continuing to fall into 2010. That will not sit well with the pundits who keep telling us each month that we have seen the bottom.
For the difference in his numbers with Case-Shiller, he offers the following explanation: “The Case-Shiller national number, which is a “paired sales” analysis, showed much more price appreciation than other indices based on median prices. We suspect that there was a shift in the mix of homes sold to lower priced homes in 2006 due to subprime lending, which depressed the median value and showed large % increases in the paired sales index.”
Sales volumes are suffering. “We believe sales volumes have already fallen back to 1995 levels and will hit 1992 levels sometime next year, when they will begin to slowly rebound later in the year. We are already seeing rebounds in some of the hardest hit markets, such as Southern California, where sales fell to below the levels of the early 1990s. The rebound in sales will be driven by foreclosure buying activity and demand from real households that need to move for personal reasons and have been delaying their purchase for fear of further price corrections. Our 8% per year projected [starting in 2010] increase doesn’t get us back to normal sales volumes until after 2012, and that is because the tremendous excesses of this cycle moved many renters into homeownership earlier than usual, and allowed existing homeowners to ‘move up’ to their dream home earlier than usual. Conservative mortgage lending will also prevent a sharp turnaround.”
On a more optimistic note, he thinks new home prices, which started to correct much earlier than existing home prices, should bottom out in 2009, although some particularly overbuilt areas will suffer longer. We are actually close to a bottom in new home construction, and he thinks we will be back to 900,000 new homes by 2012. That is a far cry from the 1.68 million in 2005, but it is also a sustainable number.
There is a problem though, and that is the recently enacted housing bill eliminated seller-funded down payments, and this was 17% of new home sales. Watch for a rise in the number of new homes sold in September, as the new law does not take effect until October. Home builders will be telling people to buy now before this ability to help with the down payment goes away. But cheerleaders on TV will be telling us the market has turned. They won’t be saying that in November.
Alt-A is the New Subprime
By now, everyone in the world is aware of how bad the subprime mortgage business was. But now it is time to get ready to hear the same tale, told again, about Alt-A mortgages. These are mortgages made to borrowers with better credit scores than subprime borrowers, but who could not or decided not to document their income. One estimate is that 70% of Alt-A borrowers may have exaggerated their incomes (Wholesale Access). More than half of those were people who exaggerated their incomes by 50% or more! (Mortgage Asset Research Institute)
How much are we talking about? Around 3 million US borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding. $400 billion of that was sold in 2006. Almost 16% of securitized Alt-A loans issued since January 2006 are at least 60 days late. Many of these loans (around $270 billion) were interest-only or with a low teaser rate, and the resets were at 3- and 5-year lengths. These are called Option ARMs. That means starting next year we are going to see a wave of mortgages resetting to new rates. And it is no modest increase. Rates can jump 4-8% or more from teaser rates. Some Option ARMs are resetting at 12.25%. That can double a payment.
Wachovia and Washington Mutual were big sellers of Alt-A loans, and had $122 billion and $53 billion, respectively, on their books at the end of the second quarter. Is it any wonder their stocks are under pressure? That is why it is so hard to quantify how many more write-offs there will be. You don’t write down a mortgage until it starts to develop problems. These problems may not show up for a few years. I continue to stress I do not want to own a financial stock that has exposure to mortgage paper. Write-downs are going to continue to come for a long time.
This means there will be a steady wave of foreclosures for the next two years in communities all over the US. As long as these homes keep coming onto the market, they are going to exert downward pressure on prices. Foreclosure sales are up by 109 from this time last year.