The recent news that New Century Financial Corporation, the nation’s second-biggest subprime mortgage lender is about to declare bankruptcy didn’t come as a great surprise to me. I see it as a bellwether event. Lots of other sub-prime lenders are at risk. This is another piece of evidence that the grossly over-inflated real estate bubble, that up until now has been deflating gracefully, is about to absolutely implode. In coastal regions, residential real estate prices were bid up to unsustainable levels, fueled by low interest rates and legions of lenders that were willing to make loans to people that shouldn’t have been eligible to buy a car, much less a house. There are now millions of real estate “investors” (the folks that I call contrapreneurs) who are locked in to adjustable rate mortgages (ARMs.) Many of these contrapreneurs bought second or even third homes on speculation. (“On spec”.) The “flipping” of houses was quite profitable in the rising real estate market circa 2002 to 2006. Any idiot could make money doing it. (“A rising tide raises all ships.”) Now the market has turned, and there are not enough buyers to absorb all of those spec houses. There are countless stories about houses that have languished on the market for many months, without a legitimate offer. Here is a link to one such story.
We are now witnessing a cascading effect. The first noticeable shift came when existing house sales and housing “starts” numbers began to fall, as interest rates edged upwards. The building contractors, most of them savvy individuals, knew when to get out when the getting was good. They slashed their prices to move their existing inventories, and they cut way back on new construction. Their “bargains” and incentives (one in Reno was giving away free Hummer H3s with each house sold) created a downward momentum in residential house prices. Seeing this, the “spec” buyers started dropping their prices “just to make sure” that their spec houses sold promptly. But a funny thing happened: Most of them didn’t sell, even at the lower asking prices. Recently, the specs were faced with a dilemma: “Should I cut my asking price even more, and sell the house at a loss, or try to find renters and hang on until the market bounces back?” Based on the continuing fall in prices, it is clear that a lot of them decided to take the loss, and just plain bail out. It is noteworthy that what had been most over-hearted markets like Phoenix, Arizona, coastal Florida, Las Vegas, Hawaii, and San Diego are seeing the steepest price declines. According to www.HousingBubbleBust.com, quoting the National Association of Realtor’s Q4 2006 report, “73 metro[politan] areas have shown a price decline. Sarasota is down 18%, Fort Myers 12% and Reno 9%. Other major markets with a decline are San Diego, Cincinnati, Cleveland, Columbus, Indianapolis, Milwaukee, Pittsburg, Phoenix, Kansas City, Sacramento, Washington DC, Boston, Dallas, Detroit, New Orleans, Atlanta, Minneapolis, Las Vegas, Providence, Miami and Denver”.
The next effects were jumps in the mortgage payment delinquency rates and later, in some regions, the mortgage default rates. Unable to make their mortgage payments, the contrapreneurs are now going into default in large numbers. But the current default figures will seem small once those millions of ARM loans get “reset” in the next year, at higher interest rates. (Estimates range from $265 billion to $1 trillion in home loans that are scheduled for “resets” in the next 12 months.) I call this the ARM-twisting effect. When the ARM rates jump two or three percentage points, it won’t be pretty. There will be hundreds of thousands of people that lose their homes. The current conjecture in financial circles is that there could soon be a full scale mortgage crisis in the U.S.
The bankers, in early panic mode, are presently putting more and more post-default houses on the market, at fire sale prices. They don’t want to get stuck with them. But in some markets like Phoenix and San Diego, those houses aren’t selling. There simply aren’t enough willing buyers. In many cities, it isn’t just “buyer’s market.” It is a dead market. There are precious few people that want to “invest” in what they rightfully perceive as a declining market. The few buyers out there are now bargain hunting. And they are not in any great hurry to buy. The upward ratcheting of house prices sen in the previous four years has been replaced by a not perceptible downward-ratcheting. So the buyers know that time is on their side.
The next effect was felt by real estate agents and brokers. Many of them are a now looking for new careers. I recently heard an interesting statistic: South Florida had more than 3,000 gainfully employed real estate agents at the peak of the buying frenzy. But now there are now only about 300. Next, title companies will have to lay off employees, as sales slow.
Where and when will all of this end? With prices a lot lower, and probably not until a full decade from now. I woudln’t be surprised to see prices (in real terms, adjusted for inflation) down 50% or more in the erstwhile “hot” market regions. As the house price down-ratcheting effect get more pronounced, many homeowners”will come to the realization that they are upside down in their mortgages. (Where the current market value of the house is less than their outstanding principal on their home loan.) What will they do? I predict that many of them will walk away. They will simply hand their banker the house keys, or just do what out British cousins charmingly call “a midnight flit.” (Abandoning their houses without a proper goodbye to their banker.) This is not unprecedented. The same thing happened in Texas in the late 1970s and early 1980s, following a down-turn in the oil industry. But this time it will happen from coast to coast.
The rippling effects of the real estate bust will be felt for many years. There certainly will be huge losses for lenders. The New Century collapse will probably be the first of many. Building contractors will go out of business. (The wise ones will likely switch to remodeling.) Three-quarters of the real estate agents in the country will be out of work or chronically under-employed. The ripples of the real estate implosion will also likely touch the bond market, the insurance industry, and the derivatives market.
Once prices have dropped 30%, renters will start pestering their landlords, asking for correspondingly lower rents. By just threatening to move out, they will probably get the rent concessions that they ask for. (No landlord will want to be stuck with an un-occupied rental house. The fear of a negative cash flow is a powerful thing)
And The Good News?
Those of us that are nearing retirement, or those that are considering moving to a retreat locale may see some good come from the real estate bust. You may find some real bargains, especially as the market nears its bottom. Just be sure that you have cash in pocket to take advantage of a bargain when it comes along.
More than a year ago, I posted a recommendation in SurvivalBlog that anyone who had firm plans to sell their house within 18 months should do so, post haste, and rent them back from the new owners. (Most likely by selling to a property management company.) Now that that the market has decidedly turned nationwide, that is probably no longer an option in many regions, but it it still worth a try. I also recommended that anyone with a second home, a spec house, a rental house, or a vacation home that was not viable as a survival retreat should dump them. I hope that people took that advice. The opportunity to get out of such real estate investments is now dwindling. If you can get out now, even if it means taking a small loss, I strongly encourage that you to do so.