Why Wall Street is Missing the U.S. Housing Recovery
[Editor's Note: This is the second installment of a two-part look at how the U.S. real estate market will affect the nation's economic recovery. Today's focus: The residential real estate rebound. Last Week: The foundering commercial real estate market. Watch for an upcoming "Hot Stocks" feature that looks at potential housing plays.]
By William Patalon III
Executive Editor
Money Morning/The Money Map Report
Wall Street created the U.S. housing bubble and now it’s missing the real estate rebound.
And Andrew Waite understands why.
Waite is the publisher of the Personal Real Estate Investor, a glossy magazine that focuses on investors who buy houses or condos to manage for income or to fix up and sell for a profit. But he’s not some industry cheerleader whose statements are nothing but spin.
He’s a true expert on the U.S. housing sector who goes out of his way to "educate" journalists about the true state of the American housing market, and who criticizes most of the "indicators" in use as useless and irrelevant. Plus, as a onetime Wall Street venture-capitalist who subsequently joined Silicon Valley’s Sand Hill Road private equity crowd, Waite really understands how the Wall Street investment game is played – and, in the case of the U.S. housing market, the missteps Wall Street made and why.
"Wall Street analysts and economists do not understand the housing industry," Waite told Money Morning in a recent interview. "While stocks and bonds are relatively simple to analyze, housing is anything but. Unlike stocks, housing is a non-tradable asset."
But through the creation of mortgage-backed securities, Wall Street tried to transform housing into a tradable asset. That lack of understanding set the stage for the housing bubble. And it’s the same miscalculation that is keeping the big-money crowd from understanding that the housing market may have already bottomed – and may well be on its way back up.
Let’s look at both miscues.
Building a Bubble
Stocks and bonds are "tradable assets." They trade on central exchanges – in a very efficient manner – and play well into the kind of mathematical averaging that paves the way for all sorts of indices (the Standard & Poor’s 500 Index), and sub-indices (the Dow Jones Transportation Index).
That’s not the case with housing, which is very granular in nature – meaning how housing does in one neighborhood differs greatly from how it does in another. Housing is a "non-traded" asset because it is hard to trade – and when it does trade does so in a highly inefficient market.
As Waite says, housing is referred to as "real" property for a reason: Unlike stocks or bonds, which are paper representations of the underlying asset, housing is the asset itself. People live in houses, and most don’t buy them as investments – they buy them to live in. The typical house is owned for five to seven years, and only about 5% of the U.S. housing stock turns over in a single year. In a "normal" period – by that, I mean a stretch that’s not artificially souped up by the unrealistically loose credit that led up to the subprime-mortgage debacle – prices escalate perhaps 3% to 4% annually. And there aren’t the whipsaw pricing patterns that we see with stocks.
|
Even so, as part of its mission to transform housing into a tradable asset, Wall Street designed a reporting system that, true to form, was badly flawed, Waite says. The measures applied to the market – sample size, methodology, and statistical presentation – work well for assets that are dynamically traded, as stocks are. But they don’t work for housing:
- Stocks are analyzed by looking at the underlying company’s fundamentals, meaning the conclusions reached are very much tied to the specific earnings power of that firm.
- Housing, by comparison, is analyzed make "illogical" generalizations about the market that fail to reflect reality.
- Stocks are analyzed in a forward-looking fashion, being all about earnings projections and expectations.
- Housing analysis ends up being backward looking (45 days to 180 days), meaning the conclusions that are reached are likely outdated by the time we see them.
- Housing ends up being treated like a commodity, with "five-star" neighborhoods (where sales are brisk and the asking price is now being exceeded as prospective purchasers bid the values up in hopes of landing the house) being "averaged in" with "disastrous" one-star neighborhoods.
Says Waite: "Housing indexes and statistics emanating from Wall Street take a cynical view of housing … and they misrepresent the actual value of housing by ignoring the critically obvious point – most housing purchases are ‘buy, occupy and hold’," and aren’t a speculative play aimed at short-term profits.
By misfiring so badly, Wall Street established an environment in which housing prices were expected to escalate at better-than-their-historical norms, fanning the speculative flames. The easy credit made available by the mortgage-backed debt market only made matters worse. Banks made loans, and Wall Street bundled those loans into an asset-backed security – giving the banks back the cash that they could then use to make their next round of loans. Because the loans were "averaged" out, the resultant securities were given the highest credit ratings by the ratings agencies – which was more than the securities deserved.
It was a recipe for disaster – or, at least, for a bubble.
Wall Street never saw it coming.
Anatomy of a Rebound
Wall Street has also failed to understand the dynamics of a housing market recovery – which is already in the works, Waite says.
And he should know. The portion of the real estate market that Waite’s magazine caters to – the real estate investor – is significant. In fact, a groundbreaking study commissioned by the magazine, and conducted by real-estate researcher REALTrends Inc., in concert with Harris Interactive, found that real estate investors account for 22% to 28% of all home sales (existing and new) each year – a total of 1.5 million to 1.64 million houses each year. That’s a big piece of a $300 billion industry, so it provides a very solid sample.
According to Waite, the housing market bottomed last year. But that bottoming takes place in stages. Housing values continue to decline. But values can’t bottom, solidify, and then head north until sales volumes increase, Waite says.
"First you get volume, and then you get valuations," Waite says.
And it doesn’t get better across the board all at once: Sales will improve in a "predictable sequence" that start with the very best neighborhoods, work their way down to the really good neighborhoods, and finally reach the plain old good developments.
As noted, Waite says the very best neighborhoods are already seeing strongly improved sales, with actual bidding battles taking place as prospective buyers willingly pay more than the asking price in order to land the choicest properties.
As those markets sell out, and the credit spigots open, demand will move from the very best neighborhoods down to the "pretty good" residential properties, Waite says.
Three reports released over the course of three straight days the last week of March seem to support Waite’s view.
Sales of new homes rose 4.7% in February – the first increase in seven months, the U.S. Commerce Department reported March 26. The day before that report came out a government gauge of home prices posted its first gain in almost a year. And the third of that "hat trick" of upbeat reports issued that same week said that sales of previously owned homes – the biggest share of the market – also increased in February.
The plunge in housing prices is also starting to have an effect. In a second report issued March 26, the California Association of Realtors said that existing-home sales in the state were up 83% in February from the previous year. The reason: The median home price was down roughly 40%, which is helping shrink inventories to about a six months’ supply from 15 months in 2008.
If Waite’s theory is correct, as sales of new and existing homes pick up on a month-to-month basis, prices will follow.
But true to form, Wall Street is demanding proof.
The data "have allayed some fears that the housing market would continue to freefall," Omair Sharif, an economist with RBS Greenwich Capital, told The Wall Street Journal. "But it’s way too early to say if we’ve hit bottom."
But Waite fervently believes that bottom has already been hit and that it’s all uphill – over the long haul – from here.
"Wall Street would have you believe that putting money into a house is as sophisticated as putting money in a mattress," he said. "But as it continues to prove, nothing could be further from the truth."
[Editor's Note: Money Morning Investment Director Keith Fitz-Gerald says the ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will quickly determine who wins and who loses in today's global investing markets. Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." His key discovery: Despite the gloom, investors may well be facing the greatest profit opportunity of their lifetimes.
In his newly launched Geiger Index investing service, developed after more than a decade of work, Fitz-Gerald has amassed a winning streak of nine-straight profitable picks. Check out our latest insights on these new rules, this new market environment, and this new service, the Geiger Index.]
News and Related Story Links:
- Money Morning Market Analysis:
Will the Dark Cloud of Commercial Real Estate Blot Out the U.S. Recovery? - HousingPredictor.com:
10 Signs to the Bottom of Real Estate Markets. - Wikipedia:
Mortgage-backed securities. - The Wall Street Journal:
New-Home Sales Rise 4.7%.
Comment by Wayne R. Jahns on 8 April 2009:
The housing mkt is not showing signs of a bottom in Short Hills NJ [ which most people would agree is a “good neighborhood”.
Comment by Jens Larson on 8 April 2009:
Foreclosures are up (as much as 45% of all existing home sales in the U.S. are foreclosures, REO and short sales) and we’re beginning the cyclical upturn in housing, so we should see month-over-month gains through the summer.
But calling this the bottom is ridiculous. Year-over-year sales and prices are still down dramatically, job losses are accelerating, and lending criteria are rising across the board. It doesn’t matter how low mortgage rates go if people cannot get approved. Moreover, migration patterns are shifting rapidly and wages are falling. At best one can say, “The losses are slower than they once were.” But they’re still losses, and anyone who buys anything other than an REO property is probably going to to see losses for at least the next 9 to 12 months, if not longer.
Moreover, emphasizing month-over-month figures is a blatant disservice to your readers. That’s the same kind of numerical dishonesty that pervades the NAR monthly reports.
While housing markets may be granular, the macroeconomic conditions are affecting homes almost everywhere. Calling the markets “granular” doesn’t make them immune to recession/depression.
Comment by Andrew Waite on 8 April 2009:
Please do not trust my pronouncements rather go to our website and Market Trends tab and follow the links to the actual MLS inventory data.
I do not disagree, the Northeast residential markets were last to this downturn so they are later in the cycle.
Also granularity is both horizontal (geography) and vertical (price points). Add the fact the investors are flocking back to the market because affordability has made positive cash flow a renewed reality.
The recession has not slowed population growth, relocation or immigration, legal and illegal as well domestic relocaton.
Housing stock is an asset that an intelligent buyer, owner occupier or investor needs to analyze with the same rigor an securities investor should employ and it becomes relative obvious where one should place their long term investments.
God Bless and great investing. Andrew Waite
Comment by Paul Barrow on 9 April 2009:
Thanks for sharing this information. As a professional investor, I could not agree more. I am witnessing an amazing recovery, but it is by price range. High-end properties are still suffering, but sales under the conforming loan limits are strong and investment properties are seeing immense upward pricing pressure. the recover in Denver real estate is well under way.
Paul Barrow
Denver, CO
http://theprivatemarket.com
Comment by theaccusersgift on 9 April 2009:
Around here foreclosures are dropping about 10% PER MONTH, giving real mortgage rates of over 100% PER YEAR.
Also, around here pre-foreclosures are souring. No bank will foreclose because no foreclosures are selling AT ALL.
For every 3 foreclosures, there may be 50 pre-foreclosures.
Comment by patrick schuppe on 9 April 2009:
i hope this morage miss get settle , gets getting reducious we investors buying the bad mortages off the books of the banks, but i hope we can at least make some money out of this mease.
Pingback by Why Simply Changing "Mark to Market" Rules Won't Lead to a Happy Ending on 10 April 2009:
[...] argue that the comparison is invalid because GM’s bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds [...]
Comment by L. Malik on 12 April 2009:
Please fill in the following quote from midway into this article. It surely has something missing between “analyzed” and “make” besides just the space.
“Housing, by comparison, is analyzed make “illogical” generalizations about the market that fail to reflect reality.”
Thanks.
Comment by ed brown on 12 April 2009:
Last year there were 2.1 Million fore closures. The housing market will not recover until these units are sold. The current tax credit does not help since 70% of tax filers own their own home – $81m. 35M do not pay taxes and another 45M pay little in the way of taxes. Their were approximately 116M tax filers in 2007. So how does Waite address this issue??
Comment by Jeff Lane on 12 April 2009:
I have been a CA. contractor for 40 years. I know everything there is to know about housing. I know the market in CA,Nev,Az. I also understand the psychology of this market. 2 words..you’re wrong. And you will be wrong in 2010, as well.
Comment by Gary Wardell on 13 April 2009:
When my parents passed away I was left with an oversize lot in Edina Minnesota. Edina is considered one of the very best. So far I do not have any buyers.
I do not see any bottom.
Comment by Kelly on 14 April 2009:
“According to Waite, the housing market bottomed last year. But that bottoming takes place in stages. Housing values continue to decline. But values can’t bottom, solidify, and then head north until sales volumes increase, Waite says.”
Whoever thinks this makes sense deserves to lose money in RE.
Comment by George H. Cullins on 14 April 2009:
No matter what wall street thinks or does is immaterial as long as you have the power and thinking of the Barney Franks in the House of Representatives
Comment by Chris on 15 April 2009:
I think housing should continue to drop to the pre-bubble prices. I own a house and have for 20 years. My daughter is a local teacher and is having a very hard time finding a decent house in a decent neighborhood. She makes $32k a year and the average home prices are floating around $140k. These are for decent homes, not good. The nice homes are going for $300-800k and the run-down homes in bad areas are going for $25-40k. She wants to buy a home to live in, not turn around and sell in 2 years. I think its ridiculous that we have so many people saying we need to save housing but in reality we need to let it go back to normal. My house has gone from $140k in 1997 to over $400k today (appraised value). It was nice to think about but I never once thought about selling or BORROWING against my house. Housing needs to drop and drop big.
Comment by Chris on 15 April 2009:
I also think the average home price should be no more than 2.5X the average income for the area…not 4.5 to 6.5X. Banks shouldnt be allowed to issue interest rates over 5% and in doing that people would have a smaller mortgage payment. Also at least 5% – 10% down, no exceptions unless you get help from being a first time buyer. The 20% is just unrealistic in todays economy. This is a mess and either way its going to hurt people who bought houses for short term investments or borrowed to much against their house and on the flip side it will hurt people wanting to buy a HOME not an investment in the future if prices dont drop.
Pingback by Earnings Reports Will Play a Key Role This Week on 20 April 2009:
[...] Several economic reports will be worth a look, too. Home sales data for March highlight the economic calendar and analysts are eager to see whether February’s enhanced activity was the start of a trend or just an anomaly. Interest rates are down; home prices are low, first-time buyers have tax incentives to buy. Could the February and March numbers represent the start (continuation) of a housing rebound? It’s going to happen at some point, and don’t forget that housing expert Andrew Waite, the publisher of the Personal Real Estate Investor magazine, recently told Money Morning that the recovery is already under way. [...]
Pingback by Latest Housing and Consumer Confidence Numbers May Point to a Sustained Economic Recovery on 28 April 2009:
[...] Money Morning: Why Wall Street is Missing the U.S. Housing Recovery [...]
Comment by Cynic on 29 April 2009:
Not sure whether this is a paid advertisement….or whether the author William Patalon III needed to make a deadline to fill his column. What a crock! Print this aritcle Mr. Patalon the III and send it every year to all your readers….what about fifty or so?? ….and then send one time stamped and sealed to the “amazing Kreskin Andrew Waite” What do you use for research besides your own opinion…an Ojigii Board??? Sounds like a mirror of realtors or that Baffoon Bill Watkins at UCSB that spoke of the bullet proof Santa Barbara mkt for ten years untill someone pulled the equity loan on his home. Contrary to Waite who finds water with a divining stick…the high end markets are just starting to crack. The rich are looking at their trust funds ……like the Getty ….and are saying…..yikes…..maybe its not worth what that moron Waite and Watkins have been saying all along…..honey lets sell this dump. Well over fifty percent of the homes selling are bank owned…….only 5% are listed on the MLS …..huh???
How could that be??? The banks are not talking about the trillion dollars of ARMs that are re-setting just this month…..I repeat……just this APRIL……..!!!! With the job market plummeting……Arms resetting……banks holding back all the inventory of taken back junk…..and morons like Waite and NBR Watkins…..and all the other softheaded reporters like Patolon the III…..if you buy now into this “BOTTOM”……A FOOL AND HIS MONEY ARE ALWAYS……..SOON PARTED.
IDIOTS.
Pingback by Three Ways to Profit As Taiwan Rebounds From the Financial Crisis on 5 May 2009:
[...] a few well-run countries avoided the fallout from the U.S. housing debacle – as well as the fiscal-and-monetary-stimulus mess that followed. And although they have been badly [...]
Pingback by Is the Stock Market Rally For Real? on 6 May 2009:
[...] crisis that’s grown out of that nightmare of bad debt and parsimonious lending. There’s a belief that the U.S. housing crisis has reached bottom. Even Money Morning’s Hutchinson says that the rate of decline in the U.S. economy has almost [...]
Comment by Better Yeti on 7 May 2009:
Oh. My. God. This author is a total idiot. He has no idea about foreclosure rates, NOD escalations, shadow inventory (properties in default that banks haven’t bothered to put back on the market), and lending standards. Just stunning. Complete and total moron.
[Of course, whenever somebody flies a "III" after their name, everything that comes after is highly suspect...]
Pingback by "Hyper-local" Stats Show Housing Market Has Bottomed on 1 June 2009:
[...] Money Morning: Why Wall Street is Missing the U.S. Housing Recovery [...]
Pingback by How the Woes of the Wealthy Can Guide You to Global Investing Profits on 2 July 2009:
[...] Money Morning Real Estate Market Analysis (Part II of II): Why Wall Street is Missing the U.S. Housing Recovery. [...]