Saturday, 01 September 2007 01:00

How Far Will US Home Prices Drop?

I do not know, and I doubt anybody else does either. How much they will drop nationwide is a fools question, and to hazard a guess would be an exercise in futility due to the extremely geographic nature of the housing industry. Remember, no one lives in a nationwide home!!! There are some areas where I would bet the farm on a 20-25% drop though from peak to trough, Vegas doesn't look to good and Southern Florida is in for a lot of pain (re: condos). There are southern Florida condo developers who have been foreclosed upon because they could not sell above their cost and the land was too expensive to convert into a rental. That, in itself represents a 25% drop, retail, so it has already started happening in some areas at a rate that is higher than the historical average - and we have just started the real estate bust. Florida is an interesting area due to the inherent demand for clear water, good weather and the pretty women night life effect, not to mention favorable homestead laws. It also has laws that favor condo development for you don't need a red herring in the same fashion as cities such as NYC, hence you can pre-sell condo units with a set of plans and then finance the actual construction with a bank loan and deposits from pre-sales.

Florida also allowed letters of credit for deposits, which means that you can not only get a high LTV loan up to 100% of the yet to be built condo unit, but get a letter of credit (loan) for the deposit, sometimes borrowing more than the "EXPECTED" sales price or just borrowing the down payment, then flip the contract at a premium to another speculator without even having to put money in. I have seen these flipped several times before the condo was built, each time at a higher price, then after the condo was built, flipped several time again before the person who plans to live there ever gets the keys. This sort of rampant speculation significantly over-inflated fundamental demand. Now that easy money speculator demand is gone, and prices are still sky high, developers are STILL building condos. There are probably 35,000 condos in the pipeline, with an absorption rate a mere fraction of that. So long story short, 25% is possible in some areas and some property types. The issue is that each geographic pocket is its own microcosm, and when taken into the aggregate, spells a reversal of the upward housing value trend. Those areas that shot up 700% can easily fall 25% (especially those fueled by speculation and not by real buyers), while those that increased at the historical rate or slightly better have lower to fall to revert to the mean. From my studies, after each bubble bust, the assets tend to remain higher than post bubble, but significantly lower than the peak. The caveat is that most retail and amateur buyers buy in the peak so they feel the most pain. As for valuation of builders, I calculate Beazer to be worth about $6 a share. It is very dangerous to try to buy these companies on a discount to book value, for you (and they) really don't know what book value is. The write-downs will continue each quarter until parity is reached. In addition, there are off balance sheet liabilities that drag book value down even farther, and the builders aren't as forthcoming as they could be in revealing these, ex. credit enhancement swaps for their mortgage SPCs (special purpose companies - financing shells), joint ventures with other companies containing depreciating assets (often land is purchased in JVs to spread risk, look at CBASS, the venture between MGIC and RAD do see how $1 billion investment can go down to $0 in one less than one reporting period). Then there are on balance sheet liabilities that are not easily valued, such as their mortgage arms that use warehouse credit lines to finance mortgages to sell off to the secondary markets. These mortgage that are not conforming are considered toxic waste the same secondary market that consumed them greedily just a few months ago. How far do they have to be written down to be considered suitable for prudent book valuation? Ask American Home Lenders, Luminent, New Castle, etc. While we don't know how much, you can bet the farm that many will consider it a lot. The companies that specialized in this stuff have found there loan portfolio intently worth nothing in the marketplace. Now, while fundamentally, it may have value, but in order to realize that value you either have to sell it to someone which is increasingly difficult, or somehow profit from it. I am betting that the builders will have an even greater problem selling this stuff than the pure mortgage bankers, and they will not be able to hold on to them for they are not properly capitalized for it and the stuff will contain a lot of junk, re:bad loans for the builders are aggressively pushing loans through to get their depreciating land off of their balance sheets. I know I wouldn't buy loans from these guys in there current condition. And these are decent amounts, Len pushed 48,500 mortgages, amounting to $10.5 billion in 06.

Last modified on Saturday, 01 September 2007 01:00