| |
|
BENSON'S ECONOMIC & MARKET TRENDS
|
|
|
“SLAUGHTER OF THE HOUSING
SPECULATORS”
These days, “Get Rich Quick” has
been the mantra for too many people trying to cash in while
buying real estate speculatively. With so much “free”
money still flowing from the Federal Reserve, it has become
a real estate speculator’s dream world. These so called
speculators have purchased over 3 million residences, practically
with their eyes closed, with the sole intention of flipping
them like pancakes to the next guy, marked up 25 percent or
more. However, signs are beginning to appear that indicate
this game of getting rich quick may soon be over.
Less than 20 percent of Californians can now afford a home
with a fixed rate mortgage. The Federal Reserve is still raising
variable interest rates. In 2004, when the housing bubble
was really gathering steam, the National Association of Realtors
calculated that 23 percent of homes purchased were for investment,
and 13 percent were for second homes. With housing prices
in some markets rising 20 to 40 percent in the past year –
and 50 to 100 percent or more since 2000 – buying a
house on spec looked like a sure thing to make a quick profit.
But this housing deck of cards, in an already over-heated
market, could have a domino effect. Why?
Home sales run about 9 million a year (this
includes housing starts of 2 million and existing home sales
of 7 million). If over 20 percent of homes purchased are investor
properties, it appears that practically all new housing starts
in America are accounted for by speculative buying. If second
home buyers are added into the equation, speculative and investment
buying of real estate (not owning to live in) actually exceeds
total housing starts!
There are problems associated with owning second
homes and investor properties. Unless these properties are
rented out, they yield no cash income and become cash vampires,
sucking the owner dry because of escalating taxes, maintenance,
the Alternative Minimum Tax, and higher floating-rate mortgage
payments.
Let’s look at the economics of a “poster
property” in San Diego called Park Place. The New York
Times reported recently that a one bedroom condo is being
offered for $719,000. A prospective buyer would expect to
pay about $3,775 a month for a mortgage, plus maintenance
fees, taxes and insurance. These additional costs can bring
the monthly out-of -pocket total to well over $5,000 a month,
or $60,000 a year. However, a renter, who would benefit from
the same granite countertops, hardwood floors and fantastic
views, can rent a nearly identical unit for only $2,400 a
month, or $28,800 a year. At these price levels, the speculator
who bought in could run an annual negative cash flow of close
to $31,000 if they were forced to rent because no buyers could
be found.
Today’s inexperienced housing investors
may not realize that the hard costs (tax, insurance and maintenance)
along with the soft costs (revenue lost due to vacancy, and
property management services so you don’t have to become
the landlord) can easily eat up over 30 percent of rental
income before even making the mortgage payment.
In looking at some cities with major price appreciation
(New York, Boston, San Diego, Miami, to name a few), in today’s
world it just doesn’t seem possible to buy a house or
condo and expect to make an economic return renting it out!
Nationwide, there are over 3.8 million vacant units available
for rent. In some communities, the over-supply of rental units
on the market has pushed the average rent down as much as
20 percent. There remains a surplus of rental units.
First quarter 2005 statistics indicate, nationwide,
there are 440,000 new homes for sale and 2,400,000 used homes
for sale. By recent historical standards, these numbers account
for a 4-month supply and do not look worrisome. However, given
what is really going on, this is about as safe as saying “if
you see ice on a pond, it must be safe to walk on”.
The latest HUD statistics show that of the 107,775,000 occupied
housing units, 74,488,000 – or over 69 percent –
are owned (not rented). This level of home ownership is at
an all time record high. In achieving this record home ownership,
the following has occurred: Sub-prime buyers now account for
more than 10 percent; Another 10 percent can only buy with
a “negative amortization mortgage” (very popular
in California where 40 percent of mortgages are negative amortization);
Up to two-thirds of mortgages are Interest Only (“IO”)
or Adjustable Rate (“ARM”); Second homes now account
for 8 percent of mortgages; and, 38 percent of homes this
year have been purchased with less than 5 percent down (if
this doesn’t reflect scrapping the bottom of the barrel
for homeowners, nothing ever would). Yet, household earnings
haven’t kept up!
If housing speculators stop buying, who’s
left to buy? The average American with a job has already bought.
America has been creating new homes faster than new jobs,
and it has been the home speculator, and second home investor,
holding up the market for at least the past year. (The latest
reports show that the time it takes to sell a home has increased,
and price rises have been trailing off.)
One of the biggest problems I see for our housing
speculator is the forward supply of new homes they have already
been locked into. Certainly, on the east and west coasts and
in Las Vegas – and other frothy vacation and major markets
– high rise after high rise are coming out of the ground.
Ivana Trump (long divorced from “the Donald”)
is marketing the Trump luxury brand name for a high-rise building
going up with her name in Las Vegas where units will begin
at $550,000 and top out at $35 million for the penthouse.
(In South Florida alone, my wife and I recently drove south
from Fort Lauderdale to South Beach and we counted over 50
new developments in various stages of construction on the
coast road). There are twelve high-rises going up in West
Palm Beach, and another twenty four jumbo projects in downtown
Miami. Every single one of these projects is priced out of
range for the middle class buyer.
There is another “dark side” to
speculating in real estate. Hundreds of thousands of units
that have been sold in advance by developers to speculators.
This method is used by developers so they can get the construction
finance they need. The speculator is responsible for the purchase
but he won’t actually “buy” the unit until
the project is complete and the unit has a Certificate of
Occupancy. Therefore, the sale will not be counted as a sale
until the date of closing! (Moreover, the developer has gotten
the speculator to sign an agreement preventing him from reselling
the unit for at least a year – after the speculator
has taken occupancy – so the developer won’t be
selling against himself. This leaves the speculator holding
the bag, but they seem willing to take the risk.
It could get interesting over the next
six months as interest rates continue to go up and thousands
of high-priced housing units come on the market that have
been artificially snapped up by the get rich quick crowd.
It may pay to simply sit back and watch the slaughter from
a distance and stay short some home builders and sub-prime
mortgage companies.
******
Richard Benson
President
Specialty Finance Group LLC
Member NASD/SIPC
www.sfgroup.org
800-860-2907
|
