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Real Estate

8-March-2006
Real Estate Anecdotes, from Roger Arnold

So far this year, in my personal business, I have taken about 100 complete loan applications. Of those about 50 have been returned with supporting documents and checks to order appraisals. Of those about 30 have withdrawn their applications. This is something I have never experienced before. Once an application has been submitted and underwritten withdrawal is a very rare event.

About half were refinances and the other half purchases. Refi's withdrew because of rising rates and purchases because of fear of overpaying for a home and / or an inability to sell an existing residence at a desired price. All were equally scattered among my biggest markets, Florida, DC metro area, San Fran, Houston / Dallas, Portland Oregon and New York / New Jersey. Average loan amount was about $450,000. This appears to be a continuation and acceleration of the downward compression in values / sales that began in the 2 million plus market about 18 months ago.

The market up to about $250,000 in price is still very strong with many 100% loan programs still available. That market appears to be benefiting from the top down compression and actually strengthening as a result. Home sales are brisk in that range as many higher end buyers are selling their $500,000 plus homes and downsizing or renting; i.e. realizing profits and awaiting the fall out.

To wit; from Florida.

Nationally and regionally however the US is still in the denial phase with just the beginning signs of anger / blame becoming evident.

As the process accelerates in the US recognition and anger / blame should next be evident in the predominant "bubble" markets in the US; i.e. on the east coast form north to south: Boston, New York, New Jersey, DC Metro, and Florida; on the west coast from south to north: Phoenix / Tucson, San Fran, Vegas and finally Portland Oregon. Everything in between should be fine.

On a global basis these three stages should be felt first in Australia / New Zealand, UK, Canada and finally the US. Australia / New Zealand have been in mild consolidation for 2 years. They think they are now rebounding; but it is probably a very short and mild bounce up that will reverse again within the next few months. The UK is in a similar situation to them. Canada is just now beginning to show signs of weakness. The bubble there is concentrated in the Vancouver / west coast area.

The last three global real estate cycles saw appreciation and subsequent consolidations being the greatest in Australia, UK, Canada, and the US in that order, both to the upside and the downside. Many things are different now though since the last bottom in the early 90's; i.e. MBS market growth, adoption of inflation targeting, freedom of global funds flow, etc. I don't know how this is going to play out this time but I am very worried about it.

02/16/06
Landsafe? A post by Roger Arnold

Residential properties above one million dollars in valuation are being required to have their appraisals reviewed. The largest reviewer is a company called Landsafe, which is contracted by lenders to review appraisals. Landsafe is increasingly lowering valuations of appraisers by an average of 25%. As recently as last year this was more a reflection of appraisers over-appraising property values. Today, increasingly, Landsafe is apparently, from what I can tell from first hand and multiple experiences, actually setting values; rather than reflecting / reporting them.

Reductions in valuations for properties above 2 million appear to be running about 25%; i.e. a 2 million home is appraised at 1.5 million; even if it is a purchase transaction and the parties have already contracted for the higher price. This is beginning to send a chill through the higher end market. I have reviewed the reviews and fought several of these in the past year or so; and won every time. But, it is time consuming and I am now telling borrowers that I can't do it any longer. The catch phrase of the appraisal industry has always been - we don't set values we just show them.

Well, it ain't that way anymore.

Examples:

1. Raw land in Mclean Virginia's original 22101 zip code is going for 1-2 million an acre every day. But if there is an improvement on the property the value is now actually falling because the mortgage lenders and land lenders look at values differently. So, sellers are beginning to condemn their own homes before putting the properties on the market, so that a buyer can get a higher appraisal and the seller can get a higher sales price. I kid you not. And I'm not talking about condemning pill boxes. Some of these are 5 bedroom homes less than 20 years old; perfectly good homes.
2. I recently lost a deal in DC because the buyer and seller couldn't come to terms after the appraisal came in low; i.e. purchase price for a 3 unit apartment building in DC was 2.65 million. Sounds like a lot, and the review appraiser agreed, marking the value at 1.85 million; meaning the buyer had to bring another million in cash to the closing if he wanted to close at 2.65 million. Sounds like the appraiser protected the buyer from making a bad decision right? The three apartment units were 6,000, 5,000 and 4,000 sq ft respectively! With another 4,000 sq ft of storage space. The punch line is that this is easily a 10-20 million dollar property with a million or so in renovations to convert it to between 8 and 15 condo units; which the buyer intended AND which would have increased the liquidity of the building and enhanced the neighborhood. But the underwriters just saw a 3 unit building.
3. Co-Op in NY with a 2.5 million dollar price tag, a bargain considering the location. The buyer was selling a home in Boston and moving to NY. The review appraiser however said because of the lack of unit sales in the building it was illiquid and gave the value as 1.5 million. I almost choked when I saw the rationale. Nobody in this building sells if he can avoid it; the units are left on to children.

Stuff like this is happening everywhere now. The primary driver appears to be fear of the feds; i.e. CYA by lenders is now the rule.

01/26/06
Henry Gifford begins a discussion on Real Estate:

Rental numbers really are that skewed these days. I can think of some reasons.

People expect/assume the 2.8 million dollar house to be worth 3.5 million in 6 to 10 months, making the purchasing deal better than the renting deal.

People who rent are looked at like they are insane for "throwing away" money every month instead of building up equity by paying a mortgage. Nobody mentions that most of the mortgage payment goes to interest.

The house mentioned is a luxury house, the market sector that has a typically low return to the owner.

The "Cap Rate" is the return on the property - calculated by figuring the actual return before mortgage payments and dividing that number by the purchase price. Real estate people say a higher cap rate is good, a 10 is great, but I've never heard anyone say why. It seems obvious to me that borrowing money at 6% and "lending" it to a property that makes 10% is better than lending it to a property that makes 2%. Prices are so high now that finding a deal with better than a 3% return is unusual.

Other factors I think are significant include people's view that they are getting a cheap call option on real estate prices - many people figure they can walk away in a falling market, thinking nothing about promises made.

Another factor is that buying property with debt is an option on interest rates. If rates rise and the next door neighbor pays 10% to borrow money to buy a property similar to the one you own with 6% money, sales prices can take a significant dive before the neighbor's monthly payment is less than yours, thereby discouraging rentals at lower monthly rates. If interest rates fall, refinancing at lower rates is commonplace.

Steve Wisdom adds:

But why is this 'typical', one wonders. A quick counting exercise: the BMW effect. BMW is a good case study of new/used car values, offering a reasonably clean/consistent timeseries for 20 (?) years back: a "3" series (economy/entry level), "5" series (middle level) and "7" series (luxury/limousine level) car lines. Of course there are vagaries of sheetmetal refreshes every X years & etc, but one finding leaps out. If "7" (luxury) prices are normalized to units of "3" or "5" prices, the "real" value of "7"s cars monotonically declines as they age, per the every-three-year snapshot below, using prices pulled from KBB. A new "7" sells for 2.3 "3"s, but a 1994 "7" sells for only 1.3 "3"s. Similarly the "5" price of "7"s falls from 1.7 to 1.0.

Prof. Haave spoke of price discrimination the other day, and I believe something of this sort is at work. The high demographic simply "can't be seen" in a 10 year old car. Furtive glances out the clubhouse window as Charlie pulls up in an old car.. and over beers at the 19th Hole: "Charlie, if you're a little strapped right now, I can lend you a few bucks."

Similarly, the high demographic just won't rent a house, except in rare exigencies such as a temporary relo on the investment bank London/NYC/Tokyo circuit, or (as in the case I spoke of before) a stopgap residence during a knockdown/rebuild or major renovation. So rental prices are chronically "too low" for luxury homes, because those who can afford to rent them.. don't want to, at any price.

      Model..                  Price ratio..
            3       5       7    7/3    7/5
 2006   30,880  42,160  71,512   2.32   1.70
 2003   20,240  24,605  46,350   2.29   1.88
 2000   13,200  14,995  20,865   1.58   1.39
 1997    8,255  10,035  11,350   1.37   1.13
 1994    5,480   7,475   7,150   1.30   0.96

Data was taken from http://www.kbb.com, zipcode 06880. Cheapest base-model sedan, No optional equipment.
2006 = Street price
Used = Private party, avg mileage, good condition.

Mr Krisrock comments:

The game in real estate is driven by age.

Any area without many people over 55 will lose important bids for high end real estate... the key factor is the probability of making $500,000 in two years in real estate appreciation.

How this works is as follows:

If you're 55 you can liquidate a home every two years and take out $500,000 tax free. What happens is that the person selling must buy another home that he hopes will then appreciate $500,000 in the next two years... to do so usually means buying a substantially larger more expensive home whose base price ..say $5,000,0000 must only appreciate 10% to make the 500K profit... or 20% of a 2,500,000 home etc.

This is what has been the price driver in many areas

Tom Larsen suggests:

Kris, you are right about most of this except for the 55 age limit. That was eliminated, which probably makes the law even more important to real estate appreciation. For example, in my neighborhood in California, I can name 3 contractors who buy old ranch houses and live in them while they fix them up. After 2 years or so when they finish fixing them, they sell them and pocket tax free returns. Then they look for another one. They are not 55. This law certainly causes a lot of remodeling. It's a great business for people with the skills. You just need a wife who doesn't mind living in a construction zone.