Matrix Blog

Rentals, Investing

Investor Path: Stock Markets -> Housing -> Commodities -> Gold?

May 15, 2006 | 12:01 am |

With the housing market not seeing the returns of the past few years, investors have been looking at alternatives for a while now. Wall Street is seeing green with the DJIA moving close to a record high. However, some investors are seeing gold in the red-hot commodities market or just plain gold [WaPo], which acts both as a safe-haven asset [] against geopolitical uncertainty and as an inflation hedge against rising energy prices.

Upbeat bulls are clearly in the majority on Wall Street right now [WaPo], and truly negative bears are hard to find. But many stock traders and market analysts can identify reasons to be worried about the current state of affairs, and some are actively predicting at least a short downturn by the end of the year.

Gold futures, often a haven for “gold bugs” — investors concerned about inflation and geopolitical or stock market turmoil — rose above $700 in New York this week for the first time since 1980. Silver is at a 25-year high, and copper and platinum both set records in the week, though copper pulled back a bit by week’s end.

Perhaps we will start seeing Gold Bubble Blogs fairly soon as the price continues to rise rapidly.

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Supertanker Analogy Helps With Housing Market Navigation

May 11, 2006 | 9:19 am | |

PIMCO, the leading bond firm, has taken particular interest in the housing market through its Housing Project to track and project housing prices.

Even though I am not a bond market wonk, I always enjoy founder William Gross’ monthly podcast on the bond market and learn a lot from PIMCO’s insight. PIMCO has contacted me in the past to get information about the housing market.

In their In Focus series Scott Simon Discusses PIMCO’s Views on the U.S. Housing Market. They post a series of questions to him and this was the one I found most interesting:

Q: Considering the negative conditions in the housing market, why does PIMCO expect a gradual slowdown in house price appreciation this year rather than a rapid slowdown or an outright decline?

Simon: When we look at the housing market, the analogy we use is a supertanker, in that when you go to full throttle, it takes a really long time to speed up. In fact, the two biggest quarterly increases in house prices occurred last summer and last fall, which were a year and a quarter after the Federal Reserve started raising rates. In other words, the housing market was still accelerating after the Fed had shifted into reverse. And even when you throw it into full reverse, the housing market takes a while to slow down, just like a supertanker that takes 23 miles to stop if you throw it in reverse from cruising speed.

We’ve looked at housing bubbles over the last couple of hundred years and one thing that was very consistent and I think was really clear is that bubbles only burst when there is a lot of unemployment. If you just look at the last 25 years, there are two examples of housing bubbles that burst. One was in California in the early 1990s, when virtually the entire defense industry got laid off and there were 20 for-sale signs on a block. The other big case was the Texas-Louisiana oil patch problems of the 1980s where you had 35% unemployment regionally.

In both cases, the banks ended up owning property that they wanted to get out of and ended up selling at any bid. That’s how housing prices go down. Otherwise, people just live in their houses and the number of home sales really goes down a lot, but prices don’t have to collapse because people have to live somewhere.

Many people are impatient when it comes to the housing market, but the reality is that the housing is not a speedboat, it’s a supertanker that just doesn’t speed up or slowdown that fast—unless it hits an iceberg like a big jump in unemployment.

Robert Shiller: Hedging Our Housing Futures

May 8, 2006 | 12:04 am |

After the some of the commentary on my post Spreading The Housing Risk To Create International Consensus [Matrix] in addition to all that I have read about his efforts with CME to create a housing market index, I asked Robert Shiller who developed this index and author of Irrational Exuberance for some thoughts on the general feedback I have been receiving.

Here was his reply:

Jonathan, I am glad to see that there is such interest in these contracts. I and a couple colleagues have been involved in trying to develop these products for over 15 years. We hope at last that we will see them succeed.

The basic thrust of these comments seems to be that there are doubts how a futures contract can function when there is no possibility of physical delivery. One can’t deliver a house in fulfillment of a futures contract. That has been the problem that has delayed the development of these contracts for so long. It is also hard to derive a suitable index for house prices, since houses are not a standardized commodity, houses are all different.

The answer to these questions is not easy to summarize. I would recommend my 1993 book Macro Markets, which considers a lot of the issues.

There are also doubts about who would go long the contracts. But, I think that we are actually in a reasonably good time to find people willing to go long. Long positions in other futures contracts have been good investments over all, and a long position in real estate would be a fundamental diversifying move for investors all over the world.

But, the bottom line is that we will have to see how these contracts work in the real world and see how satisfied investors and hedgers are in them.

You can post this letter if this seems helpful.

I am really looking forward to seeing how these futures are viewed. In other words, let the markets decide.


Housing Myth Fodder For Cocktail Party Chit Chat

May 8, 2006 | 12:03 am | |

In Unmaking the Myths [CNN/Money] the author tries to explain why several items of conventional wisdom are not holding up under changing market conditions.

Here are some thoughts, although I don’t think these are strong elements of conventional wisdom to begin with.

  • Scarcity of buildable land on the coasts ,Äî protects the balance of supply and demand an keeps housing prices high. We hear this discussed in Manhattan quite a bit (I plead guilty myself), where its an island and the lack of land has pushed development to the other boros due to high land prices. However, recent re-zoning efforts by the Bloomberg administration make this argument less plausible. Without this change, the argument is still weak since the lack of sites is more of a phenonom of land sellers responding very quickly to improving conditions, thereby ratcheting up the cost of site assemblage.

  • Big builders learned their lessons from prior booms and only build when they have firm buyers in place – I am not sure I agree with this as a myth to begin with. I think this argument applies more to commercial development than it does to residential development. A glut of office development characterized the last building boom. I believe that builders know how to build and its naturally difficult to stop doing so once the momentum gets going.

  • Home prices don’t drop in areas where employment is rising. – The article reports this as happening in Boston, although I believe that Boston’s economic prospects and employment are weaker than Washington, DC, which may make for a better argument. Washington, DC has some of the best employment prospects in the northeast but a signficant over supply of condo housing and investor activity.

  • Hot markets will glide to a soft landing. ,Äî Thats the spin by NAR these days after 6 months of denying a market change was even happening. This is an overly simplistic rational. The missing element here is investor activity. I think markets with heavy investor activity are the most vulnerable. Many investors don’t have the deep pockets to carry their properties indefinitely. Again, each local market behaves differently so its misleading to hard sell the point that all is well. Even the phrase “soft landing” is comforting in its terminology. Some markets will be unaffected, some will be moderately affected and some will be severely affected. CNN quite aptly calls them Dead Zones, Danger Zones and Safe Havens.

One of my favorite myths is that:

  • The media caused the housing boom to end ,Äî Thats simply not true. The media may have piled on when the market began to show weakness, but it didn’t cause the change. On the other side of the argument, it could be said then that the media caused the housing boom. That is giving the media too much credit.

I think that the most significant myth is that:

  • The housing boom was caused by a change in lifestyle demands. – The housing boom and all the peripheral was stimulated, jump started, caused, etc. by low mortgage rates and loose underwriting standards. Lifestyle changes and demographic changes became options as housing payments dropped. Cheap money bred an explosion in development and sales activity. These other factors took the boom further but it all began with low mortgage rates.

Warren Buffet: Condo Traders And Dumb Lending

May 8, 2006 | 12:01 am |
Source: Las Vegas Review-Journal

Noted investor Warren Buffet, whose company owns the nation’s second largest real estate brokerage firm: Home Services of America, Inc. gave some interesting perspectives on the housing market [MW] at his recent annual meeting [CNN/Money].

His well-respected perspectives seem to be fairly macro and investor orientated, which makes sense given the nature of his business, Berkshire Hathaway.

What we see in our residential brokerage business is a slowdown everyplace, most dramatically in the formerly hottest markets. The day traders of the Internet moved into trading condos, and that kind a speculation can produce a market that can move in a big way. You can get real discontinuities. We’ve had a real bubble to some degree. I would be surprised if there aren’t some significant downward adjustments, especially in the higher end of the housing market.

Speculative investor trading is seen by many as the downfall of the current housing market. In fact, it has comprised an unusually large component of sales activity during the recent housing boom. There are significant pockets of concentrated activity to be very concerned about.

Dumb lending always has its consequences. It’s like a disease that doesn’t manifest itself for a few weeks, like an epidemic that doesn’t show up until it’s too late to stop it. Any developer will build anything he can borrow against.

I am of the belief that loose underwriting standards, is far and away a more serious issue than investor sales activity. It is a ticking time bomb, that will catch most unaware, should the real estate market fall. The large scale shift to wholesale mortgage origination (mortgage brokers) over the past decade has forced lenders to unwittingly place their trust (asset protection) to those on commission. The elimination of the most important elements of the bank collateral review process (appraisals) have made the analysis process essentially a paperwork funtion. The nationalization of banks and vendor services have cause lenders to lose touch with the nuances of the local real estate markets. The blind leading the blind – a collateral nightmare if you will.

If the real estate market continues to weaken, more of the short cuts of the recent boom that have become status quo will be exposed, but it will likely be too late. I don’t want to be the one to say I told you so, but its already too late…and thats really dumb.

Spreading The Housing Risk To Create International Consensus

May 5, 2006 | 12:01 am |

In this month’s column in Project Syndicate, Robert Shiller writes about The Global Home writes about his company’s collaberation with the Chicago Mercantile Exchange (CME) to create a market for futures and contracts on home prices in ten cities in the US. This has been tried before and failed but under different market conditions and public awareness. The public is much more attuned to the housing market than ever before.

The futures markets on home prices will allow investors around the world to invest in US homes indirectly, by buying interests in them through these markets. An investor in Paris, Rio de Janeiro, or Tokyo will be able to invest in owner-occupied homes in New York, Los Angeles, and Las Vegas.

A fundamental principle of financial theory , “diversification” or ,”risk spreading,” implies that interest in the new contracts will be high. People and businesses in New York, for example, are overexposed to their local real estate risks, so they should reduce this risk by selling New York home price futures. People in Tokyo will assume some of this risk by purchasing New York home price futures if the price is right. The New Yorkers still live in their own homes, but now they have spread their investment risk worldwide.

To date, the information available is either government-based or trade group based and national in scope. There is a built-in bias and a delay in some of the reporting. The underlying concept of trading these futures is that investors will be better able to manage risk by creating an international consensus.

Its going to get interesting.


Washington DC Real Estate Speculators: 26 Square Miles Surrounded By Reality

April 24, 2006 | 12:01 am |

The title of this post was previously reserved for politicians but now it seems more appropriate to real estate investors. Apparently investor speculation in DC [WaPo] was more rampant than we gave fair credit for. [This was a front page WaPo story on Saturday]

Not just condominiums, but also townhouses and single-family houses, were snapped up by investors using no-money-down financing and non-traditional loans. They helped send prices soaring at unprecedented rates.

The investor element of the housing boom [cnbc] appears to be the segment that is suffering right now.

In Florida, the oversupply of rental to condo conversions are causing the landlords to have second thoughts [SoFl Bus]. Known as the “condo conversion reversion,” many condos are reverting back to rentals.

Is this unexpected? Not really. You can’t pile on thousands and thousand of units in a market and expect prices to rise indefinitely.

Ever made Hollandaise sauce? You can keep adding butter but risk having the emulsion break and being forced to start over. [sorry, will try to keep the cooking analogies to a minimum -ed]


Fed To Markets: One And Done (Hopefully None)

April 19, 2006 | 12:01 am |

I have always contended that the Fed goes about 2 rate increases too far when it comes to the housing market, but of course this time its different (it always is). Housing plays a much bigger role in the economy than ever before. Its been a security blanket during tough economic times. Lets hope the quilt doesn’t unravel, for the economy’s sake.

Liz Rappaport, in her article Advantage: ‘One and Done’ attempts to dissect the Bernanke-led Federal Open Market Committee (FOMC) language.

[The FOMC] might focus on the imagery of uncertainty sprinkled through the text, in phrases such as “hard to predict” (the impact of housing price moderation) and “expressed surprise” (that energy prices hadn’t passed through to inflation measures).

There is an increasing chance that the FOMC may pause in its quest to keep inflation in check, without making global markets nervous about inflation. The Fed is worried about tightening too much [MW] before policy changes have had time to take affect.

The fed funds target now stands at 4.75% [AFX] after the central bank put in 15 consecutive rate increases since June, 2004. The market has fully priced in another quarter-point increase to 5% next month.

I think by this point Fed policy has had its desired effect, when it comes to housing. I had read somewhere that changes in the federal funds rate can take as much as 12 months or more to take full effect. Its probably not a bad idea to take a breather and see where this is going. The Fed is walking a fine line between fighting inflation and taking us into a recession.


Hedging Your Housing Bet With An Index: Here’s How It Works

April 17, 2006 | 12:01 am |

You’re worried that the law of gravity, as it applies to home prices, has been merely suspended, not repealed. Short of selling the attic (or a few outbuildings, if life has treated you very well), how can you hedge against a decline, if it ever comes?

The International Herald Tribune has a very good article on the upcoming launch of the housing index by the Chicago Merc. Actually, its more of a nuts and bolts article: Investing: New hedge on housing [IHT]

Its going to be very interesting to see how whether this strategy compartmentalizes risk to the consumer. Here are some previous posts.

What Do Cheddar Cheese, Nonfat Dry Milk and Housing Have In Common? [Matrix]
Another Exchange Joins The Housing Index Party [Matrix]

Commentary: Stop Whining About The Media’s Housing Coverage

April 13, 2006 | 9:05 am | |

Sometimes, its easier to blame someone else for your troubles, especially someone you love. I’ll explain.

Red Light Theory [defined: You tend to remember all the red lights you stopped for and forget about the green lights that you didn’t.]

On one hand, the investor and real estate brokerage community can place a lot of blame on the media for poor or simplistic coverage of the housing boom, bubble, soft landing, etc. There are plenty of examples.

NAR has made a lot of mistakes in this regard by feeding them with endless stats that seem to contradict or confuse when compared to the text of their press releases. David Lereah, their economist/spokesman, has become the poster boy for anti-bubble speak spin.

However, there has also been equally insightful and excellent coverage of the housing market. Access to data is almost immediate and dissected ad nauseum. I think the issue is more about the source and bias of the data fed to the media and some of the lax reporting associated with it.

The source of some of the national data that is regurgitated locally is often made by brokers who don’t really understand what they are saying or are frustrated by their weakening ability to spin the results. For example, in the last media cycle after the end of the first quarter here in New York, prices did not fall. Somehow this became proof that there was not a housing bubble or it was proof that housing was still strong. In economic terms, I’d call that a credibility leap. One fact doesn’t support or link to another.

The media has a way of equalizing spin with reality. And thats good thing for the consumer.

In Michael Calderone’s post Why Not Blame The Media? [NYO] he makes this point with utmost clarity:

But it’s always interesting to hear a Florida real estate investor blame the media because he can’t make a quick flip. Of course, it’s alright when headlines mention a “red-hot market” but any reporting on “cooling off” is just no good for business. So, instead of blaming rampant construction, increased speculative buying, why not take a jab at the media.

The result? Despite the investor and the brokerage community’s frustration with the media coverage, the market has not caved in at this point. There are no guarantees however, but if you believed the headlines last fall, we should have been toast by now. On the other hand, if you believed the headlines two years ago, we should be seeing double digit growth right now. It cuts both ways.

But the media has moved on to other headline topics for the most part but the consumer still has a strong appetite for housing coverage.

Sure, the purchase decision is an emotional one, but consumers still tend to vote and make decisions on economic terms (ie vote with their wallet) and often don’t make that final decision from a tabloid or other big media headline. I feel its a cop out to say that:

Investors and brokers should not flatter the media as having that kind of influence on the buyers out there. Consumers really are smarter than given credit for.

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Real Estate Speculators Are Switch Hitters: Is It Time To Bat Lefty (Stock Markets)?

April 12, 2006 | 12:01 am |

A very self-serving survey by TD Ameritrade discussed in the article Speculators Start To Eye Stocks As Home Sales, Price Gains Slow [IBD] but it provides food for thought.

Guess whether the survey favors the stock market or real estate?

A recent TD Ameritrade survey asked several questions of investors, including “What is the best type of long-term investment?” — real estate or stocks. Those picking real estate peaked in July, with 48% of investors favoring housing vs. 32% for stocks. That came as many real estate stocks and home prices in many markets topped.

The following seven months showed a shift back to equities, with stocks edging past real estate as the preferred investment choice in February — 40% vs. 38%.

The results would appear to be bias and thin but a good point is made. With inventory and mortgage rates rising, investors might start looking toward the stock market in search of returns on par with real estate seen over the past 5 years. This is not to say the current stock markets are at the point were their returns are better than real estate, but perhaps, the risks are lower. Its something to consider.

On one hand, the exit of speculators could be reduce some of the volatility in pricing, mostly by easing upward price pressure.

However, the loss of transaction volume would reduce overall demand in markets heavily dependent on speculators resulting in a significant drop in the number of sales and an eventual drop in prices. Markets with limited investor activity may not see much of an effect at all.

Note: In an ironic twist, Manhattan, with its limited exposure to speculators and dependence on Wall Street, would likely benefit from this transition when and if it occurs. More churn in the stock markets generate more income to Wall Street firms, which generates more bonus income to its employees, which generates more disposable income to purchase real estate. [self-fulfilling logic -ed]


Speculation On Whether NAR Investment Sales Stats Are Speculative

April 6, 2006 | 12:02 am |

Here’s coverage of the stat release on second homes from NAR. Second-home sales at all-time high [CNN].

Are home still a good buy? Americans seem to think so — they bought second homes, both as vacation properties but especially for investment purposes, in record numbers last year.

Source: Calculated Risk

A hat tip to Northern New Jersey Real Estate Bubble for alerting me to the post on Calculated Risk about Second Homes. [See larger graph.]

Calculated Risk (CR) uses the numbers NAR actually reported on prior occasions to show how the current press release has indicated that something is wrong with their numbers. NAR says 39.9% of all sales in 2005 were second home sales.

I find that number very hard to believe.

But Calculated Risk, using the actual figures, indicates that the number is closer to 47.2%.

I find that number very hard to believe as well.

Nearly 50% of all home purchases were for investment purposes? I don’t see how.

Now think about the fact that the Housing Indexes that I have discussed in recent posts will be based on these indexes. I can only imagine the potential litigation if NAR is really in error here – especially basing an index on data provided by a trade group rather than an independent resource.

Update: Calculated Risk revised the chart. Corrected: Second Homes Graph