Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.
Now when the lending community really needs to know what the values are…
No one orders a real estate market analysis anymore or they are poorly done!
Not the banks, not Wall Street and clearly not home builders. Yet home builders today are feeling the pain that results from a poor or missing market analyses. Wall Street analysts, rating agencies, and their advisors, including the accounting firms that report on the financial conditions at similar companies, do not seem to understand the residential real estate industry. Either that or they have been looking at the wrong data for two years or so.
The following chart summarizes how publically traded home builder stocks have fared this year.
Wall Street analysts who report on these companies and recommended their shares, as well as company management and their advisors, would have to give back a large portion their pay, bonuses, benefits, stock options, etc. to their shareholders to offset the losses that were incurred as a result of overly optimistic forecasts. In fact, New York State Comptroller, Thomas DiNapoli, estimated a 10% drop in Wall Street bonuses this year. With average year to date home-building stock prices down well below 50%, management equity (not to mention job security) would be similarly off. Yet this doesn’t come close to the losses incurred in the housing market. Regrettably, many of these losses could have been avoided by obtaining a properly prepared real estate market analysis.
The overall weakness in the residential real estate market was well known going into 2006: demand was falling and an inventory glut was beginning to take place. There is only limited demand at any one time; nevertheless, supply kept coming and the residential property cycle turned down. Current market indicators show that the housing recession will worsen in coming months, which may further impact the underlying value of the assets owned by many of these companies.
As demand peaked, poorly planned additions to supply continued. This was caused by many factors, including incorrect market analysis of potential supply and effective demand. Many inexperienced investors, analysts, appraisers and accountants, seeing the soaring profits in residential development, recommended entering the market in 2004-2006. They purchased vacant land outright, and began construction, thinking that effective demand would remain forever. Prices for land were increasing so fast that developers moved to lock up property without completing the proper market studies. Lenders were all too accommodating for the fee income. Similar to the stock market, investors became speculators in residential development, but lost due to their fear of poor timing and shades of greed.
Compounding the sudden leaps in price was the much slower permit process. Obtaining the necessary permits to develop residential real estate often takes one or two years, and as long as five or six years in certain markets. If one entered into a contract to purchase vacant land in late 2003, the market was in a down-turn by the time all entitlements were obtained. Yet, bankers provided the money and developers continued to move forward, being optimistic opportunists. The result? A repeat of the 1970’s and 1990’s debacles in residential real estate!
It appears that no one, neither Wall Street, company management, their accountants, advisors nor the lenders learned anything from the earlier cycles in real estate development. (Everyone over fifty was fired or let go for youth, many who are still learning. But that’s another article.)
A proper real estate market analysis would have predicted the change in market conditions based on analyzing the following factors correctly:
This list is only a partial catalog of factors that should have been considered by all of the players in the real estate market. Until real estate market analysis is bought back by company management, accountants, Wall Street analysts and lenders, we should expect ratings to be reduced and dividends to be cut and more losses and loan write-offs to occur in the real estate and banking industry.
Special thanks to Noreen Whysel who provided some input and assistance.
Tags: Soapbox Blog, James MacCrate, Straight from MacCrate
cycles? supply & demand? do you think that the Wall Streeters would have let that interfere with their looming astronomical bonuses from the securitization avalanche? It reminds me of when I was at one of the BIG BANKS that had shelled out between $9-10 billion in settlements to the SEC, Justice Dept. NY State Atty. General Spitzer, and others on the Enron and WorldCom debacles. The the fines included an admission stating they did not violate any regulations or wrongs BUT promised that what they previously did they would not do again….how’s that for lawyering? The upshot of the whole matter is that the institututions had self-imposed amnesia or else the senior execs who got them in the previous mess had been packaged off into retirement.
Market fundamentals don’t matter to speculators, unless they can manipulate the data to justify what they’re going to do anyway. What’s more, no market study could have forecasted the enormous increase in prices, the demand from speculative buyers, the collapse of mortgage underwriting standards, etc. And noone could have forecasted when the frenzy would end or how bad the fallout might be.
I am sorry to inform you that you are incorrect on a number of your comments.
The problems were not caused by speculators.
Yes, the mortgage underwriting standards impacted the demand but the basics of a fundamental market analysis would have predicted the end.
There are just so many buyers in one market that are qualified to buy.
Miami is a great example of overbuilding and a repeat of past errors!
I agree completely that rational market participants will base their decisions on a thorough analysis of fundamental market/economic conditions. In the long run, the fundamental factors rule. But in the short-run, irrational behavior can take over and force rational investors to the sidelines.
I have to disagree that problems were not caused by speculation in some major markets, Miami being a prime example. I suspect a good fundamental market analysis would have shown that the market ran out of qualified buyers long before the speculative frenzy peaked.