Saturday, December 29, 2007

Real Estate Ponderings

It was about a year ago that we were considering buying a low-end investment property to flip. Jeff had been in the real estate industry for a few years and had some decent contacts. I'd done a ton of research on the topic, binging on real estate books. Everything I'd seen over the past few years indicated that it was a solid, proven investment strategy.

The business model we decided on was pretty simple: buy significantly undervalued properties, bring them up to condition, and sell them at market value. No magic, no scheme.

Since identifying undervalued properties was essential to our plan, the most important piece of work we had to do was to learn the local real estate market, especially our "target" neighborhoods. Using a spreadsheet, some legwork, and a few simple online resources, I set out to map the asking and selling prices for neighborhoods in our city over a few months time. Some of the very first trends we spotted caused us to drop real estate as an investment idea entirely. And fast.

First, foreclosure handling (buying and selling foreclosed properties) made up roughly 25% of our local real estate activity. That seemed crazy high. High end homes, low end homes, and everything in between. Banks selling to investors, investors selling to buyers. 25%!

The second thing we noticed was that investors were buying a lot more as a group than they were actually selling. This could be seen not just in the raw numbers but also on physical inspection. One older neighborhood was notoriously popular with investors and you could spot the "flipped" homes immediately with their formulaic fixes and their shiny front door lock boxes. I say this quite literally: every other home in a 12 block radius near my dad's old office was a flipped property for sale. As a result, the pricing trend was actually going down. Not the direction a speculator plans to see his investment dollars go.

The third thing we noticed was the sheer number of investment buyers. Somewhere along the line, an amazing number of single guys, grandpas and grannies, and just plain old married couples decided to incorporate companies with quaint, folksy names like "Bob and Sally Investments" or "Jim's American Dream" and start buying properties to flip. Obviously we were very, very late to the party.

That was the moment I began to realize that the negative mumbo jumbo being uttered by a few alarmist real estate bears might actually be true (despite many bullish reassurances that it was not). It was also the moment that I began to realize that maybe the real estate bubble wasn't confined to major metro markets like San Fran, New York, Atlanta, and Boston. That maybe freakishly low interest rates and easy loans were fueling the kind of speculative buying that was creating a bubble everywhere.

This was all before the sub-prime crisis blew the lid off of the financial industry, of course. Now the whole thing has gone into a flaming death spiral.

Nouriel Roubini (who I've come to trust and who has been dead-on right about the market all along), had this to say yesterday on his blog:
Following the meltdown in new home sales - down a whopping 9% in November alone based on data published today – it is clear that this is not going to be the worst housing recession in the last 50 years as I predicted; it is rather going to be the worst housing recession since the Great Depression or, better, the worst housing recession ever in US history.

At this rate of falling sales (and they will fall much more ahead) housing starts that have already plunged over 40% from peak to a level of about 1.1 million will have to fall another 25% - to a level below 900K – to start clearing the excess supply of unsold new homes that is now at 9.3 ratio relative sales. And even a 20% fall in home prices now looks like too optimistic; the total cumulative fall in home prices may turn out to be closer to 20% with some urban areas of excess (in Florida, California, Nevada, Arizona, etc.) showing even 40% fall in prices.
Pretty scary stuff.

I'm not sure how this has affected my own home, which saw a market value appreciation of 37% over 7 years. Seemed too good to be true... now I'm fairly certain it was. It's hard for me to tell what the current market value for our home is since I haven't seen any other homes in the neighborhood on the market for while. I'm guessing most people are like us, fixing to ride it out.

What a time to be a first time buyer with good credit, though... after a long, dry spell of being priced out of the market, they finally have a little leverage.


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