Outlook Dim, but...

The National Association of Home Builders just released their latest index on homebuilder confidence, and while homebuilders are seeing an increase in potential purchasers, their outlook for the for the next six months is still negative.

"Some potential buyers who have been sitting on the sidelines are starting to at least research a new home purchase given improving affordability factors and the large selection of units on the market," said the Association’s Chief Economist, David Seiders.

"That said, builders know there's a difference between people looking and people buying, and their current outlook remains quite subdued," Seiders added.

In today’s environment, where any good news is really, really good news, even a slight increase in potential purchasers is a breath of fresh air.

Mortgage interest rates are terrific for those who can get them, and the smaller real estate investors are much-better poised than the publicly-traded homebuilders to turn those lookers into buyers.

About The Future

The other night, I was out having drinks with a friend of mine who works for a homebuilder located just outside of Atlanta.

As a builder, his company is doing well; while the current market has certainly affected their business, they’re still chugging along and closing around five sales each month. But they are in a good market: they build moderately-priced homes in the low-to-mid hundreds, and really concentrate on first-time homebuyers with good credit. As he said: they’re the last ones to feel a drop in the housing industry, and the first ones to recover.

But, even though his company is continuing to thrive, my friend was interested in where I thought the housing market was going and what real estate investors were going to see in the near future.

As a real estate closing attorney, I follow the housing industry very closely. I have always thought that knowledge is the most important resource that one can have as a real estate investor; if you know more than the other guy, then you’ll probably do better than he will. Knowledge, they say, is power.

One thing to recognize is that the spectacular boom of the past few years in real estate investing came as a direct result of the access to easy mortgage money. Mortgage lenders were willing to lend trillions of dollars to those least able to repay. Why? Because there was an insatiable appetite for these types of products on the secondary market up on Wall Street. Hedge funds, pension plans, overseas banks couldn’t get enough.

This resulted in one of the most dangerous loan products out there, and one that I believe is at the root of the majority of difficulties facing the real estate market in Atlanta: the 100% adjustable-rate mortgage.

As a closing attorney, I closed hundreds of these loans, subprime and not. Buyers came to the closing table with no money and got a low interest rate on their loan for the first couple years. Everyone looks only at that initial payment, because they expect to refinance before the loan to reset to a higher rate; and as long as property values keep increasing, then there’s plenty of equity to pay for that refinance. Like I said, I closed hundreds of ‘em.

Well, of course, we know what happened: prices didn’t keep increasing.



These charts, in one form or another, have been on the wall of my office for the past year. They are, I believe, the single two most important indicators of where the mortgage industry is headed, and how long it will take to recover.

Both were created by Bank of America, the top is the original, the one below revised. And they show, in billions, the amount of adjustable-rate loans resetting to their higher rates.

Why is this significant? Because it is primarily the ARM resets that have driven down the housing market for the past year. As borrowers found their payments increasing, many of them quickly realize that their new payment was not affordable. Burdened with a home that they can’t afford, with little-to-no equity, these borrowers started scrambling for options.

Unfortunately, the options are few and far between. Refinancing isn’t possible for most because of tightening credit standards and reduced loan programs. Unable to refinance, borrowers try and sell their homes, leading to the glut of homes on the market. And with more homes on the market, there is more competition for the few buyers out there.

Prices are pushed downwards.

Lastly, there’s the final option for borrowers in these loans: foreclosure. And of course, foreclosures are at an all-time high and are expected to increase. The flood of REOs back onto the market again push prices down.

Both of the charts are very telling: that we haven’t seen anything yet. All of the homes on the market, all of the lenders going out of business, home prices deteriorating; and we haven’t yet even reached the peak of ARM resets.

The original Bank of America chart showed that peak in March of 2008; the revised has ARMS peaking in June.

For most borrowers, once the rates adjust, they’ll do everything they can: but the odds are definitely against them. They may struggle to make payments, and some certainly will. But the great majority won’t – and faced with a home most-likely worth less than what is owed, they’ll be unable to refinance or sell. Eventually they’ll fall behind on their payments.

So: as an example, let’s take someone who has a loan that adjusts in March. Their payment increases, and they make them for as long as they can. Say, four months. In August, they miss their payment.

Is the lender going to foreclose then? Probably not. It’ll probably take another four months for the lender to initiate foreclosure proceedings. So the borrower may get their foreclosure notice in December.

In Georgia, foreclosure is a fairly speedy process, generally taking two or three months. For our hypothetical borrower, it’s March of 2009 before the property is deeded back to the bank.

What does this tell to us? That as an industry, things are much more likely to get worse before they get better, and that the housing slump we’re in now is probably going to last for some time to come.

What else does it tell to us? That there are still ways to survive and profit as a real estate investor. I can't say this enough. My friend who works for the builder; they are still doing well. And other investors, who recognize and understand the broader market forces at play continue to thrive. Traditionally, in down times, investors do well. There’s a smorgasbord of potential deals out there. The smart investors recognize that, and continue to work today’s and tomorrow’s market to their advantage.

Looking Ahead

In the cover story for its January 31st issue, Business Week Magazine details the housing meltdown and sets forth the case that home prices may drop another 25% before bottoming out.

While a 25% decline would be unprecedented, it’s certainly not out of the realm of possibility. Right now there are a tremendous number of unknowns at play: foreclosures are at record highs and projected to increase; more homes are on the market now than ever before; the wave of adjustable-rate loans resetting to higher rates hasn’t crested; and more and more people are stuck an homes with little or no equity to help them get out.

Plus: there’s the rising specter of a government bailout.

Now, almost certainly the home values in Atlanta won’t drop as much as other places in the country. We’ve certainly seen that so far: as cities like Detroit and Miami and San Diego have been seen home values plummet, Atlanta has held steady. Even today, though the Atlanta area is seeing price depreciation, it is mild in comparison to the rest of the country.

But, nothing is certain at this point, and we really won’t have any idea how bad the problem is for some time to come.

So what does all this mean for the real estate investor? Is there no money to be made in investing in real estate?

The answer is: certainly not. There is plenty of money being made every day by investing in real estate. There are plenty of investors who are doing well and are capitalizing handsomely on the current market.

That is: there are still areas of the housing industry that are thriving.

For example, for those who can get them, mortgage rates are exceedingly good right now. For borrowers who can put significant amount down, who have excellent credit, and who are looking to borrow less than the conforming $417,000 limit, interest rates in the fours are not uncommon; and the smart investors are marketing their properties to these purchasers.

It’s not as easy as it used to be, and investors may not be making as much as they used to, but the profit is still there for those who are willing and able to adapt to the market at hand.

Down, but not out.

CNN Money just ran an article from Investors Business Daily on the effect of the current housing market on some real estate investors. On the whole, it’s a good read and echoes a number of the things we’ve been saying for a long time.

Subprime Mess on 60 Minutes

For most real estate investors, the boom times of the past few years was fueled by easy access to money given by the big mortgage companies like Countrywide, Homebanc, and New Century. Money, as they say, flowed like water.

The “subprime mortgage crisis” has pretty much put a stop to that, and our real estate investor clients are finding new and different ways to profit in this challenging market.

60 minutes recently ran a segment which does a fairly nice job of detailing the relationship between simple homeowners, mortgage lenders, Wall Street, and international banking. It’s an interesting watch.