The 2008
Economic & Housing Report
June 27, 2008
Gary Watts’ forecast for 2008
marks the 34th year of bringing to the real estate industry his
outlook for the resale housing market.
More than just forecasting appreciation numbers such as those below,
For the record, here are his appreciation numbers compared to actual numbers since 2000:
2000 2001 2002 2003 2004 2005 2006 2007 2008 Totals:
Forecast: 12.5%
12.0%
10.0% 15.0% 25.0% 15.0% 15.0%
7.0% *
109.5%
Actual: 13.0% 10.1% 16.8% 19.1% 24.8% 16.5%
3.4% - 1.5%
102.6%
* No forecast can possibly be made until the
financial markets gain some stability.
2008 Mid-Year
Real Estate Economic Report
Last Years
Forecast . . .
. . . ended my 33 year run at forecasting the direction of real estate. I apologize for not seeing what Wall Street was doing
to the financial structure of our economy and its future effect on real estate.
Is it
Sub-Prime’s Fault?
The numbers showed that sub-prime loans were not that big of a problem but the media said differently!
♦ Sub-Prime Foreclosures Soar!
The truth is that only 18.79%% of all sub-prime loans are delinquent (30 days or more). That means 81% of the borrowers (who could not get a Discover Card) have never missed a payment!
♦ Record Foreclosures Hit 5-Year High for
Sub-Prime Loans!
Interesting headline! In 2001, sub-prime loan volume totaled just 7% of loan originations. By 2006, the volume had exceeded 20%! This explosion would naturally cause a new record in the number of sub-prime foreclosures! Presently, only 20% of delinquent loans end up as short-sales, deeds-in-lieu or foreclosures. The remaining 80% of borrowers either work out a repayment plan, a note modification, refinance, sale or reinstatement!
♦ Sub-Prime Write-Downs Cause Financial
Crisis!
If you combine sub-prime and Alt.A loans (non-prime), they represent only 12% of the
entire home loan market. Half of these loans are fixed-rate, thus the 6% of
sub-prime loans that are adjustable are responsible for 39% of all
foreclosures! Today, only 3.65% of all sub-prime loans go to foreclosure. This
may help to explain why David Wyss, chief economist
at Standard & Poor’s in New York said, on January 4, 2008: “You
look at the magnitude of the sub-prime problem, and it’s just not that big
relative to the size of the economy or the financial market.”
So What Caused This Financial
Crisis? A Structured Investment Vehicle (SIV)!
Wall Street says these multi-layered finance products, created in the early ‘90s, were developed to meet the needs of a changing investment market and provide a way for risks to be diversified.
“These ‘structured’ finance products normally entail aggregating multiple underlying risks (such as market and credit risks) by pooling instruments subject to those risks (e.g., bonds, loans, or mortgage-backed securities) and then dividing the resulting cash flows into “tranches,” or slices paid to holders of these tranches in a specific order, starting with the “senior” tranches (least risky) and working down through various levels to the “equity” tranches (most risky).”
The Structured
Investment Vehicle (SIV)
So when the sub-prime loans began to weaken in large numbers, the banks blamed the sub-prime loans for their massive write-downs. What really happened was the collateralized debt obligations (CDO) were having problems, the collateralized loan obligations (CLO) were not fully performing, and the asset-backed securities (ABS) were having defaults. The sub-prime loans were only part of the catalyst that got the whole mess rolling!
♦ As sub-prime defaults increased (with them being incorporated in these complex and difficult-to-value
structured finance products), fears from investors rose.
♦ Then the 3 main credit rating agencies (Ambac Financial Group, MBIA, Financial Guaranty Insurance)
were forced to make precipitous downgrades on a large number of these structured finance products - due to
rising default rates that exceeded earlier assumptions.
♦ With these downgrades, added pressure was put on insurance companies that insured various parts of these
structured investment vehicles, but it quickly became clear that they did not have the reserves to cover all the
potential losses.
♦ Banks began to lose confidence in the ability of their counterparties to meet their contractual obligations.
♦ Investors did not have a clear idea of what portion of the SIV they owned, who they owned it with, what
portion (if any) was insured, what was their “tranche” position, and were any of the insuring companies
covering any of the losses. Not knowing, many investors withheld funding from these complex structured
products, even those with high-quality underlying assets.
♦ With no market to sell all or part of these complex products, values quickly plummeted, and thus the
resulting financial crisis.
Participants (in
these SIVs)
and Percentages: (approximate)
1. Banks (both
2. Hedge Funds & Sovereign Trusts 28%
To make matters worse, SIVs were entities that allowed financial institutions to transfer risk off their balance sheets (OBSEs) and permit exposures to remain mostly undisclosed to regulators and investors. They did this to improve the loan liquidity and generate fee income, while achieving relief from regulatory capital requirements.
During the relatively long period of excess liquidity and low interest rates, credit was made available to various types of borrowers (sub-prime, businesses, credit card holders, leasing contracts, commercial loans, manufacturing, auto loans, etc.) who would otherwise have not been able to obtain such credit! To make matters worse, they were using short-term maturities to originate long-term loans.
So what effect did this all have on have
on housing?
The Current State of
Current Listing Inventory: (As of June 13, 2008)
♦ 14,880 - a current housing supply of 4.86 months
♦ 47.9% - of our entire inventory is priced below $500,000 representing 57.5% of the demand
♦ 39.6% - of our entire inventory (5,898) is distressed properties:
a. Short-sales make up 79.6% and have a market time of 7.18 months
b. Bank-owned make up 20.4% and have a market time of 1.43 months
c.
In southern
♦ 77.5% - of distressed properties are priced below $500,000
♦ 93.5% - of distressed properties are priced below $750,000
♦ 33.2% - of attached homes are vacant
♦ 23.9% - of detached homes are vacant
♦ 17.8% - demand for homes above $750,000
a. Distorts the median sales price – 9 month decline in the jumbo purchases (40% vs.15.8% today)
(1) Smaller sales reduces the sample size thus reducing the validity of the conclusions
(2) The dominance of foreclosures and short-sales usually concentrated in a smaller area
(3) Median sales price is now being dominated by the low-end/smaller property market
(4) Larger price declines on distressed sales, actually distorts actual metro sales prices.
The Future of Orange
Why The End of This Downturn May Be Near:
♦ Inventory is decreasing while sales are increasing and the April sales finally ended our 7 month
record of declining sales.
♦ The bulk of sub-prime loans were made in 2005/2006, therefore most of these problem loans
have already entered the marketplace.
a. During those years, OC funded approximately 22,500 sub-prime loans.
(
b. They were largely concentrated in the areas
of
c. In May, 78.6% of all buyers who closed loans in OC, chose fixed-rate financing.
♦ We have a rather stable real estate market
a. 23% of OC properties have no loan on them
b. 60% have long-term fixed-rate financing with plenty of equity
c. 10% will be successful in some form of note modification or re-instatement of their loans
d. In
e. The current 1st Qtr. delinquency rate (60 days) on loans in OC, was only 3.14%.
♦ Foreclosures (unfortunately) should occur for at least another year, so the market will be “soft”
through 2009 unless . . .
The Challenges
The economy is currently facing four distinct headwinds:
1. Wealth Effect – due to declining real estate prices
a. Federal Reserve reported that real estate “net” equity declined $879.6 billion last year.
b. Household equity is at 46.2% - a record low, since keeping track after WWII.
c. Prime ARM’s entering foreclosure now exceed the entering sub-prime foreclosures.
2. Price Effect – due to higher energy and food prices
a. As inflation begins to rise, consumers and business spending decreases.
3. Funding Conditions – due to the “credit crunch”
a. 60% of banks have tightened credit standards for residential borrowing.
b. 40% of banks have tightened credit standards for consumer loans.
c. 80% of banks have tightened credit standards for commercial loans.
4. Income Effect – due to higher unemployment
a. Current unemployment rate has risen to 5.5%.
b. Less income, less paid taxes, more pressure on federal, state and personal budgets.
Watch out for the “spill-over” effect. If prices were to continue to decline significantly, another tier of
properties, with exhausted home equity lines or increasing loan balances, could set off another round of
potential foreclosures. (Note: 75% of option ARM borrowers have been paying the minimum payment)
♦ Current delinquency rate (30 days or more)
for all
♦ Nationally, there were 1.5 million properties that entered the foreclosure process last year – in
normal markets, the yearly average is 600,000.
♦ Of all 51 million
mortgages in the
♦ 4 States (CA, FL, AZ,
A Final Perspective
The media will still report decreasing sales and more sub-prime mortgage losses, but let’s deal with the
facts:
♦ Global income will hit $53 trillion in 2008
and the
♦ Sub-prime losses will be about $100 billion this year ($300 billion last year) – but the world
earns that amount of money every day!
a. This
loss only represents 0.01% of the $100 trillion in combined assets of all
households,
♦ Lenders will recover approximately 70% of their outstanding loan balances through repossessing
homes and then reselling them!
♦ Investors have “parked” $3.5 trillion dollars in money market funds – it has to eventually
move someplace, and hopefully a large chunk goes into real estate lending once again!
♦ Last year, sales of investment property were down only 7% from the peak years (2005/2006),
while vacation or 2nd homes remained the same at 12% of all existing and new-home sales.
a. The
weak dollar is making it very attractive for foreigners to acquire
estate.
b. They are betting that our prices are near the bottom and the U.S. dollar will begin
to rise – giving them the “double whammy,” when they sell in the future.
♦ Price declines have allowed first-time home buyers back into purchasing real estate!
♦ Pent-up demand from buyers who have been “fence-sitting” for the past two years and are
now re-entering the housing market should reduce our current housing supply.
♦ OC home sales in May were up 8.3% and the