Monday, December 11, 2006
There is a lot of wishful thinking about housing in the headlines. Today the National Association of Realtors projected that housing would turn NEXT quarter. So let me get this straight. That condo next to mine in the West, which sold for $X three years ago and is now is on the market for nearly $2X is likely to sell next quarter. At the risk of being persona non grata West of the Rockies, my answer to the National Association of Realtors and real estate speculators is, "Ain't no way." The skyrocketing prices of housing and the concurrent new construction in many parts of the country over the past 4 years have caused a glut that will take another year, maybe more, to work through. The reason is simple. Right across the street from my neighbor and me is a whole new development of handsome, nicely appointed units priced at $1.9X. I took a self guided tour through the development a few weeks ago, and I stumbled on one of the sub-contractors. I voiced my admiration of the workmanship and then asked him how they were selling. He said, "Funny thing; we had lots of interest in the project eight months ago, even some earnest money, but to my knowlege we have not sold any. That's not funny. That's called lack of demand, that's called too much supply. That's bad news for real estate and real estate investors. My story is purely anecdotal, but it is a symptom of why real estate in some parts of the country has a long way to go before its supply and demand reach equilibrium. Much of the Midwest is in good shape, but as I have said before, housing at the "right" address, or with a view of the mountains, lakes, oceans, or the 18th hole of a course that Jack built, is in for a long period of stagnation. Too much of it has been built, and in my judgment, some prices are likely to fall by more than most people believe, including my neighbors, mine, and the new development across the street. The reason is the banks. The developer of the project across the road from me probably hasn't thought about it, but his banker has been watching his progress. Bankers are nosey that way when it's their money. Bankers have sophisticated models that tell them how things are going, and they know in certain areas things are not going well. In another generation, in another real estate contraction, the banks played the bag holder. They hung in there with all the builders and speculators, and in the end, their bags held all the real estate, which they then sold for pennies on the dollar. A long history of bag holding has been a slow but sure teacher to the banks. They have decided they are not going to be the bag holder this time. They will call loans early and often. The reason is because they have a ready buyer -- private equity funds. Private equity funds will buy anything for the right price, and the banks have decided if they are always to be the bag holder when the dust clears they might as well sell their loans to the private equity funds sooner rather than later. This scenario sounds like tough medicine for the economy, and while it will be difficult if you are a big borrower with slow moving properties. The news is not all bad, however. This scenario implies a sharp, narrow correction in real estate that will resolve itself without major damage to the banks or to the economies of whole regions of the country. But having said this, this process will not be complete by next quarter. Furthermore, there will be very worrisome headlines in the weeks and months ahead about mortgage defaults and foreclosures that could make it Feel like the housing problem will go on indefinitely. The operative words in my judgment are sharp and narrow, but I'll keep you posted. The stock market is painting the best face on the financial facts at this time. But the facts will soon turn darker as a result of the lingering housing slowdown, and the current bull market will narrow dramatically. High-quality, blue chip stocks will be the only bull standing by the middle of 2007. Blue Chips will continue to get a lift from their international business, which will continue to be strong in 2007. Stocks have already priced in a Fed rate cut in March. Recent employment data is much too strong for a March rate cut. I think the cut will come much later and for cause. History shows us Fed rate cuts are not presaged by such a celebratory atmosphere as the one we are currently witnessing in the US stock market. Blue Chips are, indeed, underpriced by 10%, but the average stocks in no bargain. Next time: A look at some undervalued stocks. This blog is for information purposes only. Do not make buy and sell investment decisions as a result of anything you read here. Please consult your own financial advisor.