Those of you who watched this week’s Democratic Party debate will note that the current foreclosure mess was an oft repeated theme. The candidates are trumpeting what they’ll do if they win in November, but two bills are already before Congress that will impact lenders and consumers.

The somewhat awkwardly named Emergency Home Ownership and Mortgage Equity Protection Act of 2007 and the Foreclosure Protection Act of 2008 are both being debated. Both are focused properties with nontraditional (neg am, interest only, etc) mortgages or subprime mortgages. Mortgage balances and monthly payments would be reduced based on how much a home’s value has decreased.

These won't impact investors directly, since they only applies to owner occupied properties. However, the measures are defiantly of interest to investors since it’s likely that it will impact the cost structure of the entire industry. The measure might decrease the number of underwater owners who walk away from mortgages, but essentially it forces the bank to eat the cost of the market downturn, instead of owners.

This is reform on the cheap, since short term the banks will be shouldering the cost. But the medium/long term effects won’t be good for consumers:

• Banks who are already reeling will be dealt an additional blow. This will lead to a real bail-out, paid for with real taxpayer dollars. The short term “reform on the cheap” won’t stay cheap for long.
• Banks are already recalibrating the way they quantify risk. But the current model assumes that a when a buyer purchases a home then said buyer will both enjoy the benefits of appreciation and the risk of a decrease in value. This assumption no longer holds, and the banks will be justified in charging accordingly. Home ownership will slip further out of reach of an increasingly large segment of the population.

Reform on the cheap doesn't work.  The banks will fix their own messes.  Some should fail - we should let them.  And if the government determines that citizens who are in trouble need help, we shouldn't fool ourselves that this can be accomplished without the government pulling out it's checkbook and spending some tax dollars.  Coercing the business sector to take an altruistic step will backfire in the end. 

This week's Fortune magzine featured an interesting article that puts an interesting spin on the housing market that takes a page from the real estate investor's playbook. 

Followers of the equities market will be familiar with the P/E ratio, the most often quoted financial ratio calculates a company's share price as a multiple of its earnings.  A high P/E ratio is evidence of the market's collective assessment that earnings are poised to grow dramatically, whereas a low P/E ratio tend to stick to companies with poor growth potential. Sky-high P/E ratios are not sustainable.  Either the companies blow up (pick the dot.com of your choice as an example) or they mature, stabilize, and earnings "grow into" the stock price (Ebay, Microsoft, etc.)

So what's the P/E ratio for the property market?  It's the relationship between property values and rents. 

Again, for investors, this is pretty intuitive.  How much do you want for that starter house?  $500 thousand you say?  And it should rent out for $2,000 per month?  Hmmm....I don't even have to plug that one into my economic model to figure out that those numbers don't work.  The only way that investment will pan out is if the market races along for another couple of years at double digit rates of appreciation.  If that's your belief and you're willing to put your money where you mouth is then by all means go ahead and write that earnest money check. 

But, like P/E ratios in the stock market, sky high price-to-rent ratios are not sustainable (which is why, for the time being, Jeff Brown is sending his sunny San Diego investors hunting for deals in the Great State of Texas).  The article quotes Yale economist Robert Shiller: "Like P/Es, price-to-rent ratios are mean-reverting."

There is a little bit of good news hidden in this analysis, however.  Once the price-to-rent ratio gets out a whack there are two ways for it to drift back in line: a) property prices fall or b) rent rates go up. 

Fortune crunches the numbers for the major metropolitan areas and they stack up pretty much how you'd expect them to.  The article isn't online so you'll have to hit the newsstand and plop your $4.99 down if you want the details. 

Nationwide Foreclosures are up 30% in the third quarter, compared to last quarter - and up nearly 100% over this time last year, according to RealtyTrac.

At the top of the list is Nevada, with one fourclosure filing for every 61 households, up over 200% from this time last year.  California is in second place, with 1 filing for every 88 homes. 

Investors will keep a close eye on their local situation in making investment decisions, but there are some interesting national trends forming.  Notably, 45 out of 50 states experienced year-on-year increases in foreclosures.  This, along with tightening credit, increasing oil prices and declining consumer confidence have the potential to have a broad national impact.  This is "the tide that lifts/lowers all boats."  So even though we may view national headlines with a shrug, smart investors in Oklahoma and Virginia realize that what's going on in California and Nevada really does matter. 

I wrote a few days ago about the phantom bounce that some housing statistics may be implying.  The New York Times has followed up with an additional piece on the evolving condominium market, which might flag some opportunities for real estate investors.  

The condominium market is more vulnerable to large fluctuations in price because they disproportionately attract speculative investors, as opposed to single family homes.  Residential homebuyers tend to be less fickle – a property which is purchased as a home as opposed to an investment is less likely to be whipsawed by the market.  

That’s starting to show in some major metropolitan markets where condos used to be selling like hotcakes, but are now slowing down.  Buyers in some cases are forced to sell at a loss – or to rent them out at a rate that turns them into negative cashflow investments.  

This, undoubtedly, will turn out to be a blip in some areas, not a long term trend.  Nervy, contrarian investors can find bargains by jumping onboard when everyone else is headed to the lifeboats – and this current wave of woes was prompted by investors who did exactly the opposite: they broke ground when the market was white hot and development costs were through the roof.  

Check out these stats on the WashingtonDC area.  

Note:  the downturn at the tail end of the "condos sold" graph is in reality likely to be even more severe than the chart indicates, given that cancellations are probably not accounted for. 

Shoot me a note and let me know how your metro area is faring.   

The fuzzy sciences get a bad rap.  Everyone likes to knock economists, and their faith in efficient markets has been canonized in marginally funny jokes  (I'm thinking of leaving my husband, complained the economist's wife.  All he ever does is stand at the end of the bed and tell me how good things are going to be.) 

We also love to bash the popular press (infotainment hacks) and automated forecasts (love ‘em or hate ‘em you cant get away from Zillow conversations in the real estate blog world).

So what am I going to talk about today?  A CNN piece compiling economic data from Moody’s that makes some predictions about future home prices .  Why?  ‘Cause I love this stuff.  Just like Zillow gives you a potentially useful data point (not a certified appraisal upon which you’re going to write a contract) economic studies can give us a glimpse into how the factors that drive prices are lining up.  Plus – there’s an element of a self-fulfilling prophecy that comes from a forecast that is shotgunned out to huge swaths of the consuming public. 

So what’s next for real estate in ’07.  Well according to this study check out these markets:

1)  McAllen, TX
2) El Paso, TX
3) Albuquerque, NM
4) Salt Lake City, UT
5) Syracuse, NY
6) San Antonio, TX

The numbers aren’t too sexy, in terms of property appreciation – the best markets in the country are expected to rise at 7% to 9% in ’07.  But consider the fact that you’re leverage goes a long way in an undervalued market – which most of these are.  A zero down investment that appreciates at 7%...I’ll take that. 

...but some are starting to cool. 

This month Global Insight and the National City Corporation teamed up to publish a survey of regional housing market valuations.  Of the 317 metro areas evaluated:

• 219 (69%) showed a slowdown in appreciation over the past year
• (21%) showed outright declines in property values
• 79 (40%) qualified as extremely overvalued. 

See the full study here.

The most overvalued metro areas were clustered on the west and east coasts with California and Florida dominating the top twenty.  Naples FL had the highest overvaluation at 101.5%, followed by Bend OR at 89.3% and Salinas CA at 79.4%.

At the other end of the spectrum, seven of the ten most undervalued markets were in Texas.  College Station, home of the Texas A&M Aggies, was the most undervalued at -22.3%, followed by Dallas TX at -21.2%, Fort Worth TX at -19.3% and Houston TX at -17.3%.

Source:Global Insight/National City Housing Valuation Analysis

The paper also lists the major regional price corrections of recent years.  Texas also features heavily in this list; back in the mid 80’s the oil industry fueled a glut of investing that resulted in a speculative bubble which spectacularly popped when the oil market crashed.  Houston declined by 21% over 12 quarters.  Odessa, another oil hub, declined by 28% over 14 quarters. 

The current market condition in cities like Houston and Fort Worth has created an environment in which it is comparatively easy to find investment properties that generate positive cashflow at relatively low risk.  The ratio of rents to property values is high, and although there is always market risk the probability of an absolute decline in mean values from this level is relatively low. 

Investors in overvalued markets however should be wary.  Price dips might look like buying opportunities, but at these levels getting into the market feels more like speculation than investing. 

Another indication that the real estate market is starting to turn in some regions is starting to reveal itself.  According to RealtyTrac, foreclosures for the month of August are up 53% over on eyear ago.  Overheated markets are posting some of the largest increases:  Nevada (+255%), California (+160%) and Florida (+62%).  Much of the increase can be attributed to a cooling real estate market, compounded with rising interest rates as adjustable-rate mortages reset and increase the monthly debt burdeon paid by homeowners.