There’s a multi-factorial equation brewing out there that is going to impact real estate investors. 

Concerns about flatting property prices tend to get the most press time, along with the ongoing sub-prime lending soap opera. And we’re all keeping an eye on interest rates and hang on Bernanke’s every word. But in my opinion the real story will be how all these factors impact all those risky loans out there, and this is a die that has yet to be cast. 

First American CoreLogic recently released a study on Mortgage Payment Reset and the potential impact that it will have on our economy. Note that First American CoreLogic is an arm of First American – and many visitors will be familiar with First American Title, one of the nation’s largest Title companies. The point being: just like the National Association of Realtors the title industry has a dog in this fight so be careful about taking all of CoreLogic’s conclusions without a bit of scrutiny. But that said, there’s a lot of good data in this report. 

Here’s something that jumped out at me. In 2006 lenders issued $200 billion in ARMs w/ their first reset in 2006. Of that $200 billion worth of quick reset mortgages the vast majority was at super-low teaser rates of less than 2%. Seemed like a good idea at the time: rising prices and brisk home sales made the risks easier to stomach.  Now that market has cooled those 2006 resets are causing problems for many buyers who were overstretched in the first place, and that’s what’s triggering the current wave of foreclosures. 

But, there’s more to come. Most of the ARMS originated in 2006 w/ 2008 resets ranged from 6% to 9% initial rates. Sub-prime territory. And these folks, based on CoreLogic’s assumptions, will be facing increases of from 30% to 50%. The second half of this story is that 23.9% of ARMs originated in 2006 have negative equity, versus only 10.3% of fixed rate loans taken in the same period. 

So not only were ARMS used by the most vulnerable buyers, they were also more than twice as likely to be used for properties in which the owners had no equity. The punchline: during the run-up ARMS were used as an instrument to buy homes that people couldn’t really afford. 

The New York Times ran an interesting article today advising those homeowners who are about to get into trouble to negotiate with their lenders. Many owners don’t realize what we do as real estate investors: the bank doesn’t want your house. Foreclosure is a disaster for the homeowner, but it’s no picnic for the bank. Expect troubled owners to take a page out of the short-seller’s playbook.

Figures released last week indicated a contraction both in housing starts (lowest level since 1997) and in median sales prices.  Median prices fell in 73 metro areas in the final three months of 2006.  These results on the back of one of the strongest housing booms in U.S. history.  The sober view is that concern is not unwarranted.

Glance at today’s USA Today, however, and you’ll get the idea that everything is rosy; unless you dig into the article you might come to the conclusion that some positive numbers have been release.  The main headline on the front page of the Money section (three of our columns - use your imagination if you're looking at the online version): Realtors expect home price recovery.  The first quote is from David Lereah expressing optimism that a “discernable improvement in both sales and prices” is already upon us. 

Real estate professionals will know who David Lereah is, but some investors might not.  Lereah is the Chief Economist for the National Association of Realtors®.  The NAR is the industry group charged with keeping the real estate market moving, keeping prices on the rise – and most importantly ensuring that sales volume stays high, which means more commissions flow into Realtors® pockets. 

A statement from Lereah isn’t "news", it’s a sales pitch.  Lereah is just doing his job – trying to convince homebuyers (and investors) that everything is rosy.  The problem is that consumers will read an article like this one – prominently published by a high volume national news source like USA today, and mistakenly conclude that it’s news. 

So what does it mean to me?  Two things to consider as an investor.

• Consider the source.  It’s fine that the National Association of Realtors® has a voice in the press, but don’t give their forecasts and vies the same weight that you’d give to an impartial market expert.  The NAR has a point of view that they’re trying to sell. 

• Look at the underlying numbers.  Even a bad article like this can yield some information.  National median sales price for an existing single family home is down 2.7% nationwide from the same period last year – so instead of trending upwards with inflation (the natural path) the market has entered into a quantifiable correction.  Ask yourself “is this enough.”  What’s your view on your own area. 

• Be skeptical about some “information” you get from the popular press.  I note that on the same page of the USA Today they have a color photograph of the new Ford Edge HySeries prototype SUV, a fuel-cell plug-in hybrid that the paper refers to as “pollution free”.  This is simply wrong.  A car that you plug into your wall to recharge runs on electricity, and the vast majority of electricity in the United States is produced by power plants that burn hydrocarbons – primarily coal and natural gas.  Electricity isn’t free, and it can’t be produced unless you burn something, which creates pollution.  Fuel cells run off of hydrogen, which in itself is clean, but is produced as a by-product of natural gas – again, a hydrocarbon. All cars pollute – it just makes us feel a bit greener if the pollution is coming from the smokestacks of a remote power plant or hydrogen facility instead of the tailpipe of the car we’re driving.  A tangent from the topic of real estate?  Perhaps – but for me it’s a clear example of the fact that the press will simplify issues until they’re simply wrong – and that’s dangerous for an investor.  

David Lereah, the chief economist for the National Association of Realtors, gave a view of the future of the housing market this week during  a meeting of agents in Saratoga Springs.  In Lereah’s estimation the decline that started in the third quarter of 2005 was a needed cooling off period, but would be short lived. Interestingly, he stated that a rebound would occur in the next three to six months in most regions, but prefaced this prediction on the condition that the Federal Reserve shows restraint in raising interest rates. 

Lereah’s most quotable statement was in reference to the median price for a single family house in San Francisco: $740,000:  “Who can afford that?”

Read the full article here

Note that prices vary widely by region.  As a sample, according to NAR figures Houston averages $152k, Orange County $726k, Boston $421k, Chicago $278k, and Springfield $112k.