Why do house prices have farther to fall?
Many people seem to find it incomprehensible that housing prices have further to fall. And yet when you look at what is going on, it is perfectly reasonable that they have to. For the first time in several years, monthly payments are being reconnected to house prices, which ultimately are based on local area affordability.
Let me explain.
Wall Street and the real estate industry accomplished something amazing early in the boom. Consumers stopped focusing on house price and started focusing instead on monthly payments.
Remarkably, monthly mortgage payments were disconnected from the price of the house. Money became cheaper and easier while leverage increased (i.e., down payments shrank). With increasingly exotic mortgage products making a house ever more accessible and the virtual elimination of a down payment, consumers started to view buying a house as they would any other consumer good. Like cars and appliances, houses became a function of the monthly payment, which was progressively manipulated through increasingly exotic loan programs. The more this process continued, the more prices of houses could rise, further fueling the boom. To the consumer it did not matter what the price of the house was, only the monthly payment.
Furthermore, the builders still were working in “house price” dollars, so they also pushed prices higher, fueling the supply side of the equation. In response to rising prices, mortgages become more esoteric in order to maintain a palatable monthly payment. As long as credit was easily obtained, interest rates remained low and house prices continued to rise, people flocked to participate in the American Dream. Speculators saw prices rise and jumped in to participate in this apparently easy way to harvest money, fueling demand. This never-ending cycle continued until one day in late 2005 when it stopped. Mortgages were as exotic as they could be, consumers could not stretch their dollars any further. In an unprecedented flash, it was over.
Now precisely the opposite is occurring. Although money is relatively cheap now, it did get more expensive helping to grind the wheels to a halt. However, access to money is not easy. Equity is now required. Credit underwriting has reemerged to ensure that loaned funds can actually be repaid. Monthly payments are being forced back to being a function of price because a home purchase is dependent once again on a significant down payment and a verifiable income source to repay the mortgage loan. Whether you consider the traditional debt to income ratio of 28% or a multiplier of 2.5 times income, based on the historic relationship between income and mortgage payments, prices will need to fall much further to bring the two back into line.
The market has spoken.
Let me explain.
Wall Street and the real estate industry accomplished something amazing early in the boom. Consumers stopped focusing on house price and started focusing instead on monthly payments.
Remarkably, monthly mortgage payments were disconnected from the price of the house. Money became cheaper and easier while leverage increased (i.e., down payments shrank). With increasingly exotic mortgage products making a house ever more accessible and the virtual elimination of a down payment, consumers started to view buying a house as they would any other consumer good. Like cars and appliances, houses became a function of the monthly payment, which was progressively manipulated through increasingly exotic loan programs. The more this process continued, the more prices of houses could rise, further fueling the boom. To the consumer it did not matter what the price of the house was, only the monthly payment.
Furthermore, the builders still were working in “house price” dollars, so they also pushed prices higher, fueling the supply side of the equation. In response to rising prices, mortgages become more esoteric in order to maintain a palatable monthly payment. As long as credit was easily obtained, interest rates remained low and house prices continued to rise, people flocked to participate in the American Dream. Speculators saw prices rise and jumped in to participate in this apparently easy way to harvest money, fueling demand. This never-ending cycle continued until one day in late 2005 when it stopped. Mortgages were as exotic as they could be, consumers could not stretch their dollars any further. In an unprecedented flash, it was over.
Now precisely the opposite is occurring. Although money is relatively cheap now, it did get more expensive helping to grind the wheels to a halt. However, access to money is not easy. Equity is now required. Credit underwriting has reemerged to ensure that loaned funds can actually be repaid. Monthly payments are being forced back to being a function of price because a home purchase is dependent once again on a significant down payment and a verifiable income source to repay the mortgage loan. Whether you consider the traditional debt to income ratio of 28% or a multiplier of 2.5 times income, based on the historic relationship between income and mortgage payments, prices will need to fall much further to bring the two back into line.
The market has spoken.
David Levin
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Tax Reform Passed. Okay Florida, Now What?
The people have spoken and the tax reforms presented to us have passed. I hope I have given the Governor and Legislators adequate time to congratulate themselves on a job well done selling this package to Floridians.
The portability issue will have positive affect on the margins of the market, but it cannot address the broader fundamental issues including affordability, credit accessibility, deflating prices and the psychology that goes along with such market forces. Then there is the economic contraction that is occurring in the State further dampening real estate activity.
The government needs to confront the more difficult issues that are before us. They must examine spending. Not just on the state level, but spending as a whole as it affects the individual citizen where he/she lives. If the state budget is cut only to see local fees for services increase, Floridians are not better off as their net out of pocket remains the same.
Our government layers need to accurately assess budget priorities and a realistic plan for funding. Floridians are reeling from economic contraction (a.k.a. Recession), high taxes and high insurance. The $240 of savings the average homeowner is allegedly to receive is not meaningful relief from these burdens. And it does nothing to promote sustainable economic growth in our state. Our lawmakers should know that and be willing to do what is necessary to get us back on track. Otherwise Florida, including all commerce and all residents, will languish.
The portability issue will have positive affect on the margins of the market, but it cannot address the broader fundamental issues including affordability, credit accessibility, deflating prices and the psychology that goes along with such market forces. Then there is the economic contraction that is occurring in the State further dampening real estate activity.
The government needs to confront the more difficult issues that are before us. They must examine spending. Not just on the state level, but spending as a whole as it affects the individual citizen where he/she lives. If the state budget is cut only to see local fees for services increase, Floridians are not better off as their net out of pocket remains the same.
Our government layers need to accurately assess budget priorities and a realistic plan for funding. Floridians are reeling from economic contraction (a.k.a. Recession), high taxes and high insurance. The $240 of savings the average homeowner is allegedly to receive is not meaningful relief from these burdens. And it does nothing to promote sustainable economic growth in our state. Our lawmakers should know that and be willing to do what is necessary to get us back on track. Otherwise Florida, including all commerce and all residents, will languish.
There is a shift Underway in South Florida Demographics
Welcome to the Third World, a place with “Haves” and “Have Nots”. Our middle class is leaving, forced out because those of us that work for a living and try to live on what we make cannot afford to live here. Housing prices, insurance rates and taxes are just too high relative to the salaries available in the area. So increasingly, we are left with the wealthy, coming to the area with their money, and the poor working class that serves the needs of the affluent.
Such a state of affairs does not bode well for a healthy, vibrant, diverse economy.
However, watching the actions of our government officials, it appears that this may be their plan. They have gutted education spending, not produced substantive action on tax reform, have offered insurance reform that is essentially a farce and watch over run-away government spending. These actions indicate that they believe it is not that people can no longer afford to live here, but rather we do not have people wealthy enough living here. Local government officials have verbalized this smugness, and other officials reinforce this idea through their unwillingness to take the tough political stands to rein in government expenditures and provide meaningful relief to those trying to live here.
In the meantime while ignoring the needs of those already living here, and to add further credence to the argument, is this running about attempting to solicit hi-tech industry to the area. The idea is to bring in new companies with higher paying jobs; Diversifying the economy is a good thing. However, these new higher paying jobs will go to new workers not those of us who are here. Our schools and infrastructure suffer as this new group is beckoned with sufficient money to buy higher priced houses and private schools.
If we do not do a better job of reconciling our taxing and spending, our region’s economic prospects look dim. People will leave to find work where they can support a family on what they make, middle class retirees will seek other places in the country where they get better value for their dollars, real estate prices will continue to fall to compensate for higher carrying costs of property, and related industries will suffer from the effects of a continued pull back. It is time our government officials step up and take the courageous stands necessary to stop this process. It is time they become leaders. And it is time we demand that level of performance from them. Otherwise we all suffer the consequences.
Such a state of affairs does not bode well for a healthy, vibrant, diverse economy.
However, watching the actions of our government officials, it appears that this may be their plan. They have gutted education spending, not produced substantive action on tax reform, have offered insurance reform that is essentially a farce and watch over run-away government spending. These actions indicate that they believe it is not that people can no longer afford to live here, but rather we do not have people wealthy enough living here. Local government officials have verbalized this smugness, and other officials reinforce this idea through their unwillingness to take the tough political stands to rein in government expenditures and provide meaningful relief to those trying to live here.
In the meantime while ignoring the needs of those already living here, and to add further credence to the argument, is this running about attempting to solicit hi-tech industry to the area. The idea is to bring in new companies with higher paying jobs; Diversifying the economy is a good thing. However, these new higher paying jobs will go to new workers not those of us who are here. Our schools and infrastructure suffer as this new group is beckoned with sufficient money to buy higher priced houses and private schools.
If we do not do a better job of reconciling our taxing and spending, our region’s economic prospects look dim. People will leave to find work where they can support a family on what they make, middle class retirees will seek other places in the country where they get better value for their dollars, real estate prices will continue to fall to compensate for higher carrying costs of property, and related industries will suffer from the effects of a continued pull back. It is time our government officials step up and take the courageous stands necessary to stop this process. It is time they become leaders. And it is time we demand that level of performance from them. Otherwise we all suffer the consequences.
This piece was submitted to and published by the Sun-Sentinel
Real Estate and The Art of Banking
It is easy to make a loan and get the money out the door. The hard part is to get the money back.
As a lender starting out, I was told I would not be a real banker until I lost my first Million. Up until that point, no matter how good you thought you were as a lender, it was all theory. The experience of “doing all the right things” and still losing all that money was very sobering indeed. The scars of cruel reality made you rethink everything as you realized things did not always happen like they were supposed to, just because they were supposed to. It is at that point you really start to become a lender, instead of just believing it to be so. This is also a period of transition. You rethink and retest everything you thought you knew. Everything becomes suspect and doing the next deal is fraught with so much risk aversion you run the risk of paralysis.
The current state of the credit markets is similar. Things were going along swimmingly for quite a while. So good that the pricing seemed to be eliminating the risk premium for deals as though nothing could go wrong. And of course, something did. We are now in the aftermath of ridiculously easy cheap credit. The markets are now remarkably unsure of themselves. Collateral values are unknown and it seems as though lenders are genuinely fearful of loaning money since they do not know if they will get it back. As a former banker I recall the fact is that it takes many, many, many paying loans to provide enough interest income to cover a principal default on just one loan.
It will take a while for the credit markets to regain their sea legs. Eventually things will return to normal. In the interim cooler heads must prevail in order to prevent a complete freeze. The Fed needs to shepherd the lenders providing reassurance and liquidity, like my old boss did with me to help me regain the confidence necessary to make that next deal.
As a lender starting out, I was told I would not be a real banker until I lost my first Million. Up until that point, no matter how good you thought you were as a lender, it was all theory. The experience of “doing all the right things” and still losing all that money was very sobering indeed. The scars of cruel reality made you rethink everything as you realized things did not always happen like they were supposed to, just because they were supposed to. It is at that point you really start to become a lender, instead of just believing it to be so. This is also a period of transition. You rethink and retest everything you thought you knew. Everything becomes suspect and doing the next deal is fraught with so much risk aversion you run the risk of paralysis.
The current state of the credit markets is similar. Things were going along swimmingly for quite a while. So good that the pricing seemed to be eliminating the risk premium for deals as though nothing could go wrong. And of course, something did. We are now in the aftermath of ridiculously easy cheap credit. The markets are now remarkably unsure of themselves. Collateral values are unknown and it seems as though lenders are genuinely fearful of loaning money since they do not know if they will get it back. As a former banker I recall the fact is that it takes many, many, many paying loans to provide enough interest income to cover a principal default on just one loan.
It will take a while for the credit markets to regain their sea legs. Eventually things will return to normal. In the interim cooler heads must prevail in order to prevent a complete freeze. The Fed needs to shepherd the lenders providing reassurance and liquidity, like my old boss did with me to help me regain the confidence necessary to make that next deal.
The Far Reaching affect of the Real Estate Market
Long ago in another real estate cycle far far away I learned that things are not easily isolated or contained. Collateral Damage is real. We were in the “oil patch”. A community bank president was about to close his doors, his bank decimated by bad loans. He commented that he thought he was being prudent all along. As oil was skyrocketing, he did not make loans using projected prices for oil as his collateral. He knew that those prices had to come down and lending against that future source of repayment was a fool’s errand. Instead, he focused on the local market and made loans to local real estate and local business.
As he later came to realize, everything was somehow tied to that inflated price of oil. The money that flowed into the local economy was based in that projected price of oil. People making money from this oil were the ones driving everything else- from shopping in stores to buying houses. When oil collapsed, everything else was dragged down with it.
Now the real estate market is doing the dragging. Especially in those local economies where real estate is the primary driver, as in Florida, everything will be affected by the contraction of this market. People will spend less; jobs will be lost across all categories. Agents making less commissions, spend less at restaurants, who scale back because less customers dine out, purveyors have smaller food orders from restaurateurs and need to scale back as well. All these people with jobs at risk then spend less on housing, reducing demand and values will continue down further. The real estate inflation we experienced permeated every facet of our economic lives and the deflation in real estate prices will as well.
As he later came to realize, everything was somehow tied to that inflated price of oil. The money that flowed into the local economy was based in that projected price of oil. People making money from this oil were the ones driving everything else- from shopping in stores to buying houses. When oil collapsed, everything else was dragged down with it.
Now the real estate market is doing the dragging. Especially in those local economies where real estate is the primary driver, as in Florida, everything will be affected by the contraction of this market. People will spend less; jobs will be lost across all categories. Agents making less commissions, spend less at restaurants, who scale back because less customers dine out, purveyors have smaller food orders from restaurateurs and need to scale back as well. All these people with jobs at risk then spend less on housing, reducing demand and values will continue down further. The real estate inflation we experienced permeated every facet of our economic lives and the deflation in real estate prices will as well.
