Stock-Markets / Credit Crisis 2008 /
Mar 24, 2008 - 08:42 AM /
By: Ronald_R_Cooke /
The decline in fixed asset values continues. Homes. Shopping Centers.
Commercial and industrial properties. Land. And the decline is not
done. Not by a long shot.
Residential Housing
Let's look at the decline in residential housing valuations.
According to National Association of Realtors data, average American
home prices have declined by ~ 13% from their high in June 2007 to
January 2008. Unit sales were down ~ 23% during this seven month
period. Although unit sales are expected to increase this spring,
property valuations are still under downward pressure.
Geography plays a big role in real estate valuations. Prices are
either stable or increasing in many specific geographic markets. In
bubble markets like California , however, current asking prices are
out of sync with reality. Higher quality home sellers are asking - on
average - for $270 - $340 per square foot. Lower quality and
obsolescent properties have listing prices of $214 to $268 per square
foot. The larger the lot (particularly for homes with acreage), the
higher the asking price. On the other hand, actual sale prices are
declining. According to the California Association of Realtors, the
median price for a single family California home declined by 21.9
percent from January 2007 to January 2008. A review of foreclosure
data shows that average Bank repossession sales are in the $178 to
$260 per square foot range.
If we run the numbers, it is highly likely the final sales price of
higher quality properties will come down another 15 - 20% from current
asking prices. Lower quality and obsolescent property values will
decline by another 8 - 12%. In this scenario, the net loss from the
highest real estate valuation in 2006/2007 to the actual sales price
in 2008/2009 for higher quality properties could exceed 35%. Lower
quality and obsolescent home values loses could exceed 20%. In some
California communities, over 30% of the "For Sale" listings are in
foreclosure. It is highly likely Bank repossessions will frequently be
sold at a discount to the original loan value.
The point about the sub-prime mess that everyone seems to be missing
is this: a high percentage of mortgages in these "bubble" markets
(including refinance and second loan deals) now exceed, or will soon
exceed, the sales value of the underlying asset. That's all mortgages.
Prime or sub-prime. Furthermore, purchase home values will tend to
decrease until there is some reasonable equilibrium between rental and
purchase home values. Or to put it another way: why would I pay $268
per square foot for a purchase property when I can rent an equivalent
house for $195 per square foot? ( For lower quality properties, and
assuming a 7% gross ROI, this means the owner occupant who pays $1.81
per square foot per month can reduce cash outlays to $1.14 per square
foot per month by renting an equivalent unit).
This is actually happening. As banks continue to unload Real Estate
Owned (REO) properties (where the bank has foreclosed and taken
possession of the property), and property owners find it is better to
rent, rather than sell, their vacated property, the number of rental
units will increase. For a buyer with cash, it's a good investment so
long as rental income exceeds property owner****p costs.
Does that mean our banking system will continue to suffer a decline in
the value of its fixed asset ****tfolio?
Yes.
If consumers - on average - are strapped for cash to pay current
expenses, they will max out their credit card debt (thus further
increasing the risk of loan defaults), and cut back on discretionary
purchases. Since they are unable to borrow against the value of their
home, many consumers have no way to sustain their prior lifestyle.
Let's face it. For them, monthly income will be less than monthly
expenses. There are only two ways out: bankruptcy and/or create a new
downscale lifestyle. For some, that means spending less on shelter.
The monthly cost of owning a home must be competitive with the monthly
cost of renting a home.
In California the median down payment for property purchases in 2005,
2006 and early 2007 was less than 17%. Most of these loans are under
water. With no equity left, buyers are now able to treat monthly home
mortgage and tax costs as rent. Under pressure to cut their cost of
living, and with the need to re-allocate monthly income from housing
to food and fuel, consumers will be forced to consider less expensive
shelter. This is both a direct and an indirect result of high oil and
natural gas prices, increasing world demand for more and higher
quality food, the inflationary impact of America 's ethanol program,
and the shortfall of current agricultural production.
In effect, Banks have become property managers. They "rent" to the
buyer. If the value of the house goes up, the buyer can cash out the
additional equity by refinancing the mortgage or taking out a second
loan. If the value of the property does not change or declines, the
buyer may chose to walk away from the loan.
Bleeding
Under existing accounting rules, Banks can cook the books by claiming
income long before actual cash comes in the door. Option loan income
includes interest which has not been paid, but merely added to the
balance of the loan. Earnings from mortgage backed securities can be
booked as income long before they are earned. Banks have considerable
flexibility when it comes to identifying the status of bad debt. Add
these items up, and a bank may face asset losses that exceed reserve
capital.
It would appear to be imprudent to claim this will be a short and mild
recession. Conventional economics looks at dead data and assumes the
numbers look good for a quick recovery. Cultural economists, like me,
look at what is happening to consumer lifestyles. And that picture is
not good. Higher food and fuel costs do force a reallocation of
consumer financial resources. They will have to spend less on other
non-discretionary purchases - like housing. They will have less free
cash to spend for discretionary purchases. A return to more
conservative financing rules, and relatively weak real estate values,
have effectively eliminated the use of home equity financing as a sort
of savings account that can be tapped at will for more cash.
No. The collapse of our financial markets is not over. The value of
debt financed assets (fixed asset deflation) will continue to
deteriorate until intrinsic value roughly equals the underlying debt.
Look for further declines in the value of:
* residential real estate (single family homes in one to four unit
structures),
* commercial real estate (shopping centers, apartment buildings,
office buildings, industrial properties, and land),
* mortgage backed securities and collateralized debt obligations
(CDOs), and
* leveraged debt (including derivatives).
What determines intrinsic value?
* For hard asset properties, two parameters. How much the buyer or
renter can afford to pay per month, and the availability of lower cost
alternative properties.
* For leveraged debt: there must be an identified asset with a stream
of income sufficient to cover monthly debt payments. If one can not
determine the underlying asset upon which the income stream is based,
then the paper is worthless. And that - is one of the problems with
CDOs.
I'll stick with my prior estimate: loan losses from all financial
instruments will exceed $700 B
With the full sup****t of Congress, (including Senators Clinton, Obama
and McCain) the Fed is giving copious quantities of cash to the big
investment banks that got us into this mess. No one is being held
accountable. These banks will spend the cash. But when its gone, the
mortgage default problem will still be there. We are committed to
printing an unlimited amount of money to keep a small number of
insider institutions solvent.
This would appear to be a high risk and very inflationary strategy.
But. I could be wrong. You decide.
Ronald R. Cooke
The Cultural Economist
Author: Detensive Nation
www.tce.name
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