We know the bubble is coming; some might say it’s already here, but most likely we have only seen the calm before the storm.Â
How will the market recover? How fast will it recover? Supply and demand says that the glut of supply, resulting from foreclosures, new condo conversions (yes they are still converting, I know of a few that my realtor emailed me about) and new houses, must be absorbed at lower prices before going up again.Â
Where will the demand come from? You can argue baby boomers retiring to Florida, but more and more, the media has been promoting cities like Austin Texas for its affordability as well as leisure activities such as going back to school for adults!!
One x-factor I believe will actually come from South American nations like Brazil. Brazil just recently repaid their entire debt to the IMF, International Monetary Fund, and their financial system is starting to mature. With the help of Wall Street investment bankers, foreign capital is pouring in with the expectancy of a boom in Equity Market like India, another maturing economy. The wealth generated there could induce REI opportunities offered by foreclosures in S. Florida.
I don’t foresee this happening over the next year or two. But if you are in for a long haul, when foreign capitals start flowing in, it could well be a sign of the start of the recovery.
Â
This below is a report from www.realtytrac.comÂ
“Irvine, Calif. – January 23, 2006 – RealtyTracâ„¢ the leading online marketplace for foreclosure properties, today released year-end data from its 2005 U.S. Foreclosure Market Report, which showed that 846,982 properties nationwide entered some stage of foreclosure in 2005, and a 25 percent increase in the number of new foreclosures from the first quarter to the fourth quarter.”
“RealtyTrac publishes the largest national database of pre-foreclosure and foreclosure properties, with more than 550,000 properties in nearly 2,000 counties across the country, and is the foreclosure data provider to MSN House & Home, Yahoo! Real Estate, AOL Real Estate and HomeGain.com.”
“Overall U.S. foreclosure numbers climbed steadily over the course of the year, with more new foreclosures reported in every quarter,†said James J. Saccacio, chief executive officer of RealtyTrac. “This trend appears to be moving the real estate foreclosure market back to its historic levels.â€
“Saccacio noted that the number of 2005 foreclosures needed to be kept in context. “Even with almost 850,000 properties entering some stage of foreclosure across the country over the course of the year, this represents less than 1 percent of all U.S. households. And the increase in U.S. foreclosures from Q3 to Q4 was just below 5 percent.—
This part about Florida is what I think will drive up supply of housing even more.
‘Despite a 29 percent decrease in new foreclosures from the first quarter to the fourth quarter, Florida documented the nation’s highest foreclosure rate and accounted for more than 14 percent of the nation’s new foreclosures in 2005. The state reported 121,843 properties entering some stage of foreclosure — 1.67 percent of the state’s households.”
Toll Brothers also came out with a report of lowered expected number of new homes sold for 2006 on Bloomberg today.
“Toll lowered its forecast of the number of homes it will sell in fiscal 2006 to 9,500 to 10,200, from the 10,200 to 10,600 it projected on Aug. 25. In fiscal 2005, which ended Oct. 31, Toll sold 8,769 homes. ”Â
In the same report, a real estate analyst expected the increasing supply of housing in Miami area to cause a steady decline in housing prices. He expected that it will take the market 2 years to absorbed the increase in the housing supply.
Basically that means if I buy now, I am in for the long haul. Time to rethink this some more.
Today I met with a realtor with the intention of finding out more about investing in Japan, but we ended up talking more about investing in a local property for my first investment. Her main point was to buy a property with 10 to 18% cushion so that even in the case of market downturn, the investment is still safe. So I did some calculations and made these assumptions, but the investment still did not look attractive. Here’re the assumptions.
The health of the economy seems to be doing pretty ok through 2005; unemployment is down, stock market has been very healthy (until this past week), housing market hasn’t blown up, high oil prices didn’t seem to affect the market much other than the knee-jerk reactions.Â
So what is in store for us in 2006? The first two things that come to mind are still whether oil is going to go through the roof again and when the housing market will deflate.
First, oil. Say if OPEC decides to cut supply or foreign demands like China continue to supply, the price goes up (much as it has this past week). What really happened in 2005 is that the costs of higher oil prices were not reflected in consumer spending because everyone with their home equity loan (either cash-out or refi) were able to get their hands on a chuck of cash to continue to spend like it’s 1999. How is 2006 different? Market sentiment. Which bring us to our 2nd topic…
Housing market. If everyone expects the slowdown in housing market to materialize, the freespending will not be as liberal. Consumers, in aggregate, will think twice about spending rather than saving. It’s a tough balance because a lack of consumer spending will cause ordinary business income to shrink, which leads to higher unemployment. It’s a death spiral to recession.  But no worries, we are not there yet, consumer sentiment numbers are still in the black.
What does this mean for you? Do what the rest of banking world does, which is to watch what the Fed does. The Fed’s job is to promote steady growth in the economy. You can be assured that the Fed will be watching oil prices, consumer sentiments, stock index, commodity prices, foreign investments alike to gauge the health of the economy. If economy is growing too fast, they raise the rates (or at least say they expect to raise the rates) and vice versa.
However one thing we can be sure of is that Fed knows their history. They know that if they raise rates too much (currently at 4.5%), then they can easily restrict the economy into recession. The Fed knows that is exactly what happened in Japan in 1990. Japanese central bank also had to deal with a hot housing market, one comparable to California and Southern Florida. Japanese central bank tightened the rates too much and too fast and for the past 15 years, Japan has been in a recession and has just begun to recover recently.
From this perspective, Fed is unlikely to tighten too much, which is good for the Stock market and at least neutral for the housing market (if job creations locally can support housing prices). I am bullish for 2006. (Unless we get another 3 peat of category 5 hurricanes, fingers crossed, I live in Florida!)
Â
To understand when and if the housing bubble will pop or deflate, one point of view is to look at how investors and your everyday John Doe can continue to purchase property even as prices skyrocket. Either their income have significantly risen or mortgage companies and banks have made it easier to borrow money. When these factors supporting continued purchases of existing and new homes dissipate, the bubble will begin to deflat.
Many articles have shown that income have not kept up with the rising housing prices in major metropolitan areas.  Still mortgage rates have been kept relatively low in the 6′s for 30 year fixed rates. Despite Fed hiking the rate at every meeting, long term rates have not risen accordingly. This is because overseas investors continue to puchase the mortgage backed securities (MBS) that come from the mortgage. To understand this, we need to understand how banks can lend money continually (they don’t have unlimited supply of cash!!) After banks make a loan, banks can either hold on to the loan on their books, or they can sell the loan to Wall Street. When banks sell the loans, their cash is replenished and this process allows banks to make more loans. Wall Street accumulates the loans bought from mortage companies, local banks and when they have a substantial amount, usually in the hundreds of millions, they “securitize” the loans into a mortgage backed security. This is a bond that derives its cashflow from underlying mortgage payments. This bond is then sold to investors. Overseas investors in countries like China have been big purchasers of these MBS.
To best understand this, we can look at how cash changes hands. First, Chinese investors purchases the MBS from Wall Street. Every month, John Doe makes his mortgage payment. That mortgage payment is passed onto the Chinese investor. Investors essentially provide liquidity for the massive amounts of loans that have been generated in the last few years. But that may or may not continue indefinitely. Booming markets such as India (have you seen their Equity index in the last 3 years?? It’s ben a very wild ride) are attracting lots of foreign investors.
If there are not enough investors of the US MBS, then banks necessarily have to raise the rates to justify making the loan to be held in their books instead of selling the loan to investors. When banks start to raise rates to 7, 8 or 9 percent, everyday John Doe won’t be able to afford that loan and the support for housing prices will weaken.Â
This is not a doomsday scenario. But just one likely and possible outcome.
So there’s all this talk about the housing bubble, much like the internet bubble of the 90′s, which will someday come crashing down.  If you look at the news articles, you can probably find people supporting all side, from people who think it will fold like a house of cards, fast and painful, to people who think it will be a soft landing. The difference between this housing market and the internet bubble is that people are seeing the bubble coming because of all these news outlets prophesying the end of the bull housing market. Then again, you will find that some of these same people have been saying the same thing for the last few years. But not everyone believes in the bubble, enters my friend John.
John has just bought a one bedroom, one bath condo south of miami. He is a twenty something white collar professional in the real estate management industry, just a few years out of school. His mother has been in the real estate brokerage business for years. It’s not a big purchase by “Big City” standards, but as a first purchase; he’s definitely diving right in. I asked him whether he did all the math first in Excel to see what kind of profits he expected; he shook head with a big grin, like a kid who just got into the candy jar.Â
He does have something to smile about; he just close the deal last friday and spent the weekend with some contractors putting in new cabinets in the kitchen and the bathroom. It will be another weekend before it’s finished, but already, he has two potential buyers and rentered lined up this weekend to see the place. Tell him he is crazy, but he expects to sell the place before March 1st, when the first mortage payment is due. (Yes..in the closing cost, he already paid the mortgage payment for Feb, but we’ll forget that detail 
).
I did a quick search online and found hundreds of condos for sale near his asking price (he did purchase his property at a 20k discount).  Maybe his redone kitchen and bathroom will set his condo apart.  Also he is selling the property via For sale By Owner. If things do not go well for him, I am sure his mother (real estate broker) will lend him a hand.Â
So John is out to prove all you naysayers wrong.  Look out for a follow up post to this. I will let you know whether he is on his way to his second flip or sitting on his empty condo (with new cabinets!)