Housing Market Bust by Weiss and Larson

The housing market bust weve been warning you about has now begun.

You cannot yet see home values sinking.

Nor will you hear any bells ringing when they do.

But we now have a rapidly growing body of evidence that the market has reached a peak and is in the early stages of a sharp decline.

First, the inventories of unsold homes has suddenly surged not just for existing homes but also for new homes.

Second, the sales of new homes have just plunged.

Third, higher interest rates are now beginning to choke off demand, with Fed Chairman Greenspan warning stridently about the risks of still higher rates.

Fourth, in the stock market, the shares of home building companies have begun to suffer sharp declines, signaling the likelihood of equally sharp declines in home values.

Today, we will give you the hard facts, as we see them. Then, we will make some tough recommendations, based on where we think real estate is headed.

Naturally, where you take it from there is entirely up to you. But no matter what you decide today, please keep an open mind. If you begin to personally witness the first stages of a real estate bust in your area, dont close your eyes.

Remember our facts and the warnings youre reading here today. Then make a rational, objective judgment.

Here Are the
Hard Facts …

When theres a shortage of homes on the market, home values rise. When theres an over-abundance, home values fall.

Theres simply no escape from this simple reality. And anyone who thinks the law of supply and demand can somehow be repealed for the housing market is going to wake up to the shock of their lives.

Right now, the supply of unsold new homes has just ballooned to 479,000 units, the highest in history. Even assuming no further decline in the pace of sales, thats 4.7 months of supplies, the worst reading since June 2000!

If this were strictly true about new homes, it might be questioned.

But existing home supplies also surged by almost 100,000 units between July and August. At 2.86 million units, they are now the highest in over 19 years since May 1986.

If home sales were rising apace, it might also be questioned.

But home sales have just plunged 9.9% to a seasonally-adjusted annual pace of 1.24 million units in August, down from 1.37 million in July.

If there were no obvious reason for the decline in home sales, you might argue that its a fluke.

But alas, Americans have the most powerful reasons in history for recoiling from home buying:

The affordability of the average American home is now the worst since 1991, even with todays still-low interest rates.
There has been no lack of warnings or publicity about the danger of a bust.
Even Fed Chairman Alan Greenspan is now warning homebuyers to proceed with great caution …

Greenspan Issues His Most
Strident Warning So Far

With his long reign coming to an end, it appears the last thing Alan Greenspan wants is to go down in history as the Fed Chairman who presided over Americas greatest real estate boom … but never warned us of Americas greatest real estate bust.

We believe thats why, in recent weeks, he has stepped up to podium after podium, each time raising the pitch of his warnings by several octaves.

Consider for example, his comments this week:

Second home purchases arguably are at
historically unprecedented levels. Alan Greenspan

Yes, the National Association of Realtors recently said vacation home buyers and other real estate investors accounted for more than a THIRD of all home purchases. These arent primary homes; theyre pure investments, like high-flying stocks. And when Americans get nervous about their investments, they could start dumping their properties en masse.

Speculative activity may have had a greater
role in generating the recent price increases
than it customarily has had in the past. Alan Greenspan

Of course. Its a bubble. We knew that. Now, however, with officials like Alan Greenspan confirming the dangers, the press will be more definitive in its warnings … speculators will start selling … and demand for homes will plummet.

The apparent froth in housing markets may have
spilled over into mortgage markets. Alan Greenspan

This is a major change in Mr. Greenspans views. Last year, for example, he said: American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.

We welcome the Chairmans change. But we fear that for many home owners buried in debt, it may be too late.

The vast majority of homeowners have a sizable
equity cushion with which to absorb a potential
decline in house prices. Alan Greenspan

This view will also change. Sooner or later, Mr. Greenspan will recognize that the averages are misleading, reflecting the Americans who bought their homes years ago.

The reality: The vast majority of recent home buyers and speculators have no such cushion.

Moreover, just as in a stock market crash, you dont need a majority to get the ball rolling. All it takes is a small minority far less than 10% of investors to begin selling … and you could see a cascade of home price declines.

Plunge in Housing Stocks
Signals Risk of Decline
in Most Home Values

You cant call your broker or check on the Web to find a reliable quote on the average American home. And even if you could, it would not be up to date.

So by the time you get firm confirmation that home values have begun to fall in your area, they could already be down substantially. And if the selling frenzy is anywhere near as intense as the earlier buying frenzy, the decline could be precipitous.

But you can get a glimpse of what might be ahead by checking the price of housing stocks; and right now, they are falling.

Toll Brothers, for example, has come down from its recent closing high of $58.25 on July 20 to $41.51 on September 20. It rallied a bit in recent days, but yesterday turned back down again, closing at $43.35 late last night.

We see the same pattern with Lennar Corporation down from its high of $68.27 to its recent low of $53.49.

Like the housing market itself, these leading home building companies had a major run this year, and its too soon to say their rise has been reversed. But its also too soon to say their bust has already begun.

What To Do Right Now …

Nearly everyones situation is unique. But there are some general principles that we feel should apply almost across the board:

Step #1. If youre looking for a place to live, rent. Do not buy at this time! Last Sundays New York Times explains why:

After five years in which rents have barely budged while house prices in New York, Washington, Los Angeles and elsewhere have doubled, renting has become a surprisingly smart option for many people who never would have considered it before.

Owning a home often ties up hundreds of thousands of dollars that might be invested more safely and more lucratively elsewhere over the next decade. And while real estate brokers may hate to acknowledge it, home ownership involves its own versions of throwing money away, like property taxes and the costs of borrowing.

Add it all up which The New York Times did, in an analysis of the major costs and benefits of owning and renting, including tax breaks and owning a home today is more expensive than renting in much of the Northeast, Florida and California …

In the Bay Area of California, a typical family that buys a $1 million house which is average in some towns will spend about $5,000 a month to live there, according to the Times analysis. The family could rent a similar house for about $2,500, real estate records show, and could pay part of that bill with the interest earned by the money that was not used for a down payment.

In Manhattan, 1,000-square-foot, two-bedroom apartments on the Upper East Side now rent for about $3,700 a month. Buying a similar apartment costs around $1.1 million, which can translate into monthly payments of $6,000 or so.

The single biggest misconception about home ownership, some brokers and economists say, might revolve around tax deductions. Many people seem to believe that buying a home can actually save them money because the interest on their mortgage is tax deductible. But all that deduction does is reduce the cost of borrowing the money a cost that would not exist if the family were not buying the home.

We agree. In most regions of the country especially the housing boom areas the advantages of renting today far outweigh the disadvantages.

Step #2. If you own strictly your own residence, the choice of whether to buy, hold, or sell is primarily a personal, family decision not an investment decision.

Investment property, however, is another matter entirely. If you are making a decision about investment properties, carefully consider the risk factors weve just told you about and recognize that, in a real estate bust, their value could decline sharply.

Step #3. If you decide to sell now, you wont have to sell in haste or at a steep discount. You can afford to wait for a fair price, or better.

If you wait, however, dont expect the same result. You may find yourself in a market thats continually sinking faster than you drop your prices.

So once youve made the decision, go ahead and list the property without delay. Remember that holding onto real estate isnt like holding a stock. You also have to factor in the cost of:

Carrying your mortgage. Right now, the average mortgage outstanding is between 5 or 6 percent. But if you bought a long time ago and have not refinanced, your cost may be in excess of 8 percent. If you have an ARM, check the contract carefully to see when and how the rate will be adjusted. If the fixed-rate period is expiring soon, rising rates could add significantly to your carrying cost.
Property taxes. Some localities cap tax increases to a couple of percentage points a year. But others dont, and because home values have skyrocketed, so have property taxes.
Condo or neighborhood association fees, management fees, repairs, and more. Dont underestimate their cost let alone how much they can go up.

Sure, rental income can help offset these costs to a degree. But as The New York Times has pointed out, renters are at a great advantage right now. Landlords are not.

Step #4. Sell for cash only!

In this market, there should be no need to accept promissory notes or other paper. Then, place the proceeds of the sale in a portfolio of investments that help protect your principal and protect you against threats to the economy.

Some Major, Burning
Questions from Readers

Still not convinced? Then, consider these questions, along with our answers.

Question 1. If I sell my home now, where will I live?

Consider this scenario: You sell now and pocket a large sum, possibly tax-free. You cut your monthly living expenses by renting a comparable home for less money.

A few years from now, when real estate prices are far lower, you repurchase a similar or even better property at a lower price, if you wish. Or you can just retain the flexibility of renting for a few more years. With home values down, you shouldnt have to be concerned about rising rents for quite some time.

Question 2: What about the capital gains tax hit I take by selling?

If youre selling your primary home and youve lived there for at least two of the past five years, you can generally avoid paying taxes on up to $500,000 in gains (for married couples).

Yes, you may have to pay taxes when unloading a second home or other investment property. But, as with any such tax, you or your heirs will have to pay it someday, no matter what. So dont let the tail wag the dog. Base your decision on your financial needs and where you think the market is headed not on any tax consequences.

Question 3: But my real estate broker tells me that banking my equity right now is crazy. Why should I be among the few who are cashing in?

Youre not. Millions of homeowners have also cashed in. But theyve done it in a different, riskier way: Theyve borrowed against their equity via second mortgages and home equity lines of credit.

Many have cashed out on their equity from one property and using the proceeds to buy another … and another … and still another.

Others have embarked on even riskier ventures with the borrowed funds like investing in volatile stocks. Indeed, the National Association of Securities Dealers is apparently so worried about this trend that it has issued special alerts about the dangers involved in using liquefied home equity to invest in stocks.

Heed their warning: If youre cashing out, do so prudently. Pay off your debts and put away most of the net proceeds in a safe place, like a money market fund that invests strictly in short-term Treasury securities.

Question 4: I was just transferred. I need to buy a new home right now. What should I do?

First, consider renting. Second, if you do decide to buy, avoid buying with a high loan-to-value mortgage. Sadly, lenders will encourage big borrowing without batting an eyelash. But now that the market is slowing and prices may soon be going down, you could end up upside down, or owing more than your home is worth.

Question 5: If mortgage rates go up like you predict they will, wont buying a house get more expensive? Shouldnt I rush to buy now to lock in low rates while I still can?

Not necessarily. Remember: The affordability of a home is determined by both interest rates and price, with the price usually being the more important of the two.

Indeed, even with low interest rates, homes have become less affordable in the last few years. So dont base your purchase decision solely on interest rate trends. Factor in what you expect for prices, too.

Question 6: Were looking at a new home that we can either buy now or a year from now. We have estimated what our monthly payments would be if (a) interest rates go up and, at the same time (b) the price of the home goes down. But its pretty much a wash. So what difference does it make?

Youre thinking strictly about your monthly payments. But what about your principal? If the value of your home goes down, so will your net worth.

Question 7: I have a big chunk of my net worth tied up in residential real estate, including my home. For both sentimental and financial reasons, I must hold on. What can I do to protect myself from the fact that values may suffer a downturn?

Your best protection is to keep the balance of your net worth relatively safe and liquid, with a substantial portion in short-term Treasury securities or equivalent.

If you have speculative funds, also consider investments designed to go up in value in the current environment. These investments are not for everyone. But they can help reduce your overall exposure and risk. For example, you can buy long-term put options (LEAPS puts) on some of the most vulnerable housing stocks.

Or, you can join the service we edit together. It is especially designed to capitalize on rising interest rates and falling real estate stocks, using with options. For more details, call 800-815-2917.

Question 8: My wife and I havent seen residential real estate values go down in our entire lifetime, and with the kind of boom going on right now, we may never see a decline. So why should we wait to buy?

Youre right in that we dont have a good historical precedent. Most residential real estate busts in the past half century have been limited to certain regions and short periods of time. For example, home values plunged in southern California after the booming 70s, in Texas and Louisiana in the wake of a 1980s oil bust, and in New York City after the Crash of 87. We havent seen a nationwide housing bust since the Great Depression.

However, so much is new and different about the current boom the 45-year lows in interest rates, the big growth in riskier debts, and the rush of speculative buying that recent history is mostly irrelevant.

Plus, we see real estate declines already getting under way in countries like Australia and Britain where interest rates rose sooner than they did in the United States. The same is likely here.

Bottom line: You need to look beyond the U.S. and beyond history and face the facts in the most rational and prudent manner possible. If you do, we think you will agree that more caution is urgently needed.

Best wishes,

Martin Weiss and
Michael Larson

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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