Cross posted on Daily Kos
Thu Dec 08, 2005 at 12:30:31 PM PDT
Some of you know that among other things, I sell real estate in Manhattan. Some of you even hold that against me undoubtedly.
I’d like to tell you the real estate story of one American. Perhaps this might illustrate why you should read what bonddad has been saying and recognize why this debt financed expansion is going to inflict tremendous pain on Americans of every socioeconomic level. This should give you a bad case of indigestion, because it is going to impact, you, me, everybody.
This is the story of a middle class speculator who lives in Southern California. She could be you, your neighbor, your cousin. But her story is playing out across the country. And most interesting, until I told her she was a speculator she didn’t even realize this.
This young woman (a home health care aide with three children) owns two houses. Her income is around $75,000 or so.
She has an adjustable rate mortgage on the house she lives in. She has zero equity in this home. She bought it a few years ago for around $300,000 and it is now worth in the neighborhood of $550-$600,000. She has both a mortgage and a home equity loan on this,her primary residence. She used all the cash she removed from the home to . . .purchase a second home.
Now let’s take a look at her investment property. She supplements her income by renting out her second home, she has a tenant who is paying $1600 a month. She also has an adjustable rate loan on this property. This loan is also adjusting in 8 months. She thinks (fears) that when the loan adjusts the income her tenant is paying will no longer cover the monthly mortgage payment. I think (fear) she is correct.
I asked her how and why did she get into this pickle? She said well, to make money of course. Real estate prices can only go in one direction–right? Wrong!
She is the classic speculator. She didn’t even know she was a speculator until I told her. I explained that if you sole motive in making a real estate purchase is to see the value of your investment increase, then you are a speculator.
This sort of situation is playing out around the country. Even worse, since the real estate bubble has been fueled, almost in its entirety by abnormally low interest rates, as rates increase, housing prices will drop.
People like the young woman I described are going to face a situation called negative equity. This is when the value of the property is less than the outstanding mortgage. This is also the point at which people start to walk away from these homes and the foreclosures begin. All in all, a very vicious cycle is underway.
As bonddad has been describing, this economy is riding a massive wave of debt. Homes have been turned into money machines. These money machines which we used to call homes, have been fueling consumer spending which accounts for 2/3rds of GDP. So, if you understand only one point, it is that the Federal Reserve and Mr. Bushspan have done all that they could to keep the hapless American consumer spending. Without consumer spending, we would be knee deep into a major recession.
When these loans start to adjust (upward) in the coming months, many Americans are going to be in a world of financial hurt. This is going to impact all of us, even those not saddled with astronomical levels of debt.
So, returning to the young woman in Southern California–she is nervous, very nervous. She is actually scared. The dream she thought she could buy her way into seems to be on the verge of collapse.
My daily paper (Dallas Morning News) just this morning told me that median home prices in the area are up because:
“Consumers are more confident about the economy, which causes an increase in “move-up purchases” of more expensive homes, said Mary Frances Burleson, president of Ebby Halliday Realtors.”
This squares with one recent explanation for the surge of ‘McMansions’ in my neighborhood. As one developer’s defender said, there is a serous shortage of oversized and overpriced houses (no, actually he said “up-scale homes”)
In the same business section today I learned that 2/3 of my fellow Texans believe the will be better off financially in the coming year.
All is good here. Must just be you people on the coasts.
I don’t know what is happening in that particular market. It could be that there has not been to sort of price appreciation we have had on the two coasts.
That said, when interest rates rise, it’s almost a foregone conclusion that prices will drop.
The market here is nowhere near as bubbly as the coasts, but interest rates are interest rates; debt is debt; pipers demand payment at some point.
“According to a recent report by credit bureau Experian, Texans are the most likely to file for personal bankruptcy in the next 12 months.”
And Tx. has only allowed home equity lending since 1998 which is fairly recent compared to other areas. Until then we couldn’t get in the kind of trouble your Calif. friend is facing.
Just another reminder that those who don’t learn from history are doomed to repeat it. We all love the happy talk news more than the truth. I’m scared for the youngsters in my family that are just now getting on the merry-go-round.
Isn’t “speculation” another word for gambling? I know this sounds harsh but your friend has bought into a lot of hype and now like a lot of Americans is staring the consequences in the face. Since speculation has driven up the cost of housing in my town to waaay above what the average person could ever afford, I don’t have a lot of sympathy.
Yes indeed, library lil, speculation is another word for gambling.
But these insanely low interest rates have encouraged this sort of behavior. There is also the herd mentality at play. You see all your friends making money and you want to join the party.
Well the party is going to end with a lot of pain.
then there’s Miami. A ride on the Metro Mover in the downtown area is a tour in Crane Land. Construction of highrise condos and apartments is like nothing I’ve ever witnessed, and I’ve been here since ’82. Arrived just as a similar real estate boom went bust.
As reported in the Miami Herald, June 22, this year, the Merrill Lynch Report states:
Local real estate investors calmly (you’ll see why he’s phlegmatic below) agree:
There’s the rest of the country, there’s Miami, and there’s also Broward.
Mr. McCabe is a sort of Bubble Vulture, and probably a smart man. He’s put together a group of investors who are ready to pounce as soon as the bubble bursts.
There’s plenty being written on this market and the inevitable doomsday.
Here’s a blog;
Local NBC TV affiliate;
and go here if you want to blame the local real estate frenzy on the Europeans.
I wonder how many of those potential boomer retirees Florida expects are re-thinking the plan after the last couple of hurricane seasons? Hurricane potential has always been a factor, and one that multitudes seem to have ignored in the past, but I would think recent events would make quite a few re-evaluate in favor of Arizona or New Mexico (or even parts of Texas as indicated in one of the entries on the blog you linked to)
hurricane propensity would factor into the real estate equation in Florida. In fact, you’d think it would factor into the equation of ALL southeastern (salt) waterfront property.
And I guess it does. Making it more expensive than the safer inland stuff.
Who knew?
It’s like the California coast, sliding into the ocean all the time it’s some of the most expensive real estate in the country.
Okay, so now this sounds really self-centered and selfish, but, (clearing throat self-consciously) isn’t this good news for those of us who are currently completely priced out of the housing market. If the bubble bursts, the balloon leaks, whatever the metaphor, home/apt. prices will come down. And yes it will be impossible to get a mortgage with low interest, but at least even with high interest, some of us will be paying less money to buy, and could swing it….
Or is that not a possibility at all?? I am a complete real-estate novice here.
Poco, you’re absolutely correct. You’re not such a novice. Yes, when prices drop a sufficient amount, these new lower prices will attract a new wave of very cautious buyers into the market.
So just be a little patient, and you will likely get your turn if you want to buy.
The market at these heights is not healthy.
Given that higher interest rates are inevitable, what advice do you offer, or what strategies do you recommend for those who have been caught up in some of these high risk ARMs and 0 % loans? These folks are in for a ‘world of hurt’ when the market corrects itself. Foreclosures are already running at record highs and have done so for the past 3 + years, at least in Colo.
Combined with the draconian bankruptcy laws now in effect a lot of people will, no doubt, become members of the serfdom for their foreseeable future.
I know BondDad has addressed these issues, but am unable to locate those particular diaries.
Peace