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Friday, November 17, 2006

RE: Bring In The Brass Monkeys

After numerous reports of "cooling" and optimistic reports of national housing market warming in the spring, the Commerce Dept numbers today provide a blast of arctic air. Expectations for housing starts and permits were:
The Commerce Dept. today reports on housing starts and building permits: Consensus estimates are that starts fell 5.6%, but that permits are up 0.1%. If correct, that would be the first up month since February.
The actuals (at NJ Real Estate Report):
Privately-owned housing units authorized by building permits in October were at a seasonally adjusted annual rate of 1,535,000. This is 6.3 percent (±1.2%) below the revised September rate of 1,638,000 and is 28.0 percent (±1.2%) below the October 2005 estimate of 2,131,000.

Privately-owned housing starts in October were at a seasonally adjusted annual rate of 1,486,000. This is 14.6 percent (±7.6%) below the revised September estimate of 1,740,000 and is 27.4 percent (±5.3%) below the October 2005 rate of 2,046,000.
However, completions are still at extremely high rates (see Calculated Risk's post).

I have no idea why anyone was expecting permits to rise. There will be continuing strength in government building, but commercial sector building will follow the trajectory of private sector housing, which is down. The builders are now being caught in the cash flow trap, and they are racing to get product on the market to get money coming in. However, getting funding for new projects is going to become increasingly difficult. See, for example, this note in Origination News:
HouseRaising Inc., a Charlotte, N.C.-based service provider to custom homebuilders, has announced a credit program that will enable affiliated builders to buy materials and supplies from Lowe's through a master credit facility. Under the program, builders of custom homes constructed with the HouseRaising proprietary management system and with financing through SunTrust Mortgage, Richmond, Va., can buy building materials from Lowe's. Greg Wessling, chairman and chief executive officer of HouseRaising, said the arrangement will lower the cost of homes and help builders who often find it difficult to get financing for materials purchases.
Don't forget that homebuilders have also been providing incentives going forward (such as making partial mortgage payments for the first few years, or paying utilities, etc). There are future costs to any building binge, and in this case there are additional and exceptional future costs built in for some of these large homebuilders. However building supply costs are also going down in many markets, which helps homebuilders somewhat.

On the affordability side, the nominal and real drop in housing prices combined with lower interest rates is generating more purchase money mortgage apps (as well as more refi apps). Purchase money apps are now down only about 13% compared to last year. The lower rates go the less the impact will be on the adjustable rate mortgages. However we are now into about the 15th month of decline in the housing market, so the year-over-year comparisons may look somewhat better without showing any real reversal of trend.

One local wild card is property taxes; in areas in which property taxes have risen sharply, the lower mortgage rates aren't yet producing any net increase in affordability. In those areas, prices will have to fall further to generate more sales. We have not seen any significant constriction in lending standards yet, but this will begin to come into play next year as defaults continue to rise and appraisals continue to come in lower.

I don't think we are even close to the bottom at this point. In order to reduce inventory we need an influx of first-time buyers, and affordability for them is still staggeringly low in most markets. I find it difficult to believe that the practice of continuing to provide near 100% financing for first-time homebuyers with above-norm DTI's can continue through next summer in most markets, and as soon as credit tightens, this new inventory coming on the market in many areas will become an indigestible glut.

As you are out there doing your Christmas shopping, I think you'll see a pattern of retailers chasing buyers which foreshadows a rough economy in 2007. If you think about it, you'll see why. It is true that wages have begun rising, but most people pay relatively high taxes on wage income, whereas when you borrow your spending money instead of earning it, 100% or more of that money is spent (consider interest deductions on home-secured loans). We'd have to see a huge jump in wages to produce the same type of economic stimulus produced by the wave of equity withdrawals, and it isn't in the cards.

In other news, foreign treasury buys are dropping, while foreign purchases of corporate debt are rising. I think the treasuries are a better deal than most corporate bonds, so color me contrarian. Japan and some of the OPEC countries reduced their holdings in September.

For Americans, treasuries of course have the advantage that they are exempt from state & local taxes. Not sure how this plays out with foreigners.
Hi Mama; Couple of thoughts while I wait for the p+l...was out last night with some people involved in the local (Greenwich, CT) Real Estate. Since Oct 1st, the market here has picked up. I'm willing to allow that as a one off, since Wall Street bonuses are big this year. So that might not translate into more velocity elsewhere.

The Treasury TIC data....that number it totally worthless. As Hedge funds are offshore, their activity is not the real indicator of end users, and is included in that number. As far as the Japanese (and Chinese) they are currently moving from Treasuries into Mortgages. That's causing swap spreads to narrow, and option vol to decline. I agree on the view of Corporates. Pretty tight, but the money, for now keeps rolling in. That will continue until the fed resumes tightening, equities come off, or we have some systemic default. When that happens is anyones guess.
Real Estate was a good investment. The housing boom raised the price of homes and the city/county leaders took notice. Result in this area was a 50% increase in property taxes all at once. That stings and will probably kill the new housing market. The former real estate rate would have given them plenty of money as home prices rose but they're greedy and their action will eventuall lead to a reduction of taxes to the cities/counties. No brains left in politics.
Anon - it goes area by area. In some areas, taxes are low enough not to have an effect. But I agree about the brainlessness in politics. NJ, for example, seems to have dug itself into a real hole. RE will be a good investment again in many areas after 4-5 years, and I think there are a very few areas in which it still is.

CF - In this case I do think the TIC/corporate bonds numbers are tracking a real trend, but I'm not sure how significant it is. I'd rather have treasuries than corporate bonds, and I'm expecting most equities to slump next year. I think the foreign investment in corporates and MBSs is returns chasing without regard to underlying value, and I think it says something about the world economic system. There are two possibilities - the first is that everyone feels that they can get out first, and the second is that the world has chosen en masse to ignore real risk. If it's the first, we face a risk of a sudden instability. I think it's the second, which actually would be less unstable over the next year, but which would prolong the RE decline period. I cannot believe the prices that people are paying for some stocks right now. Either I am nuts or they are.

David, I don't think they withhold, do they? If they don't, then it's probably not a factor.
Hi Mama; I have lot of thoughts, but you know how I don't like to type...there is currently an arb that has been created where the Private Equity guys buy the companies by issuing huge debt, and paying themselves a big cash out dividend. This leaves the Co's highly leveraged. Seems to me it's the debt valuations that are wrong, not the Equity valuations.

I like Treasuries as well. Please keep in mind, however, that there is a lot of Central Bank interest in the Treasury/ Mortage-Corp swap, and these guys don't mark to market. that makes a HUGE difference.
GOOD observation; the really odd behavior of some of these homebuilders falls in the same category.

Yes, the debt valuations are probably wrong, but when the company's future is contingent on those debt valuations, there's a dual problem.

Looking at a range of these deals makes me think that far too many business lines have really adopted debt packaging and selling in one way or another; it's as if the debt you have to sell is as or more important than the underlying business.

I wonder if a lot of irrationality in the market hasn't come from the very short-term method of valuing companies. That's partly produced by the analysts and partly by the investors. People seem to look quarter to quarter while ignoring underlying dangers in the business plan.

Paying CEO's on stock valuation may be counterproductive, but so is a purely technical analysis.
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