National Headlines and our opinions for Oct 28th, 2009

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October 28, 2009

As we have mentioned previously we are very focused buy and hold investors in Fresno California. However, that does not mean we ignore the national news or trends. Quite the contrary we look at the national headlines and try to understand if our market is similar or different. Plus we try to figure out what the national trend may mean for future opportunities.

Of the many headlines this week two caught our attention. First was the drop in mortgage applications (3^rd week in row as we recall). What could this mean as interest rates have not ticked up any great deal. We propose there are three contributing factors, if we are correct, it will mean this number will continue down in the coming weeks.

First is the fact that refinancing has to be slowing down. As rates have been pretty close to 5% for a while now and thus anyone who could or is likely to refi the loan has done so or at least tried to. To kick start the refi engine again you either raise the average price (value) or you need to drop the average rate below 4% to restart the refi wave.

The second area that is a contributing factor is the $8,000 tax credit that is currently set to expire on Nov 30. For our money we suspect most people went ahead and got a mortgage processed already and they purchased their home or are just about to close escrow. There may be a few brave souls that are trying to cut it close and thus just starting the mortgage process but it won’t be a large number. So our guess is the peak of the first time buyer is over and done with.

The final area is that investors are still locked out of the traditional market for loans. If you own even a semi decent portfolio of properties you are toast as no bank will talk to you. We constantly find deals for 50% of replacement cost that will cash flow $400+ a month but as experienced investors we are locked out of the market unless we go with hard money option which requires 40% down (not fun but we do it because the deals are that good).

The next headline that got our attention was that new home sales were down but also new investors were down. All the articles I read on this were negative and talking about the second crash and a falling market. All of these are hogwash!

These headlines tell me that the capitalist system still works and if the government would get out of the way the market would clear itself. This clearing process would be VERY painful but it is going to happen the only question is do we swallow the pain in 12-18 months or do we let it linger for 3-5 years?

Back to the topic at hand and why we think these metrics are a great thing for the real estate market. For that we will give you an example.

Let’s say you are in the market to buy a TV and you walk into any store in America and you are presented with the following choice. You could buy a basically brand new TV that is out of the box and has some dust on it and the TV remote needs batteries for 60%-70% off or you could buy the same TV in a Box with all the packing material and pay full retail. Which would you buy? Our guess is you buy the TV today that is out of the box and 60% off. Now what would happen if you were the TV manufacture and you knew with 100% certainty that there were over 500 basically new TV’s at the store that could only be sold at 60% discounts to your new in the box TV. Would you be in a rush to build more new TV’s? I certainly hope not. In fact we would do everything we could to build zero TV’s for a few months and let the natural law of supply and demand get into balance.

So back to the specific metrics;

New homes sales are down. GOOD – about freaking time. We need to chew up the supply of slightly used and vacant existing homes that were built, sold and foreclosed on ASAP. So new homes sales need to go down and go down further if you ask for our opinion.

Sales are down but Inventory is down more. GOOD, no GREAT news. This means people running for profit homebuilding operations are NOT being stupid and burning their cash. In fact if we were homebuilders and we knew our product and cost structure we would seriously be looking at buying some distressed foreclosed homes in our old markets that we sold out in 2005-2006. Think about the good karma they could build up not to mention profit by buying properties at prices significantly below their cost structure and then reselling them again. If they have confidence in their product the builders should look at revisiting communities hit hard by foreclosures. We don’t have any specific numbers but let’s say that in 2005 they could build a house for $160K and then they could sell it for $210K which gave them a profit before expenses of $50k. We suspect given the details above that if the builder wanted they could go back and buy that house for 100K, spend 10-20K on repairs and then sell it for $150K making 20-30K in profit. They would also help out the neighborhood by selling homes at retail prices instead of distressed prices.

In the end the problem we need to work through as a country is the pile of existing home sales.

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