Your opinion is welcomed as something feels off in the current market.

The market that I focus on has seen a tremendous change in the last 6 months and more specifically in the last 60 days as things have gotten really strange. I suspect we are seeing a collection of events collide. What bothers me is I can’t tell if these events are going to be something we can build on and call a foundation/bottom or if it is going to cause a large and painful event. The following is what I see:

The market or what normally is called the market is being manipulated by several external factors. These factors are not a normal part of the investment cycle and thus cause an inspired response. The factors in the current market are affecting both supply and demand which leads me to believe we are entering a dangerous time.

Items Affecting Supply:

Foreclosure Moratoriums (anyone think we will have another one around Christmas)
Banks refusing to foreclose to insure they don’t have to take the large negative hit to their books/ratio’s
Pretend and Extend being deployed in the commercial market
American’s taking to strategic non payment like a national pastime
Loan Workouts that delay problems for the future as default rates are high
FHA becoming landlords, don’t pay your mortgage but become a renter and never move

Items Affecting Demand:

Loans are hard to get, except if you’re a new investor and most likely to over pay given lack of track record
Tax incentives that are focused on first time buyers which in most cases will buy the cheap house in the bottom third of the market (Good for Them)
City programs trying to buy foreclosed homes to keep homes affordable

Given the items above I am struck by a couple of things. First all the items holding back supply is bound to loosen up by March – June next year, causing pent up supply of homes to hit the market. In addition all the artificial demand items (except the loans) are set to expire around the same time. So let me ask you this, what would happen if the restriction on supply is lifted at the same time the artificial demand is capped off? My guess big price drops, much longer days on market and an inventory/supply number approaching 12-15 months. For an investor this could mean the best time to buy is just over the horizon.

Something else I am struck by is all the demand is focused on the low end of the market often characterized by the sub prime market which was so 2008. Most of our additional pain is going to be felt in the move up or high end market. My fear is that we are going to get caught looking at a problem that for the most part solves itself because investors can buy these older homes and turn them in to rentals and miss the tsunami coming are direction. The problem in the move-up and high end markets can’t be solved with little $8k credits and these homes at least currently can not be bought as safe and secure rentals. If we are not careful this could be the tipping point next summer that sends us back into the financial abyss.

In fairness I see another outcome that is possible and one that the government is going to push with all its might.

The factors listed above have caused an interesting thing to happen and one I have seen first hand in my investment area. In my market for example the price of a vacant, bank own, 3bd 1 bath home requiring 10K or more in repairs has gone up 50% in 6 months. Yes 50% in 6 months for an annualized return of 100%!!! In January you could buy a solid property for 45-55K today it would take 65-75K if you could beat out the other 10 buyers. See what I mean about artificial, this is not healthy!!!

But guess what has happened over the last 3 months? Surprise prices have increased in this section of the market!!! This has caused the press to report that real estate metrics have turned and gone positive on a month to month basis. I don’t know why anyone is shocked by the fact that if you restrict supply and add gasoline to demand you get a price jump. Shocking!!!

But guess what happens when real estate goes up on average even if it is fake and caused by forces not common to a healthy/functioning market? Two things: First the animal spirits can be rekindled as the average American can not stand missing out on a sale. What is a greater deal than real estate (Buy low – Sell high)? Second the higher the average price may cause some banks or financial institutions to actually write up their loan portfolios. If this happens it will cause banks profits and stocks to go up dramatically. This goodness will cause the financial networks to talk about the next bull market and we are off to the races.

I see a couple of problems with this scenario. First all this financial engineering does nothing to create jobs. It may cause some banks and hedge funds to higher a few more MBA’s and pay big bonus but it doesn’t help Main Street. Second it does nothing to change the behavior around strategic defaults that will become the story of 2010.

Let me know what you think. Are you seeing the same artificial restrictions on supply and artificial sweetener around demand? Am I over thinking this and I should just realize that the government has engineered the bottom and we are all good to go from here?

Good Investing

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