Haefling on Housing

Carl Haefling is a portfolio manager in Bainbridge Island. He is a deep value player in small and micro cap stocks, biotech and medical devices; he and often takes a very long term view. Carl is often a contrarian — recently, he has been accumulating shares of Jet Blue (JBLU).

He also has a sharp eye for the Macro-environment, and I often find his take on events intriguing. Following the recent data releases on Housing, he recently observed:

I believe the stock market is predictive — not reactive — except for relatively short periods of time. 

Housing stocks topped out in Dec and are now down up to 50% in numerous cases from those highs. It will take a couple of years at least for this scenario to complete itself.  A significant decline in the housing market over the next 2 to 6 years is being predicted by housing stocks.

It takes time for the housing market to fully unravel, we are in the early stages of stage 1.  Stage 1 is where the market begins to recognize that prices have reached levels that reduce affordability and thus the number of possible buyers. Sellers, who have been holding back selling for fear of not selling at the top, begin posting signs advertising their home, usually at prices that reflect the highest paid for a similar home, and suddenly the inventory of homes foresale explodes. This has already happened in many parts of the country. This stage may take one to three years to fully unfold. 

Stage 2 is price cuts by those who are becoming convinced that the market has softened if they want to sell their home they better cut prices.  Once those "reduced" signs start appearing, buyers start reducing offers, even on properties that have been already reduced.  Prices will drop far lower then anyone thinks possible in stage 2. 

Stage 3 is the exhaustive phase.  Buyers are afraid to buy, investors have no liquidity, mortgage requirements demand a high down payment and supporting cash flow, and the press is filled with articles claiming real estate is a terrible investment. (which happens to be true in the previous 5 years).

There are serious other problems that will contribute to this cycle, including a decline in the buying power of the middle class, tilting demographics which will reduce the number of possible buyers beginning about 2010 for real estate and possible shifts in values of owning vs. renting.  There remain other problems that are related to real estate but not thought of as being directly connected.  A decline in the value of the dollar may force foreign owners of commercial and residential real estate to try and liquefy.  Higher interest rates because of inflation or stagflation  also  impact real estate prices. 

And one of the unseen values will be the desire to downsize as the cost of insurance (in some high risk hurricane states you cannot get homeowners insurance except through the state at 3 times previous cost) explodes, the cost to heat and air-condition accelerates, and the cost of maintenance become detriments to ownership. 

A house may go from being something that we take pride in, to becoming a burden.

Interesting stuff –thanks Carl.

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  1. bsteve commented on Jun 30

    I’m friends with one of the major real estate brokers in the northwest corner of Ct and I recently asked her what’s going on with the housing market. She said that sellers think that they’re in a sellers’ market and buyers think they’re in a buyers’ market. Neither one appears to be right.

    In regards to the macro economy I think Advanced Auto has their finger on the pulse of a much larger crowd than most realize:

    “We believe that macroeconomic factors, including higher energy prices, ever-higher interest rates, and higher required credit-card payments are further reducing discretionary income for our lower- and middle-income customers and has unfavorably impacted customer traffic,” said Chairman and CEO Mike Coppola.

    Note: “has unfavorably impacted”

    Inflation is contained? Give me a break! Let’s see how much the dollar buys six months from now after this laughable Fed statement. Bennie just doused the fire with a can of gas!

  2. SINGER commented on Jun 30

    interesting article…it always fascinates me how certain trends just take a while to unfold…its not like you snap your fingers and all the diverse real estate market participants realize what the new multi-factored reality is….more fuel for an ever broadening thesis that there is no “market” just peoples perception of reality…

    looking forward to BR’s take on the FED STATEMENT…”they didn’t explicitly say they were going to raise again” -WSJ then again they didn’t say they wouldn’t… GOLD—WOW!!!

  3. ~Nona commented on Jun 30

    I have a good friend who must sell a house located in Long Island, NY and a cousin who wants to buy in more or less the same area.

    Neither must act right away and both are slow to act, hoping that prices will improve. Obviously, their vantage points for possible prices differ.

    Who’s right?

    I bet with my cousin. LI broker friends tell me they must drop prices quite substantially simply to attract would-be buyers to the open houses.

  4. BDG123 commented on Jun 30

    Using an oft proven time series analysis, there is a reasonable argument to be made the housing market will bottom in Marchish of 2009. The stock using that same time series analysis the stock market has a high probability of bottoming in October of 2007. That opportunity will be the buy of a lifetime.

    Now, there will be some type of attempted rallies in between but let’s see. Sort of interesting to see if we aren’t all dead by then.

    Now, obviously predictions are scoffed at. And, I surely wouldn’t bet my life against it. Nor would I bet my life that it will happen. But, it is a framework to take into account.

  5. Andrew commented on Jun 30

    And one of the unseen values will be the desire to downsize…

    He left out one of the biggest driving downsizing in the coming decades: the aging of the baby boomers.

  6. Zephyr commented on Jun 30

    BDG, I have a very similar view on the likely timing of the next resisential real estate market bottom. I anticipate that prices in the owner-occupied market should bottom in 2009. My investing plans have been geared towards this since 2004.

    I am curious about your stock market bottom pick of Oct 2007. That seems a bit early to me, unless you expect a very soft landing or no recession at all in the near future.

  7. Zephyr commented on Jun 30

    Andrew, Most boomers cannot afford those big houses. The people who can afford those bigger houses are those who have the highest wealth/affluence in society – boomers or otherwise. When the boomers leave those positions of power and affluence someone else takes their place.

  8. BDG123 commented on Jun 30

    OOPS!!!! Stock market bottom in October of 2008!!! Thanks for pointing that out!

  9. Jim D commented on Jun 30

    Price reductions are already underway in select markets – Pheonix, Sacramento, and San Diego to name three. So, we’ve already entered Stage 2 in some places.

  10. Mitchell commented on Jun 30

    “Sort of interesting to see if we aren’t all dead by then.”

    BDG123 (FKA “B”): Care to explain this ominous reference?


  11. Paul Vigna commented on Jun 30

    What most people don’t understand, especially people who’ve made a small fortune off real estate in the last five years, is that we just experienced the biggest housing bubble in the history of this nation. Home prices have never jumped so far so fast.
    If you’re a homeowner, there’s no inflation, just rising asset values. But if you’re a first-time home buyer, like myself, inflation in the last five years has been crippling. Where I live in New Jersey there are no more starter homes. None. Starter homes that five years ago were $200-$250,000 are now going for $500,000. At least they were a few months ago.
    The top’s over. Home’s are sitting on the market for months on end without a bid. We just bid on a house, and offered 10% under the asking price, and there’s a good chance we’re gonna get it at 6% under asking. Not $6,000 under asking, 6%. That’s big drop, and we’re just at the start of the slide.
    Anybody who doesn’t think we’re in a pretty big drop in real estate is fooling themselves. How big it’ll be, I don’t know nor does anybody else, but it’s happening already.

  12. ~ Nona commented on Jun 30

    Paul, I’m interested in knowing: why don’t you wait a little longer to buy?

    I’ve been urging my cousin to wait. They just sold their NYC co-op and are renting. They could wait a while longer, but at the same time they’re getting antsy to settle down.

    Seems to me they could trade “antsy” for many, many tens of thousands of dollars saved if they could wait longer. I’d appreciate your thoughts — or anyone else’s thoughts — on the matter.

  13. Paul Vigna commented on Jun 30

    Our strategy has been that we’ve looked, but we weren’t in any rush to buy. Frankly, I’d have been happy to wait another six months or a year, but we saw a place we really like, in a neighborhood we really like, with low taxes and what passes for a low price tag in Essex County.
    Through the whole bidding process, I tried to base our offer on what I thought we could afford and what I thought the house was worth, not where the market was or what other people bid or paid in the area. To be honest, I was hoping we wouldn’t get it, because then we would have waited to see where prices go. But we got it – almost, we’ll find out this afternoon for sure (not sure why I’m telling the world this on Barry’s website when I haven’t told most of my friends, but there you have it) – at a price we can live with. That’s it basically.

  14. drey commented on Jun 30

    Totally agree Nona. Why anyone would be in a hurry to buy now, especially in one of the higher end markets, is beyond me.

    Anecdotally, it seems like there are a lot of smart people who top ticked the market a year or so ago and are now more than happy to rent for the next couple of years…

  15. jkw commented on Jun 30

    I’ve been watching the market in my area (Boston) for the past few months. The houses I’ve looked at aren’t selling. There are a lot of listing in MLS that have dropped their asking price by 5-10% already and are still sitting on the market. The realtors at open houses are getting desperate. The house next to the one I’m renting was converted to condos last year and is now being rented as apartments. Most of the sellers haven’t yet accepted that they should drop prices, but the buyers have started insisting on it. There are still a fair number of buyers that think a 1% price reduction is a great bargain, but they will be done buying pretty quickly. And the ARMs are only starting to reset. Desperation should set in next spring, when some of these houses will have been on the market for over a year with nothing but lowball bids.

  16. BDG123 commented on Jun 30

    Nothing ominous Mitchell. Just an attempt at cynical humor. Btw, I’ve of the opinion that we shouldn’t all necessarily jump to the conclusion home prices are going to just absolutely dump unless we get a bout of very, very serious deflation.

    But, I have said it again and again that IMO people are chasing their tale on this inflation thing. This is the problem with many economists. They are so infatuated with data that they don’t do any multi-cycle economic analysis because it is not necessarily quantifiable within an equation. Not all economists think this way but there are two very different schools of thought in that community. You simply cannot measure human behavior in an equation. But, human behavior is the constant that drives cycles. Economics is a……..SOCIAL science and while measuring discrete data points such as CPI, GDP, etc are worthy of mathematical analysis, there is also the behavioral economics which is all psychology. How many economists do you know that are good psychologists? Or strategic thinkers? How about none.

    And, if you want to be a contrarian, every Tom, Dick and Harry is worried about inflation. Now, I don’t believe in being a contrarian just because everyone is on the other side of the trade but there is a tremendously strong argument to buttress that inflation is a ghost. At least longer term it is a ghost.

    The parallels to earlier times in our development are great.

    -Glass Steagall has been repealed in the times of euphoria.
    -Banks have made tremendous faux paus internationally in their risk management practices. Remember the S&L crisis and housing mess in the late 1980s? Not to mention their stupidity in the 1920s.
    -Financial institutions are a disproportionate part of the economy as in the late 20s.
    -We have all of these new fangled financial instruments just like the 20s but these aren’t backed by anything other than paper. ie, Derivatives.
    -In a global financial system, we have more wealth in a totally unregulated environment than at any time in history. China, Russia, India, etc. As well as significant deregulation in the US.
    -Hedge funds in the US are not regulated. They need to be unless one believes what happened historically will never happen again. ie, We need to regulate institutions which are responsible for safeguarding our wealth even if that limits their ability to make money doing more and more risky things. Period.
    -Along those lines there was a recent study that as many as 1000 Russian banks could fail in a recession.
    -China’s savings are all tied up in banks where the nonperforming loan portfolios are estimated to be 70% of their portfolio. ie, In a catastrophe, the entire savings of China could be wiped out. Likely the same in nearly every developing nation.
    -Global deflationary pressures exist with tremendous productivity gains via IT and software. That has led to deflation historically.
    -Wages have been and continue to be stagnant while we have this great economic boom.
    -Hard assets globally are very, very inflated.

    And on and on and on and on. I don’t feel like typing forever as I get ready to head out for vacation here. But, those who view banks as defensive here are likely to be disappointed if we have an economic turd.

    No mess may come to pass but my point is being invested in stocks at all is a game of Russian Rouloutte till we get some clarity here. Have a good 4th to all!

  17. ~ Nona commented on Jun 30

    Paul, since you’re buying, not speculating, there’s a lot to be said for buying in an area where you want to live for a long time especially if the taxes are low and you found a house you really like and have been able to negotiate a lower price.

    My cousin and his wife have seen a lot of houses, but so far, none has made their hearts sing.

    I sold a townhouse last year — and thought long and hard before selling. I didn’t want to live in it and didn’t want the (continuing) hassle of renting it. I thought the market may be softening then, but wasn’t sure.

    It may have been the high for that area or just about the high, but if I had any doubts, the day of the walk-through a big pipe broke causing water damage from the third floor all the way down to the basement.

    There wasn’t time to figure out exactly what the damage was, so our respective lawyers came up with a price at which we settled at the closing the next day. Found out later from the buyers (we’ve remained friendly) that I got the best of the deal. Whew.

    Every now and then I wonder if I should have sold …and then I remember the renting hassle and related risks. I was an investor/speculator up until late 2004 when I decided to put the townhouse on the market.

    Your situation is different.

    PS: Let us all know if you get the house!!

  18. Lord commented on Jun 30

    6%. That’s big drop

    Not after advancing 12-25% a year.

  19. Paul commented on Jun 30

    You’re right, Nona, I’m not speculating, we’re looking for a home to raise a family in, and we think we found it. To Lord, you’re right as well, 6% isn’t a lot compared with the jump in prices, which as I pointed out originally is unprecedented. I just wanted to make the point that prices are indeed moving down, they’re not staying flat as many of the soft-landing types expected.
    I would have loved to have waited another year, and I’m sure I’m going to be bitterly complaining about home prices for, oh, probably about ever, but at least I’ll be doing it drinking a beer in my own backyard.

  20. ~ Nona commented on Jun 30

    To your point, Paul: A friend who bought a house in Bloomfield Hills, MI some 20 years ago bought on low price. He never much liked his house (although he loves his location). He said he would have been much happier for the past two decades living in a house that he truly enjoyed. He didn’t outright say it, but what was clear in the context is that he wished he had spent the money on a house that really pleased him.

    A house can be a house or an investment — or a home. Sometimes it’s worth it if you’re buying a home, albeit it a more expensive one, that you’ll enjoy for a long time to come. If YOU don’t feel that way, the person who wins the bid for “your” house might! I’ve known people who rued for years the house that “got away” because they tried to get a better price.

    And don’t forget: we want to know if you win that bid!

  21. adam commented on Jun 30

    I was living in Boston in late 1980’s/early 1990’s, and prices dropped sharply over a period of months not years.

    Granted, there was a tech recession at the time. If this cycle ends in recession, the drop will be farther and faster than expected.

  22. Paul commented on Jun 30

    Thanks for that story, Nona, makes me feel better that we’re doing the right thing long term.
    Just got off the phone with my realtor, and we got it.

  23. ~ Nona commented on Jun 30

    Great, Paul!

    Ignore housing prices if they decline in the near future. If you really like, even love, your house, the drop is just noise. Meanwhile, YOU have a house that you enjoy!

  24. wcw commented on Jun 30

    One quick note in re: “the biggest housing bubble in the history of this nation,” that’s what I used to think.

    Then I pulled some numbers and created this chart: http://www.bignose.org/~wcw/mortgage.pct.median.fo4.income.m.png In brief, mortgage payments on the OFHEO-index home at current rates are high relative to the median four-person family income, but not so high it hasn’t happened before. While these data series congrue only back to ’86 or so, we saw very similar ratios of payments to income in the late ’80s.

    As a result, I fully expect something very like the early-’90s trough in residential real estate to start any time in the next five or so years. That’s not a crash, but locally it could be pretty darned unpleasant; ask anyone who tried to sell his LA-area home in 1992.

    As a result, if current market bahavior is an incipient top (I think it is, but I am admittedly inexpert), then pegging the bottom of the trough in about three years is eminently reasonable.

  25. Alex commented on Jul 1

    This timeline generally matches with my experience in Southern California in the early 90s. The market began to seize up in late 1990, then collapsed in 91 through 93. The market then dragged along the bottom for 94 and 95, then began to go up again in 96.

    So I would put the bottom at 2009-2010, but it could be sooner with more rapid dissemination of information these days. There was no trulia at that time!

    The bad news of this process was it seemed to be endless torture while it was in process. No let up. But the good news is when the bottom was forming, it was very clearly defined. So it was easy to see when to enter. And there was plenty of time to catch the next wave, if one was already watching homes on the market.

  26. BDG123 commented on Jul 2

    “””OOPS!!!! Stock market bottom in October of 2008!!! Thanks for pointing that out!”””

    Ok, I did mean October 2007! I was running through all of this in my head last night and realized I had posted 2008!! Numbers, numbers and more numbers

  27. jkw commented on Jul 3

    Mortgage payments at current rates only matter if you expect rates to stay the same. In the early 90’s, rates were dropping. That is unlikely this time. Which means it will be worse than the 90’s even if rates just stay where they are. If they continue climbing, it will be much worse. Another difference is that more people have idiot mortgages where the payments double after 2-3 years. Which means there will be more people who have to sell at any price than there were in past cycles. A large amount of recent job growth has been due to real estate, so as the market slows, people will lose their jobs and make the market worse than it would otherwise be. There are a large number of speculators in the market, though I don’t know if that was common in the past or not. This is going to be the worst real-estate bust in the history of this country. Prices may merely flatten, but it is far more likely that they will decline. In some places, they will decline significantly.

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