Suburbs that will turn into ghost towns

I know, it sounds like the type of advice you would expect from your great grand dad on a family reunion, but reality is, the man was right. Don’t risk money in something you have no clue about (unless you can afford and are willing to lose your investment).
In ongoing discussions about the economy and real estate, I keep getting the question if US Real Estate has bottomed out now that maybe the economy is showing some degree of recovery and frankly my answer is : No, on both.

Of course I would love to say yes, but the truth is, real estate has definitely not bottomed in the U.S., and probably not anywhere else either. You have to take a long-term view of this. Remember that through most of U.S. history, residential real estate was not viewed as an investment. You didn’t buy a house to make yourself wealthy selling it to someone else. It was viewed as an expensive consumer good that depreciated – you bought or built a house to live in just as you bought clothes to wear or a car or bicycle to drive or ride to work and take the family on vacation. It was just a part of life – a necessity, a convenience, but an expense.

Before money was made cheap and homes turned into an annual income provider, home ownership meant a place to raise a family, build lasting friendships and invest in a long term asset that grew equity as you paid down your mortgage.
And before a lot of external factors of the supply economy pushed short term equity to the forefront of housing in America, people lived in their homes and build retirement savings over the years. But then came the era of “I deserve” and part of the accruing equity was increasingly used to finance a business or a college education or an unexpected hardship expense or leisure. The most consciencious financial planners among us made sure that annual upkeep was budgeted and adhered to, so that depreciation did not occur, only appreciation.
But for many diligent Americans the home was still the financial anchor through life, not to be jeopardized. Unfortunately other ones did that for them.

Leverage was introduced as a function of wealth perception in order to facilitate the misnomer that growth is a birthright, even if there is no productive effort at all. Money became cheap and mortgages were available to anyone alive being able to sign their name. The buy and sell machinery started running on high speed, not because of the need for dwellings to raise families, but as a leverage for anyone with the opportunity to make quick money.
Homes turned into houses and houses produced income as rent and/or as perceived equity. Periodically refinancing homes became a full contact sport and since money was cheap people went out on a limb and exposed themselves dangerously with refi’s.

With all the cheap money that was made available through the Federal Reserve and the banks, the “need” arose to keep cash turning fast so Wall Street invented a little product that they called “derivatives” or mortgages had turned into commodities futures contracts.

It was a huge change from the days where you knew your banker, he knew you, and he was lending his own money.
The result has been a huge amount of overbuilding, in residential, office and retail commercial real estate. It’s going to take years and years to work this off and even longer in South Florida, California and Las Vegas, Nevada to name a few.

Back in the fall of 2009 I predicted that real estate would go back to 40% of its boom heights. Now, almost 2 years later I do have to correct myself and say that it may be even more.  The new poverty figures in the United States are coming out this week and it looks like the numbers say that 1 in 6.5 Americans was poor in 2009 (15% of the population). It is clear now that all the warnings about bailouts, tax incentives and other economic stimuli have confused the recovery effort back into a double dip recession and Washington is facing a major breakdown in November, unfortunately I do think that it is too late to change the economic consequences of these foolish John Maynard Keynes inspired actions.

A quick look at comparable prices in the newspaper ads from the Depression era indicates that residential property fell 90% over a period of about five to ten years. There’s no reason that couldn’t happen today, especially in overbuilt markets like South Florida, California, etc., but truth be known, it could easily be much worse. And here is why; in those days, most people paid cash, to start with. If you had a mortgage, you usually put at least 20% down, and the length of the mortgage was generally five years.
Today, with even prime mortgages having much less money down, lasting 30 years, and floating rates, there’s much more leverage. And then there is another major reason and I’ve got to say that this is the big elephant in the room that no one is talking about. To me, even more important than the overbuilding and more important than the amount of mortgage debt, is that real estate taxes are completely out of control in the U.S.  I talk with people daily whose property taxes translate into $1,000 a month or more. 2% over an assessed value of $1 million calculates into $20,000 per year divided by 12 months is an easy $1,667 per month. Add to that an insurance premium made mandatory by having a mortgage, of another $10,000 per year and the negative attraction to buy makes supply and demand an academical issue.

In the great depression people could buy properties for just back taxes. Today, you can buy square miles of some cities, like Detroit, or entire suburbial deveopments for back taxes alone – but nobody’s doing it. No one sees the $1,000 minimum bid as worth it, partly because the properties are likely to remain tax liabilities well into the future.
Starwood’s $199 million bid for the Sea Palms property is a steal according to insiders, as is Omni’s $67 million bid for Amelia Island Plantation, but what is forgotten is that taxes owed to the government is cash money that has to be coughed up. I think that even though there are going to be large numbers of places where you’re going to be able to buy whole tracts of McMansions for past taxes, you’ll think twice before doing it, because those taxes are going to continue or even get worse, as government revenue from other sources keeps falling through the floor.

I also think that as transportation cost will become prohibitively expensive to continue driving 100 miles or more daily to a job that won’t have any prospects for a pay raise, and as a consequence we’ll find significant tracts of outlaying suburbs across the nation that will be literally abandoned in the not-too-distant future.

What is wisdom in real estate investing?

Buy things that you like personally and can see using yourself.
Understand that bedroom communities of cookie cutter houses way out in the desert, or in places that should still be cornfields, are dead ducks. They’ll end up being torn down or becoming new ghost towns, as it will be impossible to maintain them until a new generation of buyers is ready, if ever, to settle in them. But good locations with solid construction will always have a market between supply and demand. Locations that provide job opportunities, high tech internet capacity, safety, convenience, education and accessible leisure will do fine in terms of real estate. A form of urbanization will be the trend for the next 10 years. Kind of like circling the wagons in the old west.

More tomorrow on the prospects of Commercial Real Estate (or are there any?)