This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

The books are officially closed on a decade which will be remembered for an historic real estate boom in the United States that busted in spectacular fashion, nearly taking the entire world financial system down with it.

Of course, the real story is a touch more complicated: Our housing bust was merely the most glaring crack in a global economy that grew far too dependent on cheap debt, where flows of money around the world magnetized to the hot asset, blowing bubbles first in stocks, then real estate, then commodities.

During each subsequent bust, governments rushed to the aide of markets, stitching them up with a patchwork of looser regulations, low interest rates and promises it would never happen again.

Late in 2008, the collapse of the credit markets culminated in the failure of some of this country’s most storied financial institutions. When the dust settled, Bear Stearns, Lehman Brothers, Merrill Lynch,
Washington Mutual, Wachovia, Fannie Mae, Freddie Mac, AIG, Countrywide and a host of smaller, lesser known entities had either gone bust or been bought for a song by stronger, better capitalized firms.

Some simply melted into this or that government agency, while many members of our financial complex survived only with historic government aide. Citigroup, Bank of America, Wells Fargo, JP Morgan Chase, Goldman Sachs, Morgan Stanley, GM and Chrysler are alive today thanks to massive taxpayer-funded bailouts.

But enough looking behind us; historians and journalists will be employed for decades slicing and dicing this most turbulent of decades.

Surveying the horizon, the primary fear among economists, investors and ordinary Americans is that the inflationary effects of pumping trillions of dollars into an economy must eventually come home to roost.

To be sure, there are those who remain firmly in the camp that believes the more pressing concern is inflation’s less-well understood counterpart, deflation. But even the most ardent deflationists believe theirs is a debate that is more accurately painted as one of time horizons, rather than absolutes.

The US dollar is in the crosshairs of this philosophic, as well as very practical debate. The greenback’s standing as the global reserve currency has been thrown into question as investors around the world scratch their collective heads and try to figure out how we’ll ever repay our staggering, ever-growing debt.

And now, as our economy appears to be slowly healing, the Federal Reserve faces the unenviable task of withdrawing its generous stimulus. In March, the Fed plans to scale back its purchases of mortgage backed securities, spooking more than a few market participants.

The fear, particularly for the housing market, is that any Fed pullback will push up interest rates.

Higher interest rates translate into lower purchasing power for buyers, curtailing the steady stream of homebuying demand that, coupled with ongoing foreclosure moratoria, has propped up prices in recent months.

We kick off 2010 with mortgage rates approaching the all-time lows set last spring. Sure, they could always go lower, but the smart money is betting it’s just a matter of time before rising prices force regulators to ease their foot off the monetary accelerator. Higher mortgage rates are likely on the horizon.

So as we begin the first true test of our nascent economic recovery, Cirios would like to take you through a bit of history. We’ll look first at the macroeconomic picture as it relates to home prices, inflation and interest rates. Next we’ll examine a few California real estate markets illustrative of the localized trends masked by most broad economic measures.

But first, a word of caution: As Mark Twain’s oft-cited saying goes, “History doesn’t repeat itself, but it often rhymes.”

It goes without saying that the financial upheaval of the past 24 months has been, in a word, unique. There is no historical analogue, no matter how neatly we try to jam this experience into some mold cast in the 1930s, 1970s or 1980s. By extension, any conclusions drawn from this historic perspective should be taken with a very large grain of salt.

Nevertheless, understanding where we stand and how we got here is essential to understanding where we’re headed. And understanding where we’re headed is essential to finding and taking advantage of the plentiful investment opportunities the previous decade’s turmoil has created.

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This post first appeared in the SPECIAL EDITION: Cirios Trends: A Decade in Flux

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Life is always so much clearer in hindsight.

The graph below shows the US Median Home Price (blue line, as measured by the 6-month moving average of the Median Price, admittedly as arbitrary a metric as any other) graphed against the year-over-year change in prices (red line). While it doesn’t take a degree in econometrics to identify the ongoing correction as the most significant in recent memory, here are a few additional items to glean from this broad view of history.

(click to enlarge image)

First, on a year-over-year basis, even at the height of the real estate boom in 2004, at no point did prices rise as quickly as they did in both of the booms in the early 1970s or mid-late 1980s. Instead, prices grinded upward without a meaningful correction: Prior to late 2007, the last annual decline occurred back in 1992.

Second, although prices are now roughly back in line with the historical trend of appreciation, understanding what drives this particular dataset paints a somewhat cloudier picture. Of the myriad ways to measure home prices, Median Price, despite being the most ubiquitous, can be misleading. Foreclosures and other distressed sales have driven the most active housing markets in recent years, so a larger-than-normal portion of sales have occurred in lower priced markets. This, in addition to nominal price declines, has skewed median price data to the downside. Now, as lower-priced markets stabilize and luxury markets continue to tumble, the dataset should return to a more historic mix of cheap as well as expensive homes. This means median price data could show appreciation where, in reality, no such rise in prices exists.

Finally, it is crucial to understand home prices in relation to inflation and the value of the dollar. Continue reading for some interesting comparisons between home prices and inflation while considering this: Simply adjusting for inflation and ignoring all other factors, a house bought in 1965 for the median price of $17,200 would cost $118,123 in today’s dollars. With the current median price just over $200,000, that means more than half of all home price appreciation in the past 45 years can be attributed to inflation. Nothing more, nothing less.

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By ANDREW JEFFERY

This post first appeared on Minyanville.

Treasury Secretary Hank Paulson is hoping he’s found the magic bullet to solve the US housing market’s seemingly never-endless woes.

He hasn’t.

By throwing around the weight of recently nationalized mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), the Treasury Department is considering a plan to push interest rates on purchase money mortgages down to 4.5% – well below the current market rate of around 5.75%.

Artificially lowering rates so buyers can afford more house led us into this mess; it’s doubtful the same tactics will lead us out.

According to the Wall Street Journal, the plan is in the early stages of development, but officials expect the initiative to spur buying activity. The aim is to prop up home prices by enabling borrowers to afford more expensive houses. Columbia University economists believe such a program could help between 1.5 million and 2.5 million Americans buy new homes.

In order to qualify for the low rate, borrowers have to meet Fannie and Freddie’s now-stricter loan underwriting requirements. But even with more affordable monthly payments – the lower rate amounts to savings of $150 per month on a $200,000 loan — precious few prospective buyers are willing and able to pony up the tens of thousands dollars still required for a down payment.

Combined with the Federal Reserve’s recent $200 billion lending program for securities backed by newly originated mortgages, bureaucrats are pulling out all the stops to buoy falling property values.

This is the latest in a series of botched attempts to re-inflate the housing bubble. And like the others before it, the plan fails to address the root causes of ongoing home price declines: Negative equity, over-supply and mounting job losses.

The flood of recent loan modification programs championed by FDIC Chairman Sheila Bair and rolled out by JPMorgan (JPM), Citigroup (C) and Bank of America (BAC) also miss the point. Like any distressed market, the housing market badly needs price discovery. And like any other asset class, the true price of a house is only discovered when someone buys it on the open market.

By creating unnaturally low interest rates and allowing buyers to purchase bigger homes than they could normally afford, Paulson and Bernanke are preventing home prices from falling back to where responsible, fiscally minded Americans can buy without the crutch of government subsidies.

These continued distortions of the free market end up running in contrast to their intended goals: As long as the charade continues, as long as the real estate market is prevented from finding a natural bottom, home prices will continue to fall.

The silver lining — for those brave enough to uncover their eyes and look – is that just as it overshot on the way up, the housing market will likewise overshoot on the way down.

A protracted period of stabilization will ensue, during which time the opportunity to purchase high-quality residential real estate below its long-term intrinsic value will be extraordinary.
Savvy investors with the ability to identify attractively priced properties will, eventually, have the buying opportunity of a lifetime.

This post first appeared on Minyanville.

I came upon an interesting report out from Deutsche Bank on the effect high gas prices are having on home prices. Below are some highlights:

• Gas prices are up 167% in the last five years, 32% in the last year.
• Monthly gas expenditure is up to $519 in June ’08 from $173 in June ’02.
• $54,000 in home price purchasing power has been lost in the last five years; $22,000 in the last year alone (Inland Empire, CA is the worst at 46% lost in the last five years).
• As measured by increased monthly expenses and translated into mortgage payment terms, the impact of rising gas prices is equivalent to a 2.47% increase in mortgage rates over the last five years; 0.98% in the last year (Inland Empire is again the worst at a 4.35% effective increase over five years).
• Deutsche sees non-bubble areas like Texas and the South more exposed to gas price increases than bubble states, due to long commute distances and low relative home prices.
• Homebuilders are being negatively effected by this trend, particularly in developments far away from the city center.
• Builders will likely switch strategies and focus on urban “infill” and closer-in townhome projects.
• According to Deutsche, Meritage Homes (MTH), Ryland (RYL) and Lennar (LEN) have the most exposure to highly impacted areas; MDC Holdings (MDC), NVR (NVR) and Toll Brothers (TOL) have the lowest exposure.

Click here for details on this House of the Day

Value: $250,000
Projection: Depreciating

Fallbrook is located in Eastern San Diego County, just south of Temecula along Interstate 5. The city and the surrounding area are being adversely effected by the economic slowdown, as much of the growth in the area was due to new home construction. High gas prices are also weighing on consumer spending in an area dominated by commuters. As a result, home prices have fallen dramatically from their peak in late 2005 and continue to fall.

Our property is centrally located, making it more desirable than those on the outskirts of town. There are, however, many listings in the subject’s immediate vicinity. The property also requires some “TLC,” which indicates its condition is likely inferior to its neighbors. Listings in the area range from $273,900 – $549,000. Only three properties have sold in the area since April 15th, all of which are superior in quality to the subject.

515 Shady Glen road – aside from having a suspect address – is a similarly sized home, but in turn key condition. It sold for $265,000 on 6/19/08. The subject is on a slightly larger lot, but the inferior condition, combined with the weak local economy, high gas prices and an oversupply of houses place the value of the subject property at $250,000. Further declines are likely in the near future.