Before We Get All Sappy Happy: Housing and the Economy

Foreclosure StreetSurely, there was a homeowner somewhere in the Sand State of Nevada who saw the headline about home values increasing 9.3% nationwide and smiled.  Not to be a buzz killer and turn the smile into a grimace, but there’s a catch. ” Stan Humphries, chief economist at Zillow, a real estate data provider, cautioned that the national figures are being skewed by sharp rebounds in cities hit hard during the housing bust, including Las Vegas and Phoenix. Investors are helping drive up prices in those cities.” [RGJ]

What’s the meaning of all this?  Investors skewing the prices shouldn’t be news in any commodity, and for the moment let’s think of houses as a commodity.   Who are the investors?  Perhaps they’re the ones who looked at the Local Market Monitor and decided that of 316 cities in the United States, Las Vegas was the best in “estimated returns on investment for single-family rental properties.”  [CNN] Let’s assume for the moment that no one has repealed the law of supply and demand, so a return on investment would be bolstered by having a low initial price for the commodity in question.  At this point there’s a second catch.

Getting a return on the investment in rental property means there have to be people who want to rent and they want to do so at a price which will achieve what the investor believes will be an acceptable rate of return.  As of July, 2012 rental rates across the country were up 5.2%, enough to whet the interest of potential investors.  [HuffPo] However, since all real estate investments are local, someone should have noticed that as of the middle of last year the Las Vegas rental market was the only major one not to see YOY increases in rental prices.

Investors would like to see returns of 7.5%-9.5% (after HOA fees, and taxes, are included), but there are some factors mitigating against those estimated rates of return which are so attractive to the investors.

What happens, for example, when an investment group moves into a local residential housing market and makes offers for homes about 20% over the current market price?   This strategy is fine when there is a glut of residential properties on the market and the home values have taken a real pounding, circa 2008-2010.  The strategy is not so productive when the cream has been skimmed off and properties which have been vacant for some time are still included in the supply figures, circa 2011-2013?

If markets for commodities don’t function well with uncertainty, then Las Vegas could be a poster child.   Foreclosures, a nice source of residential real estate suitable for renting, were running rampant prior to the enaction of AB 284 in the last session of the Nevada legislature.   As of 2012 foreclosure rates were down as banks swanned about trying to clean up their acts in regard to robo-signing and blatantly consumer-unfriendly practices.   The pendulum may be swinging back?   Realty Trac reports that Nevada’s foreclosure rate declined by about 14%, but the 1:320 ratio was still among the highest in the country. [VegasInc]  This might be a good sign for those “investors” if there weren’t so many gray areas in the picture.

A “No Show” doesn’t simply mean absence.  There are “no show” properties as well.  A property could be on hold (H) when there is a valid listing contract but the seller has requested a “no show” because of personal circumstances or because repairs are needed.  A property might also be subject to third party or court approval, in which case it’s “on market” but in a “back up status.”  A residence could also be pending (P) meaning that there is an offer which has been accepted but not finalized.  Then there is the following:

“Las Vegas has thousands of homes with delinquent mortgages where  home owners who have been living mortgage free in their home for more than 2 years, have no motive to short sale their severely under water homes. In a normal market threat of foreclosure would motivate these home owners to seriously market their home as Las Vegas short sales, right now Las Vegas MLS is full of no show, highly over priced short sales that are marketed just to prevent foreclosure. A good example is an agent who has put his own no-show home in Las Vegas MLS at twice the price of comparables; he knows that his home has zero chance of selling.”  [LV4us]

“In a normal market” — but this isn’t a normal commodity market.  We have investors trying to scoop up “value” in residences for speculation offering inflated bids, and sellers who are listing “no shows” without much intent to sell, combined with the prospect of another surge in properties listed as the bankers go for another round of foreclosures.

Timing is everything and nothing.  Or, as Warren Buffett once opined: “We continue to make more money when snoring than when active.” [CBS]  Is an investor likely to see those 7.5% to 9.5% returns if he’s timed his entry into the Las Vegas residential real estate market just as the “big players” have inflated prices and skewed the numbers?  Will the investor see those returns if she has entered the market when the number of short sales increases, and the value of her newly acquired “assets” trends down making the purchase price look good but the assets counted in the total value of the investment look a bit grimmer?    By how much would interest rates have to increase to turn a bargain into an unsalable elephant weighing down the finance planning?

Let’s guess for the moment that the private equity behemoth Blackstone Group is one of the major players in the Las Vegas real estate game.

“The firm has also invested in Northern California. Statewide, Blackstone has poured close to $740 million into California real estate through January, according to DataQuick figures. Nationally, the firm has invested in seven other regions: Atlanta, Phoenix, Charlotte, Seattle, Las Vegas, Chicago and multiple cities in Florida.” [LAT]

And, further let’s review the part in which they have a very financialist version of a business plan for all this activity.

“These firms are also exploring ways of packaging rental income streams into securities, similar to the way mortgages were bundled during the boom years. Those mortgage bonds — often packed with risky home loans that produced mass defaults — turned into the toxic assets that helped bring down major banks during the financial crisis.” [LAT]

What is contorting the Las Vegas real estate market? Why are the prices skewed?

There’s “packaging rental income streams into securities.”  Instead of packaging the mortgages of single family homes into a “revenue stream,” they’re packing rental agreements.  An assortment of 1,000 rental agreements are packaged up as a bond.  Some are very good agreements, others are to people who may vanish with stealth comparable to the Irsays moving the Colts out of Baltimore.  The “value” of the bonds depends upon the quality of the rental agreements included in it.  How does a potential investor in the bonds know the value of the package?  Does fiduciary responsibility require the investor to examine each of the rental agreements or — in a wrenching reminder of days not so long by — does the bond investor rely on the rating agencies to stamp AAAAAAA’s on the paper?

Does the bond investor repeat history by repackaging the bonds, and by creating derivatives?  Will we see a repetition of the CDO quadrupled game as played by Wall Street firms who invest in both sides of the residential rental property market?  That a major private equity firm is willing to risk a repetition of the mortgage market mess created as of 2008 by creating a rental agreement mess culminating in a lovely crash in the not-so-far future seems prima facie evidence of how little Wall Street learned from its most recent escapades.

I’d like to smile about the return of value to Las Vegas homeowners, but the uncertainty in the residential real estate market, the machinations of the private equity crowd and some bankers who have the Bourbon-esque capacity to never forget and never learn, and the prospect of boiling yet another Securitization Stew, makes me want to grimace.

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