Foreclosure Outlook 2005: Bubble Trouble

Year 2004 will probably be remembered as one the finest years in the real estate market of the U.S. As we pointed in our Foreclosure Outlook: 2004, low mortgage interest rates have helped fuel the soaring home values. According, to the research of the Office of Federal Housing Enterprise Oversight (OFHEO), the average year-over-year increase in home prices throughout United States was 12.97% from the third quarter of 2003 through the third quarter of 2004.

                  Source: OFHEO

In his report, Mr. Armando Falcon Jr., Director of OFHEO makes an important observation. He states that “the appreciation reflected in this quarter’s report shows further acceleration from (an) already rapid increase; (and) the growth in house prices over the past year surpasses any increase in 25 years.”

Several factors could be playing into these elevated numbers. One possibility is that even though the short-term rate has been rising this year; the long-term interest rate to which mortgage rate is pegged has remained below the 6% mark. These low rates continue to bolster home buying at attractive levels. Another factor affecting the high home price numbers is the end of the refinancing boom; refinancing loans in the current quarter fell well below recent levels. Such loans with low loan-to-value ratios were made only to refinance existing loans (non-cash-out loans); hence, they may have not captured the true increase in home sale prices as experienced in the third quarter of 2004.

A review of the table below shows that less than twenty states had returns above the US national average, while the other states did not even keep up with the national average. In cities like Las Vegas, NV homes gained a stunning 41.74% last year. This increase can be attributed to people relocating to cities where the job market has been strong during the last few years. In some Northeastern states, specifically in the Washington D.C. area, home prices jumped 24.01% because of a strong job market and also due to higher spending by the federal government.

By contrast cities with higher unemployment rates and sluggish growth lagged the national average. Cities like Anderson, SC and Austin, TX staged growth rates well below the national average.

Such discoveries confirm the notion that inflated home values are not rampant throughout the country, but rather limited to certain states or major metropolises. Hence, if there is a bubble it is localized and regional, but not national.

In a different study reported in MSNMoney.com Edward Learner, a UCLA Economist looked at home price-to-earnings ratio (P/E) levels to see if the home values were overpriced. He used the same concept used by stock investors to measure stock valuations based on P/E ratios. His findings were as follows:

• In Boston, the residential real estate market’s P/E recently topped 30; compared with just under 20 in 1988.

• San Francisco’s previous peak of 25.6 in 1989 has been eclipsed, with the P/E currently at just over 27.

• San Diego’s current P/E is nearly 30, compared with a 1989 high of 23.4.

• New York, by contrast, was significantly below previous peaks. The area’s current 22.5 P/E is above its recent nadir of 17.6 in 1993, but down from 28.6 in 1988.

As Learner pointed out, knowledge of the exact P/E is not critical, what is important is the extreme between price and the underlying value of home, as measured by their market rents. Hence, when area P/Es get to elevated levels therein lies the potential for a bubble.

Following are some of the P/E valuations in major cities across the US.

            
        Source: MSNMoney.com

Mr. Learner’s research substantiates the findings of the OFHEO; over valuations are not all across the US, but rather localized in certain hot spots of the country. As observed in the past, market dynamics usually normalize any excesses and/or overvaluations in areas that have overshot themselves. Such regions may either experience flat returns in the future or may actually go through a correction to adjust for the soaring returns realized in the last three years.

As we approach 2005, there is a likelihood that mortgage rates will trend upwards. This by itself could slow the appreciation rate of home prices. In fact, we could see a reversal of a trend back to single digit numbers, which would be more in line with the national average.

As investors, finding foreclosures deals in this sizzling market has definitely been a challenge. The returns have been so strong, that most homeowners in default have had time to sell the property and walk away with a net profit after paying what is owed on the home to the bank.

What is evident from these studies is that the hot real estate markets are localized and not nationwide. As an investor, one may need to “think out of the box.” Thus, herein lies the opportunity; cities such as the ones listed in the table below make good candidates for investors to prospect. Finding discounted properties in place like Irvine, CA or Las Vegas, NV may prove challenging. However, North Carolina is a good case in point: textile and furniture manufacturing make up for about ten percent of the states gross revenue. Both these industries have been hard hit by outsourcing due to cheap labor cost in China and Mexico. However, if we look at Charlotte, it houses some of the nation’s largest banks. Moreover, Raleigh and Durham are attracting jobs from Silicon Valley due to lower business cost and of course lower real estate prices. Most recently, Dell announced plans to construct a new assembly plant in North Carolina. As North Carolina moves forward to rebuild its economy, investors should look for similar potential opportunities.

Although, it goes beyond saying that due diligence is required before making any investment decision. Investors should also consider the assistance of a professional real-estate agent as there are many intricate factors that require serious consideration before making a purchase.

As we approach 2005, we anticipate foreclosure opportunities to be more prevalent than in the current market. However, consistent and persistent research will be required. We at Foreclosure4Sale.com are committed to supporting our clients with information and data, to help them make better investment decisions.

We would like to wish you a very Happy, Healthy and a Prosperous New Year.

Your team at Foreclosure4Sale.com

Sources:

Office of Federal Housing Enterprise Oversight (OFHEO)
MSN.com