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Erica predicts your news headlines for 2007

It’s pretty interesting to me that the financial news sector has such a disconnect from the regular news sector. I read about many things in the financial news that most people have no clue about. These things will only make the regular news when they start to affect people, not just markets. Therefore, I’m stepping out on a limb to predict your news headlines for 2007 based on what the financial news sector is saying today. I firmly believe that all of these will become front-page news headlines (some for days and days, until you get sick of reading them) in 2007 — or possibly late 2006. Here we go:

The real estate boom is over. Toast. Dead. Done with. That’s already starting to hit the mainstream news. But the really interesting news is the shocking stories that will appear once the largest real estate bubble we’ve ever had turns into the largest real estate bust we’ve ever had, and it’s a bust that will likely send our country into a spiraling recession.

Let’s start with Florida. Florida will turn into a complete disaster area in the next year… if not by hurricanes, then by ridiculous overbuilding, oversupply, and glut of condos. That old joke, “Why are Florida condos like STDs? Because you are stuck with both for the rest of your life.” will resurface. The ridiculous price of hurricane/wind insurance (even inland!) will result in a lot of Florida condos (and some houses) that will not be able to be sold at any price.

Other markets that you’ll see break in 2007 include San Diego, Las Vegas, and Phoenix. All of these markets have been overbuilt so much that price declines of 50% or more by 2011 are likely. Here are some inventory numbers from Phoenix. Available homes for sale, May 2005: ~5,000. Available homes for sale, July 2006: ~55,000. Vegas is just as bad, with greedy developers snatching up everything within 5 miles of the strip to build condo towers on, and investors who will not be able to bail out of the condos they bought at overinflated prices. San Diego has 3,500+ condos that are being built right now. (Folks, $300,000 for a San Diego condo is soon going to seem as ridiculous as buying dot-com stock for hundreds of dollars a share. Bookmark these links for a good, hearty laugh in 5 years.)

The other thing you’ll start to see surface that is directly related to overbuilding of houses and condos is developer lawsuits. Pretty soon, some of the “investors” that bought condos at ridiculous prices and realize they can’t sell for even 70% of what they bought the condos for will start suing the developer. Claims? Anything from shoddy construction (oh, and you’ll find some nightmarishly bad construction on some of these condo units…they were slapped together at the peak of the market as quickly as they could be) to false promises regarding a return on investment that never materialized.

Let’s take a look at realtors, mortgage brokers, and the others who make their living in the real estate market. Did you know that 70% of the jobs created post-dot-com-boom in California are NOT in high tech, but in real estate? How about the fact that there is one Realtor(R) for every 55 people in California? At least half of these people will be out of work by 2011. Also, mortgage brokers and mortgage lenders will go out of business fairly quickly (perhaps aided by more lawsuits from angry buyers that were sold false promises.)

Here’s what may be the worst headline in 2007. Fannie Mae earned $10 BILLION less than they stated in their 2004 earnings report. What does that mean for us? Fannie Mae and Freddie Mac are two of the largest holders of mortgages in the country. They are allowed to borrow money at interest rates lower than any private company due to the assumption that they will be bailed out by the U.S. government if they go under. The problem is that this implicit (NOT explicit — Fannie/Freddie loans do have a disclaimer stating that the government does not guarantee their loans) assumption has allowed corruption to reign supreme. Earnings were ridiculously overstated. Then the executive management paid themselves huge bonuses based on the fraudulent earnings. This has “Enron” written all over it.

If the government does end up needing to bail out Fannie or Freddie due to massive corruption imploding them, our U.S. dollar will tank relative to other currencies. The dollar has remained strong because foreign investors keep pumping their money into the American economy. If a real estate bust and/or a Fannie or Freddie bailout happens, foreign investors will seek other countries to increase investment in, further sending the dollar down. Note this recent article regarding the dollar, which has the following quote:

“The dollar will no longer enjoy the benefit of consistently rising interest rate yields and will now have to compete on U.S. economic performance alone.”

U.S. economic performance is likely going to be very poor over the next 5 years — and perhaps longer. If you want to make money on this, bet on the dollar to be weak and hold a long position. Buy currencies of countries you think investors will want to invest in. You will come out ahead.

Finally, let’s head back to the local real estate scene. Here in the Bay Area, inventory has increased, but prices have remained fairly steady. With 30% more homes on the market this year than last year, and houses taking longer and longer to sell, the next move is a price drop. And drop they will. Prices have been disconnected from fundamentals for years now. (Read that link for an excellent, in-depth description of why the current housing market in the Bay Area is unsustainable.) But if you want the quick run-down, here are a few facts:

  • Housing supply in the Bay Area, per person, is significantly larger now than it was in 1999. Normal laws of supply and demand state that prices should have gone down from their 1999 levels. They have not.
  • Developers are still building condos, condos, condos. Have you been to Emeryville lately? And they are building thousands more condos near Jack London Square in Oakland…a quick drive or BART ride to San Francisco.
  • Population has been decreasing here since 1999. One friend of mine is sure that San Francisco real estate prices will remain at their current bubbilicious levels due to population growth. It’s not his fault he’s been sucked into this myth; it’s the same line we’ve all been fed by Realtors(R) and others who make their living selling houses. I’m sorry to say that this is a myth. The population of San Francisco was larger in 1950 than it is now!
  • 1950 San Francisco population: 775,357
  • 2005 San Francisco population: 739,426
  • Uh-oh.

I predict at least a 35% decline in housing prices (overall, average) from 2005 prices for the Bay Area by 2011. The hardest-hit areas will be outlying areas that rely on commuters to make the numbers work. As commuters see gas prices go up, up, up, the advantages of paying less for a house decrease. Sacramento will be hit extremely hard due to too many single-family homes being built. Tracy will be hit hard. Places that will be hit less are places close to where people work and/or close to public transportation other than buses. For instance, houses close to BART stations should retain more value than those where you must drive a car to get anywhere.

Condos will be hit worse than houses. There are more condos being built right now, but more people desire single-family homes. Those looking to “move up” from a condo to a SFH (single-family home) may find themselves trapped in a condo that is worth less than when they bought it — if they bought it later than 2001.

So when does the real estate bust finally end? It’s hard to say, but you can use this guide as a rule of thumb. Take the rent that you would be paying for an equivalent place and multiply by 200. If the house you are looking at costs less than that, it’s probably a good deal. Doing the math on the place I live in now, we find the magic number to be $570,000. My landlord paid $625,000 for the place in 2004. It is now worth approximately $800,000 (if he could find someone to buy at that price — duplexes are not hugely popular here.) A 35% decline over the current “high-water” $800,000 price puts the duplex at roughly worth $520,000.

This duplex sold for $325,000 in 2000.

This is why 35% price declines are not unreasonable. $325,000 in 2000 to $520,000 in 2010 is a 62.5% price gain in 10 years, or 6.25% per year, which is still over the historical average for the Bay Area. That means by the time we overshoot the bottom in 2011 or 2012, it could well be that this duplex would be valued at only $450,000…or less.

And time goes inexorably on…

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