Real Estate Enthusiasts and Friends,
Lately, many of my clients have been asking me what I think about the U.S. economy and my outlook on our troubled market and how this turmoil is going to play out in the real estate market. During this real estate crisis, I have been working with several clients in developing strong financial and real estate foundations that will grow and generate wealth over the long haul. In this effort, I have decided to create a monthly newsletter that will touch on the status of the economy, the financial and real estate markets, and other information that will be useful to you in your pursuit of Financial Independence. I thoroughly hope that you enjoy this letter that will be coming to you monthly with weekly updates and that it will assist you in your business decisions.
MARKET OUTLOOK
The financial markets are struggling to stay afloat and the threat of a recession is growing. By definition, a recession is a decline in the Gross Domestic Product (GDP - this is the total market value of all goods and services produced in an economy in a given year) for 2 or more quarters. The fear of economists is that as foreclosures increase, the real estate market will be pressed further downward and financial institutions will see further losses. If this is played out to the worst case scenario, we could see a retraction in business activity, which will result in increasing unemployment and a decrease in demand for goods and services across the board.
It is important to recognize that markets are cyclical and if we look back in the past, we can see that this is a normal occurrence. Our economy is just coming off of a very heated real estate market artificially buoyed by super low interest rates. On June 25, 2003, the Fed Funds target rate was 1% and it was held there until July of 2004. The Fed's position of easy money created a national frenzy for home purchases and refinances. It was so cheap to buy a home that many people whether they could afford it or not, bought into the hysteria. Dr Mark Skousen wrote in his January 2008 newsletter, "...We know that inflationary booms are unsustainable and require a bust." Alan Greenspan talks about these market frenzies as "irrational exuberance." Correctly stated, people incorrectly reasoned that any real estate venture would naturally turn to gold. Fortunately, all things come to an end.
As a result of these negative economic conditions, Wall Street has been on a roller coaster ride. Since the beginning of the New Year, the Associated Press reports that the S&P 500 as well as the DJIA are down 5% NASDAQ is down 8%. Since October 2007, the S&P 500 is down 11% and any decline greater than 10% is generally considered to indicate that a market correction has occurred. This is also an election year and Wall Street always reacts poorly to uncertainty. If the democrats win the Presidency and they are successful in their quest to raise taxes, I expect the market to retract even further as needed revenue is rerouted to Washington. No doubt, you will continually hear a barrage of negative press concerning the state of the U.S. economy and those sensational media reports will add a great deal of unwanted consternation to your life. Even so, it is my experience that it is unwise to underestimate America. We are the product and heritage of generations of winners.
Will the U.S. Economy fall into a Recession?
As dire as many of these things are, the reality is that the U.S. economy is finally compensating for the real estate frenzy which began cooling off in 2006. The effects of increasing foreclosures and the bankruptcy of numerous mortgage banks, has placed the economy in a dangerous position. In spite of all of this, Bloomberg reports that the U.S. economy is still expected to grow at an average 1.5% in the first 6 months of 2008. With the market teetering, it is very likely that the Fed will lower the Fed Funds Rate. This move will add liquidity to our system and it has the potential of turning the real estate market around. If the housing market rebounds, we will see decreases in housing inventories and foreclosures. This could slow the bleeding that has been occurring in the financial markets and we could start to see some increased profitability reports by the 3rd quarter of 2008. If there is a recession, it is likely to be very mild in its effects as several other sectors of the economy continue to grow strongly.
I will keep a close eye on the reports that Chairman Ben Bernanke and the Federal Reserve Governors make about the market and their inclinations to either maintain or lower the Fed Funds Rate. If the Fed Funds Rate is reduced, I expect Wall Street to react favorably and regain some lost territory. A lower rate will also eventually result in lower mortgage rates. Typically the mortgage market competes for investments dollars with Wall Street but with cheaper rates, banks can competitively offer lower mortgage rates to consumers. If this rate reduction materializes, it is very probable that many people, who were priced out of the market over the past two years, may finally see some new opportunities.
The Banking Industry is Successfully Regulating Itself
Banks may have been overzealous in their efforts to knowingly write loans to poor borrowers in the past because the appreciation gains truly mitigated the risks. Lately, I often hear news reports that disparage the banking industry as a group of greedy lenders who dishonestly sold loans to people who were unwittingly suckered. There is battle cry being shouted in the halls of government to blame the banking industry for the sub-prime meltdown and all of the woes associated with it. Unfortunately, this blame is misplaced. The industry acknowledges its mistakes in being too candid with its lending practices; however, many of the loans that have performed poorly have been identified and shut down. It's naturally in the bank's best interest to sell loans that perform well.
Borrowers are just as complicit in this crisis and they must shoulder some of the blame. Laura Bruce wrote for Bankrate.com that, "The U.S. Commerce Department's Bureau of Economic Analysis dished out some discouraging news recently, saying that Americans spend more than they earned in 2005-a negative savings rate of 0.5 percent for the year. That's the first time that's happened since the Great Depression."
When I qualify borrowers, I weigh their credit score and financial reserves heavily in my decision to submit an application. There are very few programs available to people with troubled credit or with little reserves. Candidates who fall in these categories must meet and satisfy a lengthy and stringent list of lender imposed guidelines. The problem is that in Washington, legislators are attempting to alter the manner in which lenders can lend, hoping to weed out even more borrowers. Even though, the industry has done an admirable job of regulating itself, politicians are using this issue to gain more traction with their constituents who have been affected by the financial crisis.
The concern here is that if Washington decides to meddle in the industry, it's likely that it will become even more difficult to qualify for a loan. This has the potential to block an even larger percentage of buyers from access to the market. Even if only 1% of the borrowers are regulated out of the market, it will have a measurable impact on real estate inventories and prices would continue to decline. This overreaction by Washington could actually forestall the real estate market's recovery because fewer buyers would be available to swallow up the excess inventory. I will keep an eye on the progress of this legislation and keep you posted.
REAL ESTATE OUTLOOK
The real estate market has taken a beating this past year, but the Portland market has been very resilient compared to the National Market. The S&P/Case-Shiller Home Price Indices reports that housing appreciation was 1.9% for 2007. That's not bad especially when many markets nationally have seen negative appreciation. The flip side is that time on the market increased as well; moving from 51 days in 2006 to 67 days today. Even though, house prices are going up slowly, it's still very frustrating for buyers who are waiting for their home to sell. For people who are desperate, the time it takes to sell often exceeds their funds and they are forced into foreclosure.
I am anticipating that the real estate market is going to remain relatively flat through 2008 and it will begin to show signs that it is turning around by the 3rd quarter of this year. The local economy is slowing down but on the whole it still remains very strong. Real estate markets tend to follow the ups and downs of the local economy and we can expect that real estate will begin to grow again once the effects of the mortgage crisis have been exhausted.
STRATEGIES
Home buyers: With appreciation still positive and a market correction underway, I strongly recommend a buy decision. Since sellers are as paralyzed with fear as most buyers, this is a marvelous opportunity to get your home well under market price. I have a client who purchased a home $30,000 under its appraised value. Moreover, I suggest that you seek as much money in seller's concessions in your purchase offers as possible. This is typically around 3% of the loan amount. For example, a $200,000 loan can usually receive $6,000 towards closing costs. This can greatly reduce the amount of money that you will need to close on your home.
Sellers: I recommend holding onto your property if you can until the market turns around because you are not as likely to get your money's worth out of the sales price. If you have to sell there are a few strategies that I would employ in order to attract buyers over your competition, which is vast. In the good old days of 2005, you could put a house on the market that might have had some cosmetic deficiencies and still be able to sell it for top dollar. This is no longer the case. Your home will need to be immaculate inside and out and you might seriously consider professionally staging your home. I had some friends who sold their house in under a month for top dollar because they followed the advice of a professional who understood proper staging.
You can also utilize the seller concession to your benefit as a very strong buyer's incentive. In the $200,000 example, you could offer $6,000 in concessions in stead of lowering your asking price. This concession can be used to permanently buy down the interest rate on the loan that they buyer purchases. In the end, this concession could save a buyer hundreds of dollars of month and thousands of dollars in interest over the life of the loan. In fact, offering a rate buy down will result in making your home more affordable. Since one of the major qualifying ratios that determine a buyer's approvability is the debt to income ratio, a permanently cheaper mortgage payment makes a home that was previously unattainable suddenly affordable. You might be able to attract a buyer who passed by your home thinking it was out of reach.
Investors: If you are in the market to purchase an investment property or turn a current home into an investment property, this is a great time to make this move. I recommend that you use caution when approaching an investment property decision because appreciation is not your ally at this time. However, this could be a good buying opportunity. In a January 9, 2008 article, "Rental Apartment Demand Up in Many U.S. Markets-REIS," David Bailey wrote for Forbes that effective rents in Portland, Oregon have risen by 2.6% to $748. With home prices going up and the credit market making it more challenging to secure financing, more and more people are renting again. With increasing demand for rental units, the rental price that you can charge will gain momentum once more.
Renovators: If you fallen in love with the idea of buying a distressed home, rehabbing it and selling it for a nice profit, you will need to wait until the market heats up again. The key component to successfully doing this is to find properties that have a high marginal value. What this means is that you need to locate a property in a neighborhood where quality homes are selling significantly higher than your target property. If my projected repair costs were $30,000, I would want to be able to work in about $60,000 in equity to the house after closing costs to cover my profit and my renovation costs. It is nearly impossible to find homes that are depressed $70,000 or more when home price appreciation is generally slowing down. Time on the market is nearly 70 days and this causes your costs to increase as you are forced to continue mortgage payments until the sale is finalized. This strategy works best in times when housing prices are appreciating strongly because by the time the house is ready for sale appreciation has added a handsome amount to your profit.
If you are interested in a renovation project, my best recommendation right now is to purchase the home as your primary residence and live in it while you are repairing it. Plan to live in it for at least a year and this way you will minimize your carrying costs until it sells. Moreover, if you decide to live in it for two years, all of the capital gains that you earn on the property is exempt up to $250,000 if you file individually and $500,000 if you file with your spouse. That's huge. This is perhaps one of the best tax loop holes on the books and individuals can use this strategy to build tremendous wealth, tax free, and rather quickly.
REFINANCING UPDATE
Due to the troubles on Wall Street, the Bond market has seen an increase in demand as funds are moving to safer investments. As a result, of this flight to safety, bonds have been trading up and the rates have been coming down. If you currently have a mortgage at 6.5% or greater, you may be able to save hundreds of dollars a month off of your mortgage payment. This is an excellent time to think about a refinance, if you would like to lock in a cheaper rate and increase the purchasing power of your monthly income.
Normally, longer loan terms tend to extend more risk to the bank because future interest rates may be higher which makes your inexpensive loan look bad on a profit sheet. Therefore, 30 year fixed rate loans usually carry more risk than a 15 year fixed rate loan and they are consequently priced higher. The reverse is true that shorter amortization lengths tend to be cheaper. However, the market prices are experiencing an inverted yield curve. This means that 30 year fixed rates are tending to be the cheapest rates in the spectrum. If you have a variable rate product that you secured when sub-prime rates were low and fixed rates were high, this would be great time to roll out of that loan into a cheaper 30 year fixed rate loan.
JANUARY ACTION STEPS
When everyone is telling you that the market is poised for destruction just remember that this is the greatest nation in the world and that it possesses incredible resiliency. It is normal for the market to have a correction followed by years of economic growth and this is a really good thing. If the system didn't have such a mechanism for bringing growth down to normal levels, worse things might be on the horizon (E.g. the Stock Market crash of 1929). I believe that this downturn is exactly what this economy needs to get back on a good growth track. If you were waiting to get into the real estate market because the frenzy and subsequent boom in prices kept you at bay, this couldn't be a better time to invest.
Be well and have a Great New Year!
All the best,
Dave Smith
Many of you have known me for years and have come to trust my counsel in various real estate transactions and for those you who are new clients of mine; I wanted to share a little bit about my background in this first issue only.
I grew up in the bay area of Northern California close by to my grandparents and I enjoyed a very special relationship with them. My grandfather grew up in the worst conditions of the great depression and made it his life's ambition to acquire and maintain vast financial wealth. On a Navy pension and high school teacher's retirement, my grandparents retired multi-millionaires. They did this by living under their means and wisely investing their surplus. As a teenager, my grandfather took me under his wing and taught me how to invest. With his teachings, I became a very confident and successful Wall Street investor.
After two years of College, I chose to serve a two year mission for my Church in the French Caribbean, where I learned to love hot food, the beautiful culture, and the French language. Returning home, I married the love of my life and I transferred to the University of California at Riverside, California. I graduated Magna Cum Laude (the top 5%) with a bachelor's degree in Economics. After finishing school, my wife and I decided to move our family to Portland, Oregon and I spent the next 2 years building my home in St. Helens. Seeing the amazing financial rewards of the real estate market, my wife and I started our own Real Estate Investment firm and for the next 3 years, we worked on new construction projects and home renovations. As fun as this was, I decided to shift gears and get back to my finance and investing roots.
I chose Source One Financial because of their commitment to provide the absolute best service in the industry as well as a determination to keep their clients highly informed and expertly counseled. This is exactly the kind of business environment that I wished to create for my clients. Their mission statement, which I have adopted as my own, is to, "Educate our clients to help them make sound financial decisions and assist them on the path to financial independence." As a valued client of mine, I look forward to assisting you on your path towards financial independence and I will work hard to be the best in this industry. My commitment to you is to help you stay informed about the movement of the market and I will provide the counsel you need to successfully accomplish your goals. It is a pleasure to serve you.
All the best,
Dave Smith
I recognize that the financial situations of each of my clients and anyone who reads this newsletter do vary widely. Therefore, the strategies stated herein should be explored further with your financial advisor or advisors to be sure that these strategies are beneficial. The opinions expressed in this newsletter are not intended as specific investment advice or as a proposal for providing mortgage lending services.
I am a full service Mortgage Planner who will work to make certain that the home loan you choose will be properly integrated into your short and long term goals as well as your monthly budget!
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