Martin is busy this weekend writing his Safe Money Report, which will be mailed and posted to the Web on Friday. So he’s asked me to fill in for him. He’ll be back next week.
My name is Tony Sagami, the Texan who Martin wrote about a few weeks ago. I’m the guy who, despite a respectable income, drives a modest Toyota, owns a modest house, and sends his kids to public schools, while living in the middle of a fantasyland community of conspicuous consumption.
Million-dollar homes, five golf courses, European sports cars in darn near every driveway, and all the stereotypical signs of keep-up-with-the-Jones spending are everywhere in the town I live.
RICH FORECLOSURES
But the signs of wealth are skin deep, and times aren’t nearly as good as they appear. Indeed, several of my neighbors have recently gotten over their heads in debt and found themselves facing foreclosure on their homes.
These are not just a few isolated cases. Consider, for example, this headline from a front-page article that appeared in the Austin American Statesman on March 18 …
Hard up, hundreds forfeiting houses
In Williamson, Travis counties, foreclosures reaching peak levels
Nationwide, we have near-record numbers of foreclosures, but it doesn’t surprise me. Americans have been on a decade-long spending spree, accumulating mortgage and credit-card debt with wild abandon.
As a percentage of disposable income, household debt payments reached a record 13.3% in 2002 and 13.1% last year. The previous peak was 12.3% in the summer of 1987, just months before the steepest stock market crash of the century.
Meanwhile, personal bankruptcies and credit card delinquencies are also at or near record highs.
WORSE THAN A JOBLESS RECOVERY
Wall Street and Washington know all about the “jobless recovery.”
What they seem to be forgetting is that the people WITH jobs are also falling behind.
Indeed, according to the Department of Labor, wages rose just 1.6% in the 12 months ending in February – matching the lowest growth rate on record.
This is worse than a jobless recovery. It implies that the underpinnings of the housing boom – and the entire economy for that matter – are a lot weaker than almost everyone previously realized.
LENDERS ON A LIMB
Banks are only making things worse.
They’re relaxing their lending requirements.
They’re accepting lower down payments.
And they’re going berserk with aggressive mortgage options such as graduated payments, teaser introductory rates, and interest-only payments.
The goal: To keep payments as low as possible.
The result: To entice Americans to buy more home than they can afford.
Is this a key reason President Bush has been able to brag about a record-high home ownership rate of 68%? I’m afraid so.
RAMPANT OVERBUYING
In Alexandria, Virginia, home buyers were so eager to buy luxury townhouses they camped out for seven days for yet-to-be-built units. In fact, the line grew so long that the city shut it down. Prices started at $560,000 and reached $1.1 million.
A recent Bloomberg story says the same thing is happening in California:
“Firefighter Bruno Gonzalez, his wife and three children are moving next week into a new, $1.1 million mini-mansion, as he calls it, in Pleasanton, California. The mortgage requires them to pay only interest for the first seven years. Payments on the $880,000 loan will be $3,300 a month, compared with $5,000 on a conventional 30-year fixed mortgage.
“Since they won’t be paying any principal, they are betting on rising prices to increase their equity. The value of the family’s previous home in Castro Valley, California, soared to $745,000 from $375,000 in just over five years.
“‘We know in the long run the house will appreciate so much that we’re going to walk away without having to pay the principal down, really,’ Gonzalez said Wednesday in a telephone interview. While the home purchase is ‘a stretch’ for the family’s $155,000 annual income, Gonzalez said, ‘we’re going to walk away millionaires.’”
But the Gonzales family is not the only one going crazy over real estate.
Last week, the San Francisco Chronicle ran a story – Anatomy of a Frenzy – about just how nuts the real estate market has become.
With the Bay Area real estate market hopping, agents and home shoppers have seen an increase in:
- Multiple offers of 10 or more, with most above asking prices.
- Final purchase prices of tens of thousands of dollars above asking prices.
- Purchase offers waiving contingencies for inspections or appraisals.
- Pre-emptive offers, or those handed in before the seller officially accepts bids.
- Interest-only and adjustable rate mortgages, which let buyers carry bigger loans.
- Buyers allowing sellers to live in the home for free for weeks after the sale.
BUILDERS ON A BINGE
All this is following a very familiar pattern. Just as the stockbrokers were the last to accept the reality of the tech bubble, it looks like realtors, mortgage brokers, and builders will be the last to recognize the real estate bubble.
After the foreclosure article appeared in the American Statesman, my Austin newspaper ran this front-page article two days later.
Builders wager on new homes
Spec houses are on the rise, even with job slump
What this shows is that you should listen with a very skeptical ear to your friends in the real estate business when they tell you how wonderful things are. The so-called professionals inside the industry can’t see the forest for the trees.
A TOP IN THE MAKING?
No doubt about it: Real estate is wild.
That doesn’t mean it can’t get wilder. But I’m convinced we’re close to the top. Unlike stocks that can trade for 100, 200, or 300 times earnings, real estate prices have a natural limit, tied to household incomes.
Sure, some banks may be willing to let a frenzied buyer get away with as much as a 50% debt-to-income ratio … but rarely more.
I’m not alone in looking for a top. Dean Baker, co-director of the Center for Economic and Policy Research, thinks that home prices could drop 11% to 22% across the country – perhaps as much as 40% in some areas.
No matter when or how real estate tops, however, it is undeniable that today’s real estate bubble is just as obvious as the tech bubble.
HOW THIS WILL IMPACT YOU
Even if you are not overexposed to real estate yourself, you may need to take a hard, fresh look at your portfolio, debt situation, and financial goals.
Why? Because when the real estate bubble pops, it will take the economy down harder than the bursting of the tech bubble.
Remember, there are still many Americans who couldn’t care less about the stock market because they have little or no money invested in it. But you can’t say that about real estate. The majority of adults past 40 own a home.
The home represents their largest asset and most valuable possession. When they see it falling in value, they are bound to do whatever it takes to keep it.
They’ll sell their stocks and mutual funds … cash in their IRAs and 401(k)s … and sell off other assets. The impact on the stock market and the economy will be severe.
I’m not suggesting that you should sell your own home. Regardless of what the real estate or stock market does, we all need a place to live. But if you have investment real estate, that’s another story.
Here’s the bottom line:
1. The hot real estate market is nothing more than Bubble 2.0.
2. That bubble is about to pop.
3. When it does, the fall-out is bound to affect you, whether you own real estate or not.
4. NOW is the time to prepare!
Pay down your debt.
Don’t borrow a penny more than you have to.
Don’t stretch your budget too thin.
Sell off most of your portfolio assets – including stocks and long-term bonds – before everyone else starts selling.
Build CASH.
Best wishes,
Tony
Tony Sagami
Contributor, Safe Money Report
martinonmonday@weissinc.com
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