Aug262014
Sign of housing market top: high-end home flipping soaring
Headlines of house flipping and increased novice investor participation of signs of a top in the housing market for high-end homes.
Contrarian investing is the art of selecting and timing investments by directly opposing the actions and attitudes embraced by the crowd of enthusiastic but ill-informed market participants. The central premise of contrarian investing is that the crowd is usually wrong, and the exuberance or panic of the crowd misprices assets, providing confident investors opportunities they can take advantage of.
I have some experience with contrarian investing. I wrote extensively about a crash in the housing market in 2007 and 2008 when the crowd believe house prices could only go up at 10% or more per year forever. I rented to avoid the crash (shorting real estate). Later, when most believed house prices could only go down by 10% or more per year, I went to Las Vegas and bought as many homes as I could from the crowd that was in a full panic.
One of the signs of a contrarian opportunity is the widespread participation in a market by novices who got lucky with a few speculative bets and suddenly believe they’re experts. There’s an old adage of Wall Street that when your shoeshine boy gives you a hot stock tip, the market is near a top, and it’s time to look for the exit. Similarly, in real estate, when novices start flipping homes, and stories of their success flood the newspapers, it’s time to be wary of a market top.
High-end house flipping is soaring
Diana Olick, August 23, 2014
It is dirty, financially risky and potentially dangerous work, but depending on the current direction of the housing market, it can be highly profitable. But home “flipping,” defined as buying and selling a home within a short period of time for the sole purpose of making money, is now on the slide.
Home prices rose dramatically last year and are now easing, leaving a very small margin for flippers.
“Home flipping is settling back into a more historically normal pattern after a flurry of flipping during the recent run-up in home prices in 2012 and 2013,” said Daren Blomquist, vice president at RealtyTrac. “Flippers no longer have the luxury of 20 to 30 percent annual price gains to pad their profits.
The house flipping shows get more popular when prices rise rapidly too. Everyone cooks up ideas of how they too can get rich quick. When you watch the calculation of profits on these shows, it always looks like the people add huge value with their renovations. In reality, the rising tide of rapid appreciation provides most of what they make.
As the market softens, successful flippers will need to focus on finding properties that they can buy at a discount and efficiently add value to.”
So now many are looking to high-end neighborhoods to reap big profits.
The high end of the real estate market performed particularly well since the efforts to reflate the bubble gained traction in early 2012. The high end had the fewest foreclosures and the largest remaining population of underwater borrowers in cloud inventory to aid in restricting for-sale properties. Further, only the well-heeled have both the down payment and credit scores necessary to close a deal, so more transactions occur in at these price points. However, since flippers now see this as the only opportunity in the market, it’s more likely a sign of the end of the rally and perhaps a top.
Real estate agent Christal Goetz and her contractor husband, Eric,
Novices or experts?
found a home in a sought-after northwest Washington, D.C., location in January. The four bedroom, three bath house was nothing short of a disaster inside, so they got a good deal, paying about $535,000 for it.
“We definitely look for location, it has to be a great location where we know it’s going to be in high demand,” said Christal. “We look for good bones to the structure, but also what can make it really unique and interesting.”
High demand, unique and interesting? Hmmm… That’s some serious expert analysis, right?
They put thought, design and about $250,000 into the 2,600-square-foot home and listed it for $925,000. Today it is under contract at the asking price.
I suspect the $250,000 added more value than the thought they put into it.
Based on the numbers provided, these people put $785,000 into the property, including about $350,000 of their own money (down payment plus improvements). If they sell for $925,000, they must pay a buy-side commission plus other fees and incentives. They stand to make $60,000 to $100,000, to compensate them for the risk plus the time and effort involved.
“It’s like any business really. Do you go after the small individual clients where you have to do a hundred accounts, or do you go after, as I say in the business world, the ‘white whale,’ where you’re getting five or six clients but your profit margin is higher,” reasoned Christal.
That sounds very plausible until one of those white whales turns into a white elephant and eats all your money.
Still, as home price gains are easing nationwide, overall flipping is down.
Novice flippers only appear just after a period of rapid appreciation lured by the easy money they see the experts make. By the time novices enter, the opportunity is gone, and most put in a large amount of time, effort, and money only to either lose money or break even.
Flippers represented 4.6 percent of all U.S. single-family home sales in the second quarter of this year, down from 5.9 percent in the first quarter of 2014 and down from 6.2 percent in the second quarter of 2013, according to RealtyTrac.
The average gross profit of $46,000 per flip, a 21 percent return, was down from 31 percent a year ago, which was the peak since RealtyTrac began looking at this segment of the market at the beginning of 2011.
Those gross profits sound impressive, but when you add up the renovation costs, fees, and other transaction costs, a 21% gross margin is about break even.
High-end flipping, however, is heating up. Flips with a sale price of $750,000 or more rose 21 percent from a year ago, while homes priced below $400,000 declined as a share of all flips from a year ago, according to RealtyTrac. Homes priced between $750,000 and $1 million had a 41 percent return, which explains why flippers are heading to higher-priced neighborhoods.
These are also the most dangerous flips in the market because the buyer pool at $1M is much thinner than the buyer pool at $250K. It’s common for these properties to take longer to renovate and longer to sell. Flipping is both a margin and a turnover business. Turning your money over twice per year at a 10% margin is not as profitable as turning your money over four times per year at 6%.
Markets with the best return on flips in the second quarter included Pittsburgh (106 percent), New Orleans (76 percent), Baltimore (73 percent), Virginia Beach, Virginia, (66 percent) and Daytona Beach, Florida (63 percent). Metro areas with the highest dollar amount of average gross profit on home flips included San Jose, California, Washington, D.C., San Diego, Los Angeles and Seattle, all of which had an average gross profit of more than $100,000 per flip, according to RealtyTrac.
Flipping is definitely getting harder, as there are fewer distressed properties for sale. Prices may be easing, but they’re still rising because supplies are low.
“The secret to flipping houses is getting the property to be at a great price, and there’s just very, very few properties in our area at low prices,” said David Fogg, a real estate agent in Burbank, California.
Lack of available supply is the limiting factor in Southern California. Shevy and I both know investors who would participate in flips if we could find the deals, but in a limited inventory environment, other flippers are looking over every new property on the market, and only those with the most aggressive assumptions get deals, and since they are aggressive in their bidding, there is often little or no margin in the deal.
The Goetzes say it’s all about quality—the location and the renovation. They currently have three other houses that they are in the process of flipping.
They’re going to get crushed; it’s only a matter of time. People like them are a great contrarian indicators, and with the potential exodus of Chinese hot money, high-end flippers working today may get burned.
One of the best and briefest written works on contrarian investing comes from Rich Toscano at Pigginton.com. The article below was one of my favorites from the housing bubble era, but it’s information is timeless.
The Dumb Money
RICH TOSCANO | December 20, 2006
One argument I hear a lot is that foreign demand for local real estate has grown substantially in recent years, and that such foreign demand will be supportive of prices in the future.
Unfortunately, this argument puts the cart squarely in front of the horse. Investors from other countries are well known to be the very last participants to arrive at the scene of a financial bubble. They are the last to hear about all the riches to be made, the last to buy in, and the last to realize that the party is over.
The chart to the right provides an example from the history of bubbles past. The blue line represents the price of the Nasdaq Composite Index during its late-1990s flight to the heavens, along with the very beginning of its eventual journey back to earth. The red line denotes the dollar amount of U.S. stock purchases made by foreign investors.
It can easily be seen that foreign buyers chased the U.S. tech stock bubble all the way to the tippy top, and that they lagged prices the entire way. The final onslaught of foreign cash did not even hit our shores until after the Nasdaq had begun to decline from its final peak.
Far from being a positive fundamental, a sudden excess of foreign participation in an asset market is indicative of ill-informed speculative money at work. When the foreigners really start piling on, it’s always a good sign that the end of the bubble is nigh.
[listing mls=”OC14119312″]
Foreclosure starts are up for the third consecutive month
Foreclosure starts in July were up for the third consecutive month even as the overall inventory continues to decline, according to Black Knight Financial Services.
This is Black Knight’s analysis of the July 2014 month-end mortgage performance statistics derived from its loan-level database representing approximately two-thirds of the overall market.
Overall the news looked good.
http://www.housingwire.com/ext/resources/images/Overall-BK-July.png
The national foreclosure inventory is down 34% from July 2013. At the current rate, it is now the lowest since March 2008, at the start of the housing crisis.
Despite the increase in foreclosure starts, starts are still down almost 20% from July 2013, which is a significant improvement.
http://www.housingwire.com/ext/resources/images/By-states-BK-July.png
Further good news, delinquency rate declines after slight increase in June 2014.
Even more good news, the rate of prepayment is up more than 10 percent in July, making it the fifth consecutive monthly increase.
The verbal diarrhea from the new chief economist at realtor.com reveals this guy is a typical industry shill who has no idea what he’s talking about.
New realtor.com economist blowing Smoke
I think we need to encourage more innovation.
“If you’re trying to encourage ownership, there needs to be innovation that ultimately helps consumers make the best financial decision for them and gives them the most buying power.”
One could argue that finance innovation is what caused the bubble to begin with – meaning the innovations that happened around “no-doc” loans – but I would argue that there wasn’t a whole lot of real innovation. We still largely gravitated around 30-year mortgages.
People who pay attention to making the best economic decisions from a personal economic perspective will tell you that a 30-year-fixed[-rate mortgage] isn’t the best mortgage decision an individual household can make because their tenure normally never breaks even on the fixed 30-year rate. But at the same time, it’s the 30-year amortization – and the government guarantee on these mortgages – that has made housing more affordable.
The innovations that I would like to see are things that keep that amortization and the government backstop but also enables people not to make that stark decision of locking down a rate for 30 years even though there’s no way they’re going to be in that house for seven years, let alone 30 years. But the amortization is absolutely key.
If you’re trying to encourage ownership, there needs to be innovation that ultimately helps consumers make the best financial decision for them and gives them the most buying power.
http://ochousingnews.g.corvida.com/the-fallacy-of-financial-innovation/
http://ochousingnews.g.corvida.com/promoting-financial-innovation-will-result-in-future-housing-bubbles/
http://ochousingnews.g.corvida.com/financial-innovation-and-government-subsidies-diminish-home-ownership/
Watt: People don’t trust lenders
There are 800,000 families nationwide that could still benefit from the Home Affordable Refinance Program, Federal Housing Finance Agency Director Mel Watt said in Atlanta on his nationwide public campaign to urge more borrowers to take advantage of the Home Affordable Refinance Program.
So far, 3.1 million mortgages have refinanced through HARP, but many of the consumers left who can refinance are staying out of the market due to fear.
“HARP is designed to reward those borrowers who are the most committed in this country. This is not a scam,” Watt said.
Watt is making a point to reach out to homeowners he feels could benefit under HARP. But he also wants the mortgage industry to understand why some people still hold trepidations toward the mortgage finance industry.
“As it stands now, people don’t trust their lenders and it’s creating uncertainty. All of this research and anthropological evidence contributes to the downturn. Still there are casualties to this war and the industry would do right to honor that,” Watt said in an exclusive interview with HousingWire magazine. “Today, there’s just a lot of people — and no one pays enough attention to it — who got burned.”
And this is exactly what Watt is trying to combat. “By engaging directly with local community leaders, faith-based organizations, local elected officials and lenders, our goal is to leverage these trusted sources to reach as many ‘in-the-money’ borrowers as we can,” Watt said about the campaign.
So they booted Ed DeMarco for not agreeing to give principal reductions, and the top priority of his replacement is to market rate/term refinances that don’t have a principal reduction component? I’m so confused. 😉
I think it was you the mentioned the main reason Watt isn’t forgiving principal is because the impact it would have on pension funds like Calpers.
Watt is between a rock and a hard place; if he stays true to his previous advocacy, an advocacy that helped him get the job, he will cause a lot of pain and political problems from the investment community, and if he sides with the investment community, he looks like a sellout, which he probably is.
All the people who supported Watt with hopes of hitting the principal reduction lottery must be pissed.
More bait for high-end flippers…
This New York penthouse can be yours for just $110 million
Somewhere, someone has an index on how record-setting residential prices correlate to the price of gold, the length of women’s skirts, the number of brushfire wars, the amount of gingers born without souls – you know, some odd correlation between disparate events.
Well, 2014 is your year for record setting residential prices.
First we got word of House No. 1 in Hong Kong, the modest-sized penthouse that is going for about $22,677 per square foot, the highest amount recorded. At a mere 4,661 square feet, that’s about $106 million.
Then came word from sultry, sly, sexy Monaco that a penthouse on the boards is set to top $400 million for its 35,500 square feet, which is obviously pricier overall but cheaper by the square foot – $11,267 per square foot.
America’s entry into the expensive penthouse arms race beats Monaco but it’s a pale reflection of what the Far East is offering – the 9,500-square-foot eyrie atop New York’s iconic Woolworth Tower Residences is going for $11,700 per square foot, or $110 million.
Alchemy Properties’ offering plan for the condominiums at the Woolworth Building was just approved by the New York Attorney General’s office…
The plan reveals that the $110 million penthouse atop the iconic tower — a unit that has been christened the “Pinnacle” — will span 9,400 square feet with just under 500 square feet of outdoor space. This means Alchemy is asking about $11,700 per square foot for the eyrie atop the landmark tower, by far a record for Downtown and one of the priciest listings ever to hit the city. Overall, the average price for the 34 condo units collectively known as the Woolworth Tower Residences is $4,172 per foot, with a total sellout of $443.7 million. Prices start at $3.9 million for a 1,290-square-foot pad on the 44th floor, suggesting Alchemy feels even more bullish about sales prospects than it did in June, when Bloomberg News reported that the unit was asking $3.5 million.
Foreign investors has been chasing US stocks and bonds to record high in value and record low in yield during this latest bull market for a while now. While I understand that the US economy is still holding up very well compare to the rest of the world, they are buying stock with inflated valuation that investors like Warren Buffets, George Soros or Carl Icahn are starting to caution against buying. I have to admit I missed out on a big chunk of this bull market (but not completely) due to being conservative and new to investing. I’m only 31 BTW.
But all I see on stock charts since 2011 is a near straight line going up. This bull market is now, I believe the second or third longest in the last 100+ years. It can continue marching higher I guess. However, the middle class is being milked pretty good these days thanks to inflation, stagnant wages, and high rents. We might be in the last leg of the bull market due to the expansion of credit for auto leases, consumer spending, student loans, etc…Eventually the funny money will end and/or there will be threat of massive defaults and we’ll be on spending binge for a while. I think I began to understand the expansion and contraction cycle of credit a little bit better. After all, it is an integral part of our debt based society which is capable of producing many booms and busts via the creation/destruction of debt.
Bull markets run their course by the continued influx of new money, mostly dumb money at the end. At some point, the pros start to sell, and the drop in prices causes many of the late buyers to stare at potential losses. The buying stops, and the selling picks up as the weak hands are shaken out. The longer the bull run the deeper the correction.
The stock market in particular hasn’t had a deep correction to shake out the weak hands in quite a while. As more people get on the bullish side of the trade, the more likely a deep correction becomes because the late buyers are usually the ones with the least tolerance for risk, so they sell in a panic turning a small correction into a deep one. The shakeout is inevitable, and the pros will use that as a buying opportunity.
Dear Bonds,
The longer the bull run, the deeper the correction.
Sincerely,
The Free Market
If you want to see a great example of this, take a look at the NASDAQ in 1998. After a long bull run, the NASDAQ sold off very hard and shook out all the weak hands. After it bottomed, it quickly recovered back to the previous peak, and one year later, it went on the epic bull run that ended in the huge tech bubble of 1999/2000. The 1998 correction is a textbook example of a bull run correction shaking out the weak hands.
Can everyone see the sham going on in the equity and debt markets? LoL
The S&P trades at a new highs each and every week while the yield on the 10 year bond continues to trickle down each week.
The American Way … prop up assets using cheap money.
FYI, this isn’t going to end well people.
To me the biggest sign that a correction is due is the complacency in the markets. People don’t believe a correction is possible, which sets up the very conditions making a deep correction more likely.
Here’s how the big double whammy would happen: the stock market has a minor selloff that develops into a full-blown valuation panic shaking out all the weak players, much of that money flows into bonds adding to the inflation of bond prices; then an inflation scare causes investors to flee bonds in favor of cash or commodities, and the bond market crashes too. At that point, both the stock and the bond market have lost their federal reserve inflated values, and cash becomes the safe haven, which is the opposite of what the federal reserve wants. The two-step crash serves to shake the faith Americans have in the federal reserve’s ability to prop up asset values with cheap money. It could happen.
The current valuation model will be blown to bits simply because valuations are being formulated with the cost of capital @.25, and in response to massive interventionism (known and unknown). Reality is, the QE era ‘players’ have been played. Epically.
Here’s something. My estimate numbers show me that the bond market is twice the size of the equity market so there essentially are two set of players and the equity player is a minority. Also, as yields goes down bond values goes up so they still “make” money, the bond buyers. Corporations than use the cheap rates to leverage up the debt for stock buy backs, M&A, new investment etc…Further more, boosting the “growth” prospect or enhance the EPS thus juicing equities. I believe the money buying bonds [US] might be those from the EU seeking a return from even lower rates in the EU or Japan more like a carry trade. Right now both the high risk (stocks) and low risk (bonds) player are happy due to improving economic prospects, at least on paper.
Interest rates long term are tied to growth prospect and confidence in government [ability to repay] so if growth is low and confidence is high than we will have low rates. If confidence is crashing than it will be a different story. As a note, the FED only set short term rates not long term.
The fed only used to set short term rates, but operation Twist was a direct attempt to flatten the yield curve by buying long-term bonds. Of course, banks used this to sell bonds to the federal reserve as a stealth bailout.
After the big BofA settlement, nobody notices the other huge settlements for bubble-era misconduct. This time it’s Goldman Sachs turn.
Goldman Sachs, FHFA Settle in RMBS Suit
New York-based investment banking firm Goldman Sachs has agreed to pay $3.15 billion to settle a lawsuit filed by the Federal Housing Finance Agency (FHFA) alleging that Goldman Sachs sold faulty residential mortgage-backed securities (RMBS) to Fannie Mae and Freddie Mac, for which FHFA is conservator.
According to FHFA, under the terms of the settlement, Goldman Sachs will pay $2.15 billion to Freddie Mac and about $1 billion to Fannie Mae to buy back the alleged faulty RMBS the two GSEs purchased between 2005 and 2007. FHFA estimates the worth of the settlement to be about $1.2 billion due to the bonds’ current value.
The lawsuit, FHFA v. Goldman Sachs & Co., et al., named Goldman Sachs, related companies, and some individuals as defendants, according to FHFA. The suit was settled in the U.S. District Court of the Southern District of New York.
“We are pleased to have resolved these matters,” Gregory K. Palm, EVP and general counsel of Goldman Sachs, said in a press release.
The settlement makes Fannie Mae and Freddie Mac whole on their investment in the RMBS in question, and as part of the settlement, the two GSEs will release certain claims they previously made against Goldman Sachs with regards to those same RMBS, according to FHFA.
A spokesperson for FHFA referred to the press release put out by the organization when asked for comment.
The settlement with Goldman Sachs was the 16th out of the 18 lawsuits FHFA has filed since 2011 with regards to RMBS.
My wife and I looked at a crackhouse in the Northern DC area. It was just off the tracks a little, across the street from a seedy bus stop, and lots of noise selling for $300K. The house looked like gang bangers had been living there. Unidentified trash particles everywhere (no idea what they were, didn’t want to touch them to find out. Maybe unicorns the size of rats laying out multicolor poop?) and the realtor hadn’t bothered to arrange for a basic cleaning service to clean up. She clumsily staged some fancy plates on the ancient table so buyers could imagine having dinner there, but who would eat there with the filth and mess everywhere? Half of the home was a tear down and the other half was filthy.
The realtor sounded like something out of the old bubble days: It’s on the market and she’s marking it down 80 grand due to condition. You can fix it up.
But who would want to? Who would want to throw down that much money and spend months fixing it up (lord knows how many hidden issues with the property an inspector would find!) just to live in a second rate neighborhood and average home?
LOL!
Another real estate blogger here in Southern California used to publish a series called real homes of genius that showed awful houses like you describe going for outrageous prices. It really hit you on an emotional level to see a crack house going for $500K; you knew something just wasn’t right.
I wonder if the blog author has pondered on the effect of HELOC money on a second bubble bursting and kicking out the underwater squatters.
Banks and money-renters can’t help themselves. The former love to close on loans to make a quick buck and the latter like to think of themselves a geniuses when a market recovers so they have made easy money and they can always refinance as the market goes up, right?
So as homes in Northern Virginia finally clear the bubble that some bought under and they have a little equity, finally, the first thing they do to celebrate all the equity generated by adjustments and market return is…
Get a HELOC and spend it on their kid’s education. Or pay off their credit cards. Or buy a big, new car to drive to that DC Government job.
There’s tons of ways to spend excess money in the DC area like anywhere else.
Then, Lord forbid, the market stop rising and even fall a little bit… where’s the motivation to pay back the HELOC? The deal is that the buyers should pay that off 20 years down the road. Not THEM! They’re oligarchs now! So they’ll plan to walk away. I know someone in the last bubble who got TWO HELOCS!!!! Why not? He planned to walk away so why not get as much as he can?
For the first five years of writing about the housing bubble, I posted daily posts on HELOC abuse. I documented well over 1000 cases of people spending hundreds of thousands of dollars in mortgage equity withdrawal just focusing on Irvine, CA.
The banks are sitting on a large number of underwater and valueless HELOCs on their balance sheets. Right now, they are kicking the can and refusing to either sell these or write them off. They reason that if they hold them long enough, the collateral value will make them whole, and they can foreclose and get their money back later. Stories circulated last year about the upcoming HELOC resets and recasts to fully-amortizing loans. This won’t happen because it would prompt defaults and write downs, so banks will modify these loans to perpetuate the fantasy of getting repaid.
Right now we can only hope lenders are more prudent in the future and they won’t restart the personal Ponzi schemes that lie dormant waiting for some equity to breathe life into them. I suspect they will, and when times get tough we’ll get another credit crunch and the Ponzis will quit paying again.
BTW, this is one of my favorite cartoons of the Ponzi bubble era:
http://ochousingnews.g.corvida.com/wp-content/uploads/2014/06/mini_bernie_maddoff.jpg