mannfm11\'s 8/06 view of the RE market

"There is mention of the housing market and the buildinginventories around the country. This is the tip of the iceberg. I amassisting my mother in her rental portfolio, of which I believe thepeak income from which was about 2002. The recent vacancies have beentragic and the applicants we are getting are so beaten up credit wisethat I am not seeing even honest applications. 3 of the last 5applications I have taken have been people in certain stages ofeviction. These are older homes, but they are in good shape in theNorth Dallas suburban region. They are not slum properties.

Everyone is all in. 10 years ago everyone was all in and theycreated a bunch more everyones by lowering the lending standards,eliminating down payments, coming out with high LTV B & C paperwhich served to fill the pockets of mortgage brokers, dilute the marketand put more high risk people into homes.

What is left? What is left are people that can barely rent. Someof them make pretty good money, but it goes out the window to the pointthey cannot keep up their rental payments. There is a big storm brewingand the housing slowdown is only the tip of the iceberg.

But it is the iceberg as well. While the country could get througha typical housing slowdown, not this one. The industry is out oftricks. This industry funded the recovery we saw out of the bursting ofthe stock bubble and kept credit flowing. It stopped the deflation manyof us feared was starting by creating collateral for more credit. But,the resale market is gone.

Who are they going to resale to? If they are expecting the peopleI am seeing apply to rent homes to step up and buy, they have anotherthing coming. If they are expecting the people renting to buy, theyjust might, but it will force the landlords to sell their property aswell. This isn't taking houses off the market, it is putting them onthe market.

I checked the evictions posted on the JP courts dockets. Strangelyenough, FNMA was posted as the plaintiff on several of them monthly. Ifind this interesting as FNMA isn't shown to own that many homes inCollin County. But, what are they doing as landlord? Are the evictingforeclosures where people are refusing to move out? Or, are theyevicting people on rental homes that socalled investors are letting goback?

As I started out, this is a deep subject. The next step is dopeople give up their homes or do they give up their nights out on thetown? Do they pay their credit cards or their mortgage? The time ofpaying their credit card with their mortgage is behind us now and whenthese limits are maxed out, the card payment or the mortgage goes. Weare about to see selling to get out from under a thing of the past, asfew homebuyers put any money down as they didn't have any money or atleast the conventional down payment and thus are under water withoutroughly a 10% appreciation over what they paid. Here the new homes havestolen the market and I sense the new home builders can even cut theirprices if things get dire. In fact, I sense we are going to see somewholesale discounting as builders are going to be forced to lessentheir exposure and their debt levels.

There is a very small pool of available new buyers left. This isin housing and I think it is in other forms of real estate as well thatare about to really be impacted as well. Remember, as someone alreadyposted, we haven't seen the 10 year bond rate move much from where ithas been the past few years, maybe 75 BP from its mean of 2004/2005. Irecall in the late 1970's rates moving 75 BP in 2 or 3 days. This isn'ta rate induced slowdown, but a supply on the long run against demand onthe long run slowdown. This is a market that is collapsing under itsown weight.

You guys are about to see what real deflation is. Housing is by amassive amount the largest industry in the United States and probablythe world. What is supplies is a huge portion of the ground up demandfor the other goods and services bought and sold worldwide. You shutdown housing, you shut down lumber, concrete, steel, copper, roofingand appliances to a great extent. Here then you shut down theindustries that these industries are customers of. Realtors drive usedCadillacs instead of new ones. I recall seeing back in the 1980'sslowdown a long term realtor that was probably a millionaire at hispeak sacking groceries at one of the local supermarkets, a guy that wasa brand name in town when I was a kid. Others went just flat bust. Thefringe business went down the drain. Mortgage banking, a huge businessnow that has hundreds of thousands of high paying jobs is threatened towhere it has to shrink and those that are left are making a fraction ofwhat they did.

The other end is the flow of funds from housing to enable peopleto buy other goods. Remember, housing was the credit card that allowedmany to float through the last downturn and made the last downturnhardly a downturn at all. What happens when people have to shop atWalmart or pay their house payment? If they don't go to Walmart, theassociated overstocked manufacturers worldwide have their goods stackup. If they don't pay their housepayment, the banking sectors and GSE'shave to tighten their credit standards to absorb the losses and mostlikely start by tightening up credit they can pull in, mainly creditcards. This shuts Walmart and its associated overstocked suppliers aswell.

People are all in this game. Look at the tape of the stock market.I wrote about the Dow a few months ago. I believe at that time 21 outof 30 stocks were under their price at the peak. Of the 9 that wereover, I think 4 or 5 of them are starting to break down in the form ofMMM, BA, CAT and most likely C. Despite high oil prices, XOM hasn'tdone that well. Watch companies like LU, SUNW, CSCO, ORCL, MSFT, INTC,GE and a few others that made up the top 10 to 20 highest cap valuestocks and see where they stand. That was what the holders of mutualfunds were holding when this thing started down in 2000. You know I canname more and I know you can too, but this small group of stocks madeup probably 30% of the portfolios of all mutual funds combined and thestocks that have done well weren't even in the portfolio. These peopleare stuck and they have been joined by even more fools trying to push apeanut up a mountain with their nose.

How broken is the stock market. John Templeton said a few yearsago it was broken and I agree. Until valuations change, it ispermanently broken, as the real rate of return on the broad market isat best 1% above inflation. These earnings growth projections arefoolhardy and false if one wants to take them as a trend. The excess ofthe past few years, some of which was due to every company in the worldtaking their write offs when things were bad, thus having the naturalsnap back, but the rest is going to be snapped back as well. How cansomeone sell out with a 90% loss in so many stocks?

There are a lot of dominos lined up. Maybe the rest of the worlddoes well swapping their dollars back and forth between themselveswhile the US languishes. At some price, money comes to buy property inthe United States and that property will be purchased in dollars. But Isense the banks will draw in the money and those countries will be leftwithout exchange as well. I doubt many people can get signature loanson their credit outside of the typical credit card. I doubt if housinggoes the way I think it appears to be going, the mortgage insurancebusiness is going to stand and it will take with it all the derivativepostions that are used to support it. So will FNMA, JPM, WFC and FHLMC.And what about the Mexican labor that has been employed to build somuch of this stuff? Do they starve in a country they went to find workor do they go home? If they stay here, maybe the government feeds them,maybe not. If they go home, that leaves even more vacancies in thehousing market. That might solve the illegal alien problem thatcongress cannot agree to solve.

Long run supply in any product is the marginal cost of buildingone more unit. Once the bidding war stops, prices fall to the level ofmarginal cost. This leaves a lot of open shops that go unvisited, kindof like the small town merchant when Wal-Mart came to town. We aregoing to see a situation where land prices fall, dropping marginalcosts even lower, leaving those that held lots that were so dear at thetop with overpriced building sites they need to unload. This is a $10trillion wreck in a group of assets that are very illiquid, unmovableand only marginally useful in the sense that you can only live in oneat a time."