The Kenny Rogers song ‘The Gambler’ talks about knowing when to hold ‘em and knowing when to fold ‘em.
As I hear people talking about investing in real estate in light of the large price decline experienced over the past year or so, I offer two simple words – fold ‘em.
I’ve gone on record in my most recent market update (for a free copy click here www.usawealthmanagement.com) forecasting the further decline of the real estate market. As bad as the sub-prime mortgage meltdown was, this next decline could be almost as severe, and from the perspective of some, potentially even more severe.
What will be affected?
More residential real estate and commercial real estate too.
Here’s a sample of what’s going on out there.
Credit Suisse did a study and estimates that there will be 8.1 million foreclosures in residential real estate between 2009 and 2012. That represents 43% of the 19 million homeowners who will be ‘upside down’ in their mortgage, owing more on their home than the home is worth by sometime next year. That represents 1/2 of all mortgages outstanding in the entire United States. (Source: New York Times, October 21, 2008).
Those facts will likely have the following stories occurring all across the country over the next several years. This story appeared in the ‘OC Register’ on March 25, 2009.
Seems a guy by the name of Gary Watts, chief prognosticator for the Orange County Association of Realtors recently defaulted on a mortgage, not because he couldn’t make the payments, but because, as he puts it, it was a good business decision.
Watts’ track record is far from perfect. In 2006, when many others saw a real estate slump, Watts predicted that real estate values would gain 15%. In reality, sales dropped 28% and prices rose only 2.4%.
In 2007, Watts foresaw real estate prices increasing 7%; instead due to the beginning of the sub-prime mortgage meltdown, prices dropped 10%.
In 2008, Watts again went on record stating that price gains of 3% to 5% were conceivable for houses; however, by the end of the year, the economy had tanked, house prices dropped 30%, and Watts issued an apology as reported in the June 23, 2008 issue of the ‘OC Register’. Said Watts, “I apologize for not knowing what Wall Street did to our mortgages. I had no idea how Wall Street restructured these loans.”
But that’s not the interesting part of the story.
In 2005, Watts bought a rental property for $765,000 putting $77,000 down in Rancho Santa Margarita, California. One year, later, Watts was pleased with his purchase since the house was now valued at about $825,000.
Today, Watts has defaulted on the loan (“OC Register” March 25, 2009) since the current value of that home has dropped 22% from the original purchase price. He’s currently in escrow, seeking his lender’s approval to sell the house for $93,000 less than he owes on it.
“I can make the payments. That’s not the issue. It’s a business decision,” Watts said. “I tried to work with the lender. The lender didn’t help. They said, go ahead, do a short sale. It’s strictly business.”
As a side note, Watts is keeping the other 19 properties he owns all of which are creating enough income to cover expenses.
Makes me yearn for the days when folks had enough respect for themselves to honor their commitments if they could. Although I’ve never met this guy, I already don’t like him. But, that’s beside the point.
All across the country, property owners are having similar conversations with themselves. Should I keep the house even though I owe more than it’s worth? Or, should I just walk away?
Many will come to the same conclusion as Mr. Watts and walk away.
But this problem isn’t confined to just residential real estate. Commercial real estate is next.
In an article published by “The Canadian Press” on April 8, 2009, it was reported that these same issues will begin to affect commercial real estate.
David Henry, president of U.S.-based Kimco Realty Corp., was quoted in the article saying that this year will be “a lot worse” for commercial real estate as property owners find themselves unable to pay off or refinance their debt.
“We have a massive wave of debt maturities coming, at least in the U.S.,” Henry said, “Most of this is securitized, and there will be a massive amount of workouts, there will be some extensions, but there will also be some very high-profile bankruptcies, very high-profile forced sales.”
An example is the recent foreclosure sale of the John Hancock Tower in Boston. Broadway Fund Managers, LLC, bought the skyscraper in December of 2006 for $1.3 billion and recently sold it to its new owners for only $20.1 million with the new owners assuming an existing $640.5 million mortgage that was already in place. The sale price represents a 40% drop in value in only a little more than 2 years.
According to Andrea Stephen, an executive with Cadillac Fairview Corporation, maturing debt on commercial real estate doesn’t peak until 2012. She predicts that it “will be devastating to the industry”.
The bottom line if you’re considering an investment in real estate? You may want to Fold ‘em.
For the most recent market update click here: www.usawealthmanagement.com
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Investing in market related securities involves a risk of principal loss. Prior to making any investment decision, the services of an appropriate professional should be sought as investment related recommendations are dependent upon the personal financial situation of each individual investor.
