THE SNOWFLAKE THAT CAUSED THE AVALANCHE IN 2005-7

Dated: November 22 2019

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What caused the residential real estate “slow down” and what will precipitate it’s revival?  (Originally written by Gregg Fous in 2007)

 

I would like to share with you some of my feelings on these two issues. Pointing a finger at the cause for the slowdown is about as easy as pointing a finger at the one snowflake that caused the avalanche. Some might call it the perfect storm. That might by apropos because the general consensus was that the timing of the slowdown coincided with the hectic hurricane season of 2005.

When the hurricanes hit, there certainly was unrest in the mid-east as the oil prices spiked because of the short term shutdown of supply  which in turn was caused by Hurricane Katrina in the Gulf of Mexico. The long lines at the gas pumps heightened sensitivity about gas prices. Then the increased gas prices caused concerns by people contemplating a second home that their pocketbooks might suffer.

By late summer and fall the developers where finally capturing the margins that in the past were gobbled up by the investors. Most developers had already bumped up preconstruction prices to eliminate the investor and were all fighting for the “real buyer” the end users.

Raw material costs and interest rates were on the rise. The raw material increases were real, the interest rate increases were really not “high” but rates were where they should be in a healthy economy. Borrower perception is everything, however. The raw material increases, and the rising rates were a one two punch that hit from both sides. China consumption of concrete and steel drove down supply and increased prices here in the US. Prices of new homes went up and so did the cost of borrowing. Adjustable rate mortgages went up for existing home owners making them think twice about a second purchase.

The resale market slowed as new homes attracted the buyers away from the used home market. The “trade up” market (buyers looking for bigger or better homes) suffered as sellers could not sell their existing homes. High property taxes and skyrocketing insurance rates were financially trapping folks in their homes.

Sound like an avalanche?  Keep reading.

Reaction time by developers is slow. It takes a long time to entitle and permit a project. We were already in a slow-down and some projects were not even out of the ground yet having been suck in l long waits for engineering and then permitting. But the developers could not stop; they had presales and monies committed. So even though condos and homes were not moving, more and more inventory was added – kind of like adding more dry wood to a raging fire; and to add accelerant to the incendiary situation, costs continued to rise – both on raw materials and land.

Ok, so the cause of the slowdown may have been:

Hurricanes
The war in Iraq
Gasoline Prices
Interest Rates
Property taxes
Insurance rates
Raw material and labor costs increases
China’s emergence as a huge consumer of construction goods.
Inexperienced real estate investors
Developer’s reaction times
Too much inventory

Which snow flake caused it all? I don’t know. I think the answer is different for different folks. Conditions were precarious and ready to fall. We just did not know it at the time.

The recent BP oil field debacle, which by the way only effects under 2% of oil usage here in the U.S, is another scary example of just one snow flake causing an avalanche. By all rights this should not have caused the stir on Wall Street that it did. I am now reading a superb book on energy situation; A Thousand Barrels a Second by Peter Tertzakian. I highly recommend it. It will give you a better understanding of where we will be going on the oil situation.

 

My feeling is that the turn around will happen very quickly. (But not very soon) But we will be into it before we know what hits us. Look at the potential list of causes for a clue. First, for things that will not change quickly, like the cost of gasoline, we have to get dulled to the effect. Other issues, like interest rates, need to make a turn or stall to change the “high rate” perception. The recent pause by the fed is a good sign. I see another increase before the end of the year and then perhaps more pauses and a turn around. But this may mean that the economy is starting to cool.

(Gregg’s note November, 2019 – The Frank Dodd act as enacted in 2010.. That was like a steam rollers rolling over the snow. The act put a damper on Real Estate growth.

Inventory will be depleted – BUT VERY SLOWLY – and when supply and demand is in better balance prices will increase more rapidly again.

A point to make here is that indeed prices are still increasing. We are still experiencing housing inflation. Don’t by fooled into thinking prices in general are dropping. They are not. As I have said before there are pocket of super deals. But long term players will do very well in the real estate market.

Certainly the inexperienced investors are out of the market. As Joe Armenia correctly pointed out to me yesterday, the situation was similar to the stock market dot com boom. Those inexperienced investors will not be back very soon.

Watch for the snowflakes good and bad. No hurricanes this year would be a good snowflake. A terrorist attack on our transportation system a bad one. Both could have a great effect on our little corner of paradise.

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Gregg Fous

Real estate has been my passion since I took my first Al Lowery class on real estate investing in the 1970’s. I vowed during that class that I would buy one property a year. Over the next five ....

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