Finance (not) Just In Time
I read a funny story today which I think relates to our current situation in the housing market...
"There is an old story about a tin of sardines. One trader bought it and sold it to another, who sold it to a third, and so on. At each stage, the sardines changed hands for a higher price--until a real customer bought the tin. When he opened the tin, which was now very old, he discovered the sardines were moldy. He complained to the trader who had sold them. 'But, my friend,' said the merchant, 'these were trading sardines, not eating sardines.'
Investors can be split into two schools: those who go with the flow and those who seek out fundamental value. The former view shares and other financial assets (like real estate) a bit like trading sardines. They are concerned with the momentum building behind a stock, the psychology of other investors, the way a share price has moved in the past and so forth. The second school holds that, even if share prices are driven away from fundamentals for a time by herd-like behavior, they will eventually come back to fair value. "
This is a quote from a book called, Finance Just In Time, by Hugo Dixon. I really wish I'd read it before now. Whatever "fair value" is, in commercial real estate, is fairly straightforward and relatively easy to discern. Supporting estimates of value along with land and construction costs and the cost of comparable properties are things like rents, taxes, maintenance costs, leases and lease terms, insurance costs, and the like. Also included in this formula is what buyers are willing to spend, and what banks are willing to finance. Things went a bit awry in the late 80's and early 90's in the commercial world, when we saw banks writing off millions of dollars worth of loans on non-performing assets. Investors and institutions had lost sight of the importance of things like rents, maintenance, insurance, taxes, etc. In other words, they were engaging in trading sardines, not selling sardines for consumption.
In the housing market, there typically is no income and expense consideration when deciding what a house is worth. While the "income approach to value" is still there on the appraisal form, banks historically minimized the importance of that approach in evaluating single family residences. They instead focused on the cost of construction, land prices, the cost of comparable properties, and then the big one, what a buyer is willing to pay. (There is an old joke among brokers about appraisers...M.A.I. doesn't stand for "Member, Appraisal Institute" but rather "Made as Instructed." Appraisers worked for the banks, banks wanted to make the loans, so if possible, the appraisal often came out right around the purchase price.)
Consequently, housing is really an "eating sardines" model. It's best to buy your house based on what you can afford, what you like, and where you want to be for a while. While some of us grew up in that environment wherein houses doubled in value every 8-10 years, our current experience has been one of falling prices for at least the past two years. Prices are back to 2004-2005 levels in some markets. Construction costs continue to climb, and taxes have been discouragingly non-reflective of current market conditions, but the cost of land, and most importantly, comparable properties, has fallen significantly. Inflation in housing prices is proceeding slowly, if at all. Buyers cannot afford to make mistakes and wait for the rising cost of housing to bail them out, at least not for the immediate future.
The bright side of all this (I have to see a bright side, I'm in the real estate business!) is that now is an incredible buying opportunity. If you need a different place to live, have a little money and good credit, you can find amazing deals. Additionally, the Senate just passed a bill that extended the $7500 tax credit for first time buyers to a $15,000 tax credit for all buyers. That could be another compelling argument for buying now. Eventually, if immigration is allowed to return to pre-9/11 levels, and when the children of the baby boomers enter the home buying market in full force, the current overstock of homes will evaporate and prices should rise again. In the meantime, I guess we're lucky to have sardines to eat, moldy or not.
"There is an old story about a tin of sardines. One trader bought it and sold it to another, who sold it to a third, and so on. At each stage, the sardines changed hands for a higher price--until a real customer bought the tin. When he opened the tin, which was now very old, he discovered the sardines were moldy. He complained to the trader who had sold them. 'But, my friend,' said the merchant, 'these were trading sardines, not eating sardines.'
Investors can be split into two schools: those who go with the flow and those who seek out fundamental value. The former view shares and other financial assets (like real estate) a bit like trading sardines. They are concerned with the momentum building behind a stock, the psychology of other investors, the way a share price has moved in the past and so forth. The second school holds that, even if share prices are driven away from fundamentals for a time by herd-like behavior, they will eventually come back to fair value. "
This is a quote from a book called, Finance Just In Time, by Hugo Dixon. I really wish I'd read it before now. Whatever "fair value" is, in commercial real estate, is fairly straightforward and relatively easy to discern. Supporting estimates of value along with land and construction costs and the cost of comparable properties are things like rents, taxes, maintenance costs, leases and lease terms, insurance costs, and the like. Also included in this formula is what buyers are willing to spend, and what banks are willing to finance. Things went a bit awry in the late 80's and early 90's in the commercial world, when we saw banks writing off millions of dollars worth of loans on non-performing assets. Investors and institutions had lost sight of the importance of things like rents, maintenance, insurance, taxes, etc. In other words, they were engaging in trading sardines, not selling sardines for consumption.
In the housing market, there typically is no income and expense consideration when deciding what a house is worth. While the "income approach to value" is still there on the appraisal form, banks historically minimized the importance of that approach in evaluating single family residences. They instead focused on the cost of construction, land prices, the cost of comparable properties, and then the big one, what a buyer is willing to pay. (There is an old joke among brokers about appraisers...M.A.I. doesn't stand for "Member, Appraisal Institute" but rather "Made as Instructed." Appraisers worked for the banks, banks wanted to make the loans, so if possible, the appraisal often came out right around the purchase price.)
Consequently, housing is really an "eating sardines" model. It's best to buy your house based on what you can afford, what you like, and where you want to be for a while. While some of us grew up in that environment wherein houses doubled in value every 8-10 years, our current experience has been one of falling prices for at least the past two years. Prices are back to 2004-2005 levels in some markets. Construction costs continue to climb, and taxes have been discouragingly non-reflective of current market conditions, but the cost of land, and most importantly, comparable properties, has fallen significantly. Inflation in housing prices is proceeding slowly, if at all. Buyers cannot afford to make mistakes and wait for the rising cost of housing to bail them out, at least not for the immediate future.
The bright side of all this (I have to see a bright side, I'm in the real estate business!) is that now is an incredible buying opportunity. If you need a different place to live, have a little money and good credit, you can find amazing deals. Additionally, the Senate just passed a bill that extended the $7500 tax credit for first time buyers to a $15,000 tax credit for all buyers. That could be another compelling argument for buying now. Eventually, if immigration is allowed to return to pre-9/11 levels, and when the children of the baby boomers enter the home buying market in full force, the current overstock of homes will evaporate and prices should rise again. In the meantime, I guess we're lucky to have sardines to eat, moldy or not.
posted by Cynthia Maloney at
9:53 AM
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