My analysts have performed a lot sell side research, and I am an industry outsider that thinks out of the box. I have never worked for the sell side, thus I think very differently. Hence we tend to come at things from differing angles. This is good. Diversity is good, even when it results in others disagreeing with my theses. When creating the pricing and forecasting engine for the Ryland model used in my last post, I noticed that the numbers appeared to be too optimistic, at least according to my grassroots investor's gut instincts. I know "gut instincts" is not very scientific, but regardless, I told the team to go back and check the numbers. It received a slight tweak, but my gut still told me something was off, despite the fact three smart and knowledgeable people scrubbed the numbers for 2 weeks straight. They used many sources for each city that Ryland built in OFHEO, CME, Case/Shiller, MLS, REOs, Foreclosures, etc. I then got the following email which created a spark:
You’ll love this:
“While fishing one day I was introduced to the recently retired president ( age 42) of Ryland Homes and his view was that the housing debacle in Florida is going to get much worse than the current state. He had conveyed the disturbing number of houses that would not be completed to a finished project currently being constructed and their internal projections of available buyers at higher interest rates and more importantly qualification standards. In his opinion the bottom is still years away there and most like the same in other areas of previously high appreciation above the norm. They are renting unsold condo's on the beach for 1% per year of asking price in an attempt to at least generate some type of CF until a sale might take place in an unbelievably overbuilt and overpriced market. He also thought that a 30% decrease in value from today's number ( already discounted from the top) is probable and the most important idea is that most in his industry are still in the denial mode vs the desperation mode necessary to make a true bottom.”
Now, I just reviewed this guy's company so the numbers were fresh in my mind. In addition, I was pondering what could have been wrong with the analysts numbers. Empirically, the methodology was sound. So, I took their numbers and removed ALL government data, scrubbed them with market data only taking into consideration the foreclosure and REO rates (using proprietary algorithms), then back tested the results. Voila! Numbers that matched my gut feel, and more importantly numbers (or at least a methodology) that can be partially verified through back testing. Having just went through this exercise when the email above arrived prompted me to run the new numbers through the Ryland model. The result, whewww!!! No wonder all of those insiders are selling all of those shares. Things looked pretty bad with the ivory tower, conservative numbers. The more realistic grassroots numbers pushed through the Ryland model screams Bad News!!! For the record, we have Miami dropping (32.07%) from this month to 2011. You see, Ryland management and I really do think alike. We're both selling Ryland stock and we're both forecasting similar numbers for real estate pricing. Hey, to agree with me, those Ryland guys must be pretty damn smart:-)
I will have my analysts thoroughly back test the results and refine the model even more, but in the mean time I think we are on to something. Let's take a look at what we have.
For the record, this data has yet to be adequately and fully adjusted for condos. This, and the filtering of new construction and investment properties, is the weakest component of the Case Shiller index (see my opinion on that topic here). YTD, condos have underperformed single family housing in 14 out of 24 Metropolitan Statistical Areas. Needless to say, the new construction is being heavily discounted. Also, keep in mind that most of the markets that did not participate in the bubble are still participating in the recession due to the fact that many homeowners used exotic financing for their homes, which ended up with a non-traditional, often unpleasant result of distress, foreclosure an REOs. A perfect example of this would be Detroit. In the graph below I have outlined the last 20 years of housing appreciation in the US for 10 metro areas. Click the picture to enlarge.
Notice the difference in intensity between the last residential real estate bull market and this most recent bubble. It is a BIG difference. Each market entered the Boom, the Burst & eventually, the Recovery at a separate and individual date, thus have been calculated and graphed accordingly. Residential real estate is very local. What is very different this time around is the severity of the bubble, and how correlated the markets are - not just across the US but throughout the Americas, parts of Asia, N. Africa, & Europe as well. For more on how this occured, you can read “The Great Global Macro Experiment”
for a macro primer on the risky asset bubble environment. Next, notice how long the recovery took. Then take notice the steep, steep incline up representing this most recent bubble. This has been the biggest real estate bubble since the gold rush (at least that I am aware of)!!! Now, notice the burst and recession, both current and forecasted (in case there is anyone who has not realized it yet - Yes, we are in a recession!). For all of those who are looking for a "bottom" this year or next, well "I (and the management of Ryland) have some home building stocks to sell you!"
Look at the home builder's stock prices at the height of the bubble in 2005. Compare it to the graph above. Now look at the stocks in 2000 - 2001 and compare it to the chart above for the same years. Do you see the correlation. Now, where would you draw the trend line for the builder stock's decline in years 2007 through 2011???
Now referring to the first graph again, although there have been periods where prices have dropped - and recently, have dropped significantly - housing prices generally trend upward. It may take a decade, or even two, but prices do trend upward over time. The pertinent questions are:
- How much farther will prices drop?
- What is the extent of the damage of the busted bubble from peak of the bubble to trough of the bust?
- Where will the individual markets end up in terms of pricing?
Well, since you have paid so damn much to access the info on this blog, I am morally and ethically obliged to give you what you ask for. The graph says it all. A picture is worth a thousand (an one) words.
The pretty green lines show where we calculate these markets will ultimately end up at the end of the recession. NY was already a very expensive place to live. It went up a lot, will come down a lot, but end up about where normal housing appreciation would have put it without the bubble. Now, this is the MSA, and not Manhattan only. Manhattan is harder to due due its building type mix.
Place like Miami and Vegas were popular places but not necessarily higher income employment or housing bastions of excess. Due to excessive speculation through the bubble, housing prices literally skyrocketed - way above the level of affordability or rational rental yields. These prices are falling, and will fall much farther. Yet, despite the painful fall that is coming, at the end of the day, these areas are going to be considerably more expensive after the bubble than before the bubble. In order for this to be true, socio-economic demographics have to shift. In other words, the older demographic makes much more money, or they are gentrified out. I will actually post a model on socio-economic measurement to assist in quantifying the finer and more ambiguous points of forecasting real estate pricing and valuation trends. But before I do that, I will plug these more grass roots forecast numbers into the Ryland model and share the results. I will then use the price forecasting engine to map out the likely future of the other big public builders, and then move on into socio-economics.