Thursday, May 18, 2006

Burn Rates

John Doe on the Southern California Real Estate Bubble Crash Blog made an interesting post about Burn Rates.
Over the past few days, we've had the chance to review the proverbial Canary in the Coalmine, San Diego. It doesn't look good. Inventory has been continuing its parabolic rise. It surpassed its all-time record set in July 1995 of 19,250 some time late last month. The population adjusted inventory record will likely be surpassed within 1 month, give or take a few weeks.

Median prices have been flat for at least a year, with considerable weakness shown in recent months that show down since summer last year. Housing analysts agree that houses are not like stocks, and prices will not go down because they have intrinsic value that is not like a piece of paper like stocks.

True, houses are not like stocks in every way, but a market is still a market, and certain attributes of a house ARE different than a stock.

One of the biggest differences between the typical house purchase and the typical stock purchase is that most homes have substantial holding costs while stocks often have little or none (not opportunity cost, just the cost to keep someone from taking it away from you). This is your burn rate. With flat or shrinking equity, time to sell means over time, you lose money, even if you are just standing still.

OK, so let's look at some hard data:

1. According to Bubble Tracking, Current inventory stands at just over 20K and last months' sales were 2600. That puts us at roughly 7 3/4 months inventory, a decidedly bad place for the local area to be in.
2. In recent months, the average payment homeowners committed to was just over $2700/month. If you take the premise that the average home is going to take nearly 8 months to sell, the selling opportunity (new holding costs) for the current strike price could be as much as 7.75*2700=or about $20K If inventory goes higher to 10 months, it would be $27K. Keep in mind the average new payment includes equity rolled in, so we don't really get a lift from current equity.
3. Interest rates are most likely on the rise. We demonstrated that the average spread between Fed Funds Rates and 30 Year rates were about 3%, current rates are about 2.5% too low (payments should be about 50% higher than they currently are). With net out-migration, don't expect expanding rents or newcomers to handle the coming inventory.

The burn rate for many San Diegans should start to get difficult to handle in the near future.
I asked Mike Morgan of MorganFlorida his take on Burn Rates. At least San Diego is holding up better than Florida (for now). Not only does Florida have high carry costs, home prices are collapsing on top of it all. The insurance situation with hurricanes and sinkholes is not exactly helping either.

Here was Mike's response:
I just completed a two day tour of Gulf Coast and East Coast Florida developments, visiting developments in Naples, Marco Island, Bonita Springs, Miami, Palm Beach and the Treasure Coast. After speaking with several sales agents for builders, it was clear they were all willing to make deals to make sales. This is unheard of. Historically, the listed price is the price. No more. Now, you can just about name your price and name you incentives from free upgrades to price reductions, a car, vacation timeshare, etc.

The most disturbing thing I heard was from the resale market. In the same developments where builders are trying to sell, the resale market is huge. We saw 20-50% numbers of the total number of homes in developments that are on the resale market listed in the local MLS systems. The builders agents are NOT selling homes. How can they, when the flippers are willing to undercut any price the builders can drop to. To analogize this, think about going to a new car dealer to buy a new car, but right next door is a lot filled with the same brand new cars for 10-20% less. Same car, same warranty and a wider selection, but 10-20% less. There is no reason to buy the car from the dealer. And there is no reason to buy these homes from the builder, when you can buy the same home for less from a flipper that is desperate to cut his losses.

We were the only traffic at any of the builders we visited. They had no other buyers and they all told me the same thing. Sales are dead, and they will do whatever it takes to make the sale. But we heard the same thing from the agents for the flippers. I�ll stake my reputation that we start seeing negative sales numbers in Q3 or Q4. It is inevitable. Moreover, with lower prices and higher selling expenses, margins will be squeezed to low single digits . . . if they are lucky.

Think about this. In the high-rise market with a 1.5M condo, the carrying costs for Condo Association Dues, maintenance, insurance and taxes are about $4,000 a month. And that is without a mortgage. Add an 80% mortgage and your carrying costs jump to more than $10,000 a month. For a $500,000 home the number is more than $3,000 a month. The builders have been telling the Street that the high end market has no investors. I found more flip inventory in the high end than the low end!

The carrying costs apply to flippers as well as builders. As the builders complete inventory and get a Certificate of Occupancy, they must start paying Insurance, Mortgages, Association Dues and taxes based on the appraised value of the units. That, combined with lower margins and a halt in sales will crush the builders� bottom lines.

The market is in far worse shape than I had anticipated. If some of the Wall Street Analysts got out of their offices and into the field, they�d be singing a different tune. And with another Fed increase inevitable after yesterday�s CPI, it is clear the builders are in more trouble than they have ever been in. It is different this time.

It�s a lot worse than I thought. And I have been accused of being too negative!
I will put more together next week.

Mike
Perhaps this explains why would be flippers are walking away from $80,000 deposits.
By the way, those are the lucky ones. Condo buyers that closed are trapped in a situation with no buyers and no renters. The foreclosure party has just started.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

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