patrick.net

http://www.mercurynews.com/ci_6562038?nclick_check=1

Major bank stops approving home equity loans, credit lines

Here's the thing about inflation. Sure, the government will want housing/income inflation to bail everyone out. But how can/will they go about doing it? The same way they always try -- by lowering the Fed Funds rate and encouraging "free money" as others have said. However, will lowering the Fed Funds rate 100bps really make lenders eager to make subprime loans again? Will lowering rates 100bps lead to sharp income inflation? What if investors, instead of borrowing in the US to build businesses or invest in stocks, decide to put their money in commodities and foreign currencies as a hedge against a weaker dollar and a weak US economy?

The Fed can print/lend as much money as it wants. But it can't control where it goes. Watch this FNM/FRE situation that HARM pointed out carefully...it has Bernanke/the administration's fingerprints all over it.

Conor,

You're right, and it will. One thing is for sure (it won't go back into RE any time soon!)

Something I've noticed (in terms of inflexion) over the last few weeks is the astronomical rise in "Out at the Top/Bailed in '06" posters. Not nearly so much on bubble blogs but more so in MSM feedback. All of a sudden it's become rather popular to have bailed with each seller declaring the peak as the day they sold for their particular market!

Excuse me!

"We bought in _____ in December 2003 with 20% down (seems to be a favorite number) and sold in ____ of '07" and boy am I glad we did! My neighbor bought in _____ of '05 w/nothing down and...."

These guys remind of the film clips you see at "the running of the bulls". They wait for the last bull, tap their big toe once on the sidewalk and then bolt back into the doorway! Dude, you were -not- there.

If these guys were such visionaries what were they doing buying on the last day of '03? Can someone please coin a term for these "Nancy boys"?

Luminent slumps 85% after company warns on margin calls

Conor,

I was planning on doing that exactly. there are a lot of opportunities in emerging countries.

goober beat me to the headline, but here is the rest of the news... it seems to be all over the morning AM radio stations here in the Bay Area. I heard the story come up three times in my 20 minute commute. Cue up the music to Another One B.T.D. The best part is that UBS "downgraded Luminent to sell from neutral and cut its price target to zero".

Luminent Mortgage hit hard by margin calls
Shares slump 85%; secondary mortgage market has 'seized up'
SAN FRANCISCO (MarketWatch) -- Shares of Luminent Mortgage Capital Inc. plummeted 85% on Tuesday, plunging after the home-loan investment company warned that it's been hit by lots of margin calls as the secondary mortgage market "seized up."

Luminent (LUM 0.81, -3.57, -81.5% ) said its board of directors suspended payment of its second-quarter dividend. The board's also considering a "full range of strategic alternatives" to improve the company's liquidity and preserve shareholder value. Luminent shares fell $3.56 to stand at 66 cents during late morning trading on Tuesday. The stock was halted on Monday.
:
:
The company was set up in April 2003 and started by investing in so-called agency mortgages that conform to the standards of government-sponsored enterprises such as Fannie Mae and Freddie Mac. It also bought AAA-rated parts of mortgage-backed securities. However, in 2005, Luminent expanded its strategy and started investing in mortgage-backed securities with credit ratings below AAA. This year, the company also got into collateralized debt obligations, or CDOs.

Nice move, Sherlock.

SP

It has been a year since I posted my deflationary depression scenario. The biggest slug of foreclosures is due over the next 18 months. The foreclosures will destroy the CDOs and derivatives. Derivatives are about $500 TRILLION world wide now.

The inflection point is directly ahead. When housing prices start to decline dramatically then the attitudes will turn to FEAR. Declining housing sales has not yet moved the FEAR motivation into the main stream news. The average homeowner is not much affected by declining sales and a 3% (Schiller index) decline.

One major factor missing is a noticeable decline in employment. One factor in the missing decline in employment is that the illegal immigrants who are being laid off in residential construction are not accounted for in the unemployment numbers. Another factor is the stong commercial construction sector.

I have heard the argument for stagflation here many times. It is a good alternative. However, I do not see stagflation now in a meaningful way. With the huge inventory of vacant housing, I expect rents to begin declining which favors deflation as in a declining CPI.

An MSM article on the sudden hike in jumbo mortgage rates...

http://money.cnn.com/2007/08/07/real_estate/jumbo_jam/index.htm?cnn=yes

Isn't this huge? I mean, seriously, won't this rock the BA? I feel like I'm missing something...

"cut its target price to zero"

And now American Home Mortgage (formerly AHM) is now AHMIQ. The last two characters denoting "I Quit".

jeffolie

The problem is that you said the inflexion point was "directly ahead" a year ago. The other problem is that rents are going up, not down, if you haven't been paying attention to Patrick.net over the past year. Most of us have seen strong, sometimes surprisingly, rent increase pressures. Hiring in the Bay Area is also very brisk and employees in many professional fields are in short supply; not like 1999, but a bit like 1996.

These guys remind of the film clips you see at “the running of the bulls”. They wait for the last bull, tap their big toe once on the sidewalk and then bolt back into the doorway! Dude, you were -not- there.

There are no end of "accidental hero" analogies. The most recent being Will Smith's "Shark Tale" character. I'll stand by my record of selling Apr 2005 and subsequent headstone birth/death dates recounting the passage of the Clinton 2/5 cap gains exemption and date my housekeeper bought a house for 3x my house.

Robert
Vice President , Pillage & Plunder Divison [pro-tem]
HARM-X Industries LLC

By Steve Gelsi
Last Update: 9:43 AM ET Aug 6, 2007

NEW YORK (MarketWatch) -- NYSE Regulation Inc. said Monday it suspended trading of American Home Mortgage Investment Corp (AHM : AHM

I have a dumb question. What if you were shorting AHM these last two weeks? Now you can't cover your short position since the stock is no longer traded. What happens now?

Check out Jim Cramer's analysis:
http://www.youtube.com/watch?v=SWksEJQEYVU

@Rob Dawg,

Nice to see you're still an active member of the Board, if only "pro-tem". ;-)

Oh, and btw, the Fed's holding steady at 5.25%. The market didn't seem to like that too much (Cramer must be beside himself).

Check this out. The "flipper in trouble?'" house I posted in the Netherlands thread ended up in a SF Chronicle article. Evidently the owner is going by the adage "there is no such thing as bad publicity" (carrying costs, what carry costs...)

Even those sellers who choose to set certain price parameters find obstacles. Jain Wager has just relisted a historic Berkeley hills home for $3.65 million. She and a business partner purchased the house in 2005 for $1.23 million and put more than $1 million into renovating it. But after trying to sell the house for $5 million earlier this year, Wager attempted to "try to create some excitement and try something unique" by auctioning it with a starting bid of $2.249 million. Wager also reserved the right to accept or reject any offer.

"I think we came out of the gate a little high (on price), and it would have been better to lower it and have people bring it up to the market," Wager said. "I don't know if this system works for luxury homes or not. I think the jury is still out on that."

As a reminder, Propertyshark.com is showing a $980,000 variable rate mortgage on the house.

Randy H Says:

"The problem is that you said the inflexion point was “directly ahead” a year ago."

There is no denying that you are right and I was wrong on timing the inflexion point. Another problem I am having with timing the inflexion point is that consumer spending is still going strong as consumers expand their use of credit card debt.

"The other problem is that rents are going up, not down...".

I expect that this will change and rents will fall when consumer spending declines which has not happened yet.

"Hiring in the Bay Area is also very brisk and employees in many professional fields are in short supply; not like 1999, but a bit like 1996."

I am happy for you. But real estate and related jobs are declining. That is beyond denial.

It's different in the bay area......seriously!! It's really a different model....

Everybody makes at least half-a-millon a year and no more houses are being built. Median home price summer of 2008.............. 5-mil.....

Well, for many of us here, the really interesting thing about the hike in jumbo mortgage rates is how this will affect the Bay Area, where even stucco $hitboxes require jumbo mortgages. Interest rates upwards of 8% will really cut into purchasing power. The possible outcomes seem to be:

(a) buyers ratchet down expectations even more (as if they could be any lower) and buy even crappier places with the amount of money they planned to spend

(b) buyers simply put off buying

(c) sellers lower prices to attract those same buyers back

(d) buying idiots are pushed even more so towards alternative loan products

(e) it doesn't matter, since all the buyers in the Bay Area are rich foreigners paying in cash, like sybrib seems to think. ;)

(f) a combination of some or all of the above

Well SP, OO (and others), that expected interest rate hike is now here - what are your thoughts?

Brand Says:

> FAB: Can you comment on some of my observations above
> (2nd from the top)? I am puzzled at how landlords can be
> selling properties that are immediately cashflow positive.
> Can you outline some situations in which that happens for
> medium-sized and large complexes?

If you make a big enough down payment almost any real estate deal will be cashflow positive.

I didn’t see any rent numbers but remember a good rule of thumb to calculate cashflow is:

Annual Rent
- Vacancy & Credit Loss (Usually 5-10% of the Annual Rent)
- Expenses (Usually ~$3,000 + Taxes per Year)
- Capital Costs (Usually ~ $300/unit Year over a 10 year hold for apts and ~$1,000/Year for single family).
- Mortgage cost per Year
= Cashflow

goober Says:

> It’s different in the bay area……seriously!! It’s
> really a different model….
> Everybody makes at least half-a-millon a year
> and no more houses are being built. Median
> home price summer of 2008………….. 5-mil…..

It's funny but I (really) just heard a Realtor tm say basically the same thing (she told me she was worried that I would never be able to buy if I kept renting and was sure that the mortgage meltdown would not lower Bay Area prices at all).

FAB: Did you thank her for her concern?

So if property always goes up in the Bay Area, why aren't realtors telling their sellers to hold their property indefinitely? But I guess it's always a good time to buy or sell a home (tm)!

Well, for many of us here, the really interesting thing about the hike in jumbo mortgage rates is how this will affect the Bay Area, where even stucco $hitboxes require jumbo mortgages.
Skibum,
I am not convinced this has happened. From what I can gather from various blogs (see Socketsite and others), the vaunted Wells Fargo 8% rate for jumbo mortgages is for mortgage broker initiated loans. See the Wells Fargo site for loans originated in house. What we may be seeing is the banks "taking back" the broker's margin and bringing it in house. In a "normal" environment, I think the MBs could make a big stink about it, but given the current state of affairs, the banks can say they are protecting the market from the shoddiness of broker processed loans. Think travel agents and paradigm shifts as we finally emerge from this mess... At any rate, things are tightening up concerning documentation and bigger downpayments, so this should have some effect in the Bay Area.

FAB, I literally meant with a 100% loan, the places appeared profitable. Obviously you can pay cash and calculate ROIC that way. How much does a bank typically require for a downpayment on an income property? Also, what is considered good operating income?

http://www.cohomefinder.com/p/80521/405119.htm

$2,450,000 for 15 units, each 3 bed, 3 bath with W/D. Complex is located one block from Colorado State University. Two bed, one bath units one block away in another condo development are leasing at $800/month. Thus I will estimate these condos at $900-1200/month. I assume that you can actually take his assumable 6% loan on $2,450,000.

So from your calculations above:

Costs: -3000 (expenses) + -13500 (taxes) + -4500 (costs) + -147000 (100% mortgage @ 6%) = -168000/year

0.9 * (12 * 15 * 900) = 145800, loss of 22200
0.9 * (12 * 15 * 1000) = 162000, loss of 6000
0.9 * (12 * 15 * 1100) = 178200, income of 10200
0.9 * (12 * 15 * 1200) = 194400, income of 26400

Assuming that the bank required 10% (245K) or 20% (490K), in the $1100 scenario and subtracting out the mortgage difference, you would be making (10200 + 14700)/245000 = 10.2% ROIC and (10200 + 29400)/490000 = 8.1% ROIC, respectively.

Now, 8.1 % or 10.1% ROIC does not seem like a huge return for the present term. That's basically just treading water in the index funds. And 15-unit apartment complexes require major work to keep running. However, assumedly inflation will push prices upwards, eroding the mortgage deduction.

Now if you could get the place for a significantly reduced capital outlay, say $2M, then the returns start to look very attractive.

DennisN,

Long about 2002, during Harvey Pitt's brief tenure (I believe) they did something that should have been done months prior. They made "positive determination" mandatory. Meaning you couldn't have some whiz kid with a 2k account on e-trade putting in an order to short 2 million shares!

You had to be able to prove you had the resources to deliver said shares in the event you were on the wrong side of the trade. It got to be a real problem b/c there were shorts stacked up well above and beyond the total number of shares outstanding! Too bad it only took two years to get it right?

AFAIK the order book specialist pairs up as many positions as he can and if there are enough longs on the other side of the trade your short will be honored. If not, you're SOL. However... I'm told they have that pretty well policed now. Peter P might be able to fill in some of the finer points.

Randy H,

DennisN had a question (that wasn't dumb at all) and my response is tied up in moderation. A little help?

I think 2 things are happening in the mortgage market, both caused by the "repricing of risk".

1. The banks are putting a larger risk premium on broker-originated loans. I'm not sure this is so much a desire by the banks to bring the business back in house. It could also be a way to force higher standards on the brokers.

2. The banks are repricing conforming loans and therefore being forced to reprice conforming loans at near where jumbos are sitting. Since the market for jumbos is very illiquid right now, no one knows what the fair price of jumbos even are, so the banks are being conservative.

For the record, I've always had a "jumbo" on my BA homes. When I fist bought anything over $250K was a jumbo. That's because the standards are set by national medians, not accounting for regional disparities.

A little help?

Done

Brand

I had to model a very similar scenario (though it was commercial real estate) in B-School. If you run that as a reasonable monte carlo simulation you'll find a lot of loss in the demand and price variability alone.

I have noticed prices are down about 10-15% in LA area.

However there are still knife catchers out there but fewer every year.

Here is an encouraging sign: in 2004 my uneducated neighbor quit his $10 an hour phone job, got a RE lic after 8 months of hard hard study and told me he wuz 'gonna be a millionaire soon'. He starts flipping homes. He did have about 400k equity to start with so a good start. I just saw a pre foreclosure sell for 740k but this guy paid 850k in 2004. He must be broke or near broke as the home was vacant, dead lawn, mail piling up.

flippers dying on the vine every day. This time next year they should mostly be worked out of the system. Im basing this on the high number of flips I still see listed (for 6+months typcially) and the fact that foreclosure takes 12 months and mostly they wont/cant hold on that long. Even rented out some of these places will eat 2k+ a month while rented.(more if ARM loan has adjusted)

http://www.sfgate.com/cgi-bin/article.cgi?f=/n/a/2007/08/07/financial/f140331D05.DTL&tsp=1

Sun Microsystems to Reduce Work Force

What we may be seeing is the banks “taking back” the broker’s margin and bringing it in house.

EBGuy,

On the other hand, there is a piece in bloomberg suggesting that in fact the main reason jumbo loan rates jumped so much is that all of a sudden, there is no demand for them in the secondary market. Most of the demand now is in loans that can be bailed out by Fannie or Freddie if need be, which doesn't include jumbo loans.

I believe this is one componenet of what Randy is talking about with banks, lenders, and investors "repricing" risk. They are overshooting by looking for totally bailout-able loans, imo, but that's what happens during a panic...

Brand Says:

http://www.cohomefinder.com/p/80521/405119.htm

$2,450,000 for 15 units, each 3 bed, 3 bath with W/D. Complex is located one block from Colorado State University. Two bed, one bath units one block away in another condo development are leasing at $800/month. Thus I will estimate these condos at $900-1200/month. I assume that you can actually take his assumable 6% loan on $2,450,000.

-------------------------------------------------------------------------

My goal in this downturn is to pick up a similar deal (1/3 smaller) in here in my state...

1- Long term (10-20 yrs), I am willing to bet 5-to-1 that the risk-adjusted return on similar deal initiated at 2009-2010 prices will be very very attractive....great leverage, credit still relatively cheap, much smaller pool of potential competitors on the available deals (Casey Serin who?), probable high future inflation and high volatility in the stock market...

2- The usual risk-averse suspects who are now talking about 'Monte Carlo simulation, opportunity costs' will be quick/force to drop fancy concepts like ‘ex-ante, ex-post’ in a couple of years, when the attractiveness of such deals will be plain for all to see…Don’t listen to them as they don’t seem to understand very well the concept of decision making under uncertainty and incomplete information (dynamic programming)….

My only concerns are that this deal seems quite big (time/spare cash needed) to pull off with a high probability of success:
1- Managing 15 units on your spare time is a daunting task
2- You will need to have at least a 5-10% rainy day fund (unexpected maintenance...) on top of a 10-20% downpayment/renovation fund...lots of cash...
3- The implicit assumption is that students will rent the place: is that true now and is it likely to change (new dorm, stigma, university shuttle stops nearby..)
4- Can you cope under a worst-case scenario for a couple of years...

Anyway, let us know what you find/decide

Brand Says:

> $2,450,000 for 15 units, each 3 bed, 3 bath with W/D.
> Complex is located one block from Colorado State University.
> Two bed, one bath units one block away in another condo
> development are leasing at $800/month. Thus I will estimate
> these condos at $900-1200/month.

I assume that you can actually take his assumable 6% loan on $2,450,000.

If we assume $1000 a month we get gross income of $180K

Net income after vacancy and collection loss will be ~$171K

Expenses at $3K a unit leaves us with $141K

Backing out taxes and CapX will get you a NOI of $123K (a 5% Cap Rate).

The best commercial loan you will get today will have a rate of about 6.75% and the lowest DSCR you can get is 1.20 so the biggest loan you can get will be about $1,265,000 (52% LTV) so if you buy this property at the list price you will get about a 2% cash on cash return (when the cap rate is lower than the loan rate it kills the cash on cash return). The way I read it you can assume a current loan at 6% but it does not mention the loan amount so it is probably a $1mm loan.

Randy: Is the Monte Carlo simulation goverend mostly by spreadsheet equations, or is it something that I would need software to do? In engineering, we obviously do MC simuations but it takes specialized tools and considerable computing horsepower.

TOS: I am just running the numbers as a mental exercise. I doubt that I would ever buy that place, especially at a price where breakeven was so fragile. I am looking at various opportunities now with a pool of experienced and inexperienced investors (mostly small business opportunities), but I am quite interested in learning how to do the analysis and business case myself.

Brand

You need special software for anything useful. You can find some free Excel-macro driven stuff that is OK for a simple mental exercise. The easiest accurate tools to use are things like Crystal Ball (now an Oracle product) which are Excel plugins.

It's very informative to model some variability into profit models. You can take FAB's model above verbatim, then ask him for some rules of thumb about vacancy rates, deadbeat rates, and rent-price variations. Don't worry about rigorous statistics, just do things like triangular distributions given FAB's heuristics.

The amount of variation that will inject into a profit model for say 10,000 iterations will tell you where the sensitivities are in your financial business model. And it is really the sensitivities that are useful, not the predictions. Predictions are just likelihoods based on randomness, but sensitivity analyses will tell you were your probable points of failure are.

As reference, when I developed The Bubblizer I tested it with Monte Carlo simulation in Excel. The scenario output on the second tab is a simplified version of the results of that simulation.

The Bubblizer shows clearly there is a threshold condition whereby the initial asset book value (the price you pay for your home) overloads all the other conditions and consumes over 95% of the sensitivity in the model. Below that threshold, tax-shelter, mortgage interest rate, and purchase price all have roughly even sensitivities. If you refer back maybe 25 threads to when TOS tried to respond to The Bubblizer (by proxy, she never responded with criticism to it in my forum despite the fact she insisted it was categorically flawed) with her own criticism you'll see where she makes the mistake of assuming that sensitivities remain more or less constant. I had an up on her in the argument, because I'd run the simulations and knew generally where the buy-v-rent equation broke down in absolute terms, regardless of everything else (at a 95% certainty).

Apologies to keep posting about Luminent, but the news on this is just so 'are you fu*kin kidding me?':

This time from the Associated Press:
Just a week ago, Luminent Mortgage Capital assured the market it was not exposed to the liquidity squeeze gripping much of the mortgage industry.

Luminent's markets "have deteriorated significantly and in an unprecedented fashion." Its lenders want their money back. The company suspended its dividend and said it will be late repaying some of its debt.

There is something big going on, if companies like this are getting sucked underwater in just one week. Reminds me of one of those b-grade shark movies where the chick (why is is always a chick?) is splashing around and wham, she's gone and the water starts to turn red.

SP

There's a piece on NPR re: the subprime crisis and credit tightening response:

http://www.npr.org/templates/story/story.php?storyId=12561184

It's all stuff rehashed from other sources, but nice to see it's hitting the left-wing side of the MSM (redundant?)...

Randy: Of course, the interesting thing about a Monte Carlo simulation is that it depends heavily on your initial assumptions. For instance, let's assume that I estimate that college students do a typical range of $200-400 a year in damages (+/-33% in FAB's model), but the maximum is far greater than that (say $1000 for drywall damage, cracked tubs, etc.).

As you point out, the primary MC value is to inform you which variables cause the biggest deltas under which conditions. For a college student rental complex, I'm betting that potential damages and tax changes are by far the two biggest factors. You can count on the university not getting any smaller. You can count on the state population continuing to increase. But you can't count on whether or not the city council will rule against "pre-existing" duplexes made from single family homes, or whether you'll get a bunch of keggers that earn you some fines from the kampus kops.