In his latest piece, Wall Street Greek Real Estate Columnist Michael Douville thanks Mr. Bernanke for what he sees as an intentional effort by the Federal Reserve to inspire inflation. Douville posits that the eventual result will be a recovering real estate market and profits for brave and visionary real estate investors.
Thank God for Ben Bernanke! There is a black hole in the Sands and Chairman Bernanke is keeping the event horizon at bay. Lenders are bleeding capital in the Sand States of California, Nevada, Florida, and Arizona. These are the lenders that provided the money for buyers to feed the Real Estate Bubble; they are guilty of "excessive exuberance".
Many of the loan programs in hindsight were pure folly; guaranteed to fail. However, the lenders lent the money. They did not: recommend or guide the borrowers to any particular loan program from a full menu of loan products; they did not suggest the borrowers misstate their income or outright lie; they did not recommend owner occupied loans when the property was an investment purchase. They just lent the money. The ultimate lenders never met the borrower, they just lent the money.
Thousands of properties are sold each month with a huge loss to the lender. Investors are reaping enormous potential rewards at the expense of the lender. Many homes are bought below replacement prices; prices so low the builders and Housing Starts are struggling because they are finding it difficult to compete with distressed properties. Lenders need to clear the balance sheets and rid themselves of non-performing or at-risk loans. They are looking toward the future. Astute investors are also looking toward the future while they collect their monthly cash flow.
A typical short sale transaction involves a property sold at 40-60% of former value... a terrific bargain. The short sale property was probably sold by a seller that may have scraped together 3-10% of the 2005-2007 purchase price as down payment; the lender provided the balance. A home sold today for $80,000 in Surprise, Arizona, a suburb of Phoenix, is typical. The home was likely purchased for $200,000 in 2005 with a loan balance of $180,000. The lender will not only lose the difference between the loan amount and the new purchase price, but also has incurred all of the cost of sales, which usually nets the lender about 80% of the new discounted sales price... a net of approximately $64,000. That's a loss of $116,000 in just 5 years. That money disappears! There is no velocity of money from that transaction. Instead, it is a contraction of credit. Capital is lost! This is only one transaction of thousands structured the same way.
This is a Capitalistic Economy; money is the fuel. Banks and lenders have lost huge sums of capital through this correction in value. How is this money replaced? Billions upon billions of dollars need replacing. The Federal Reserve has: allowed the lenders to borrow at less than 0.25%, and lend to borrowers and even back to the Federal Reserve at 2.5% to 4%; been buying US Treasuries and earning interest; replacing lost capital and re-liquefying the system; and expanding its balance sheet. Without this extra capital, the US Economy and the Global Economy would have failed. The correction is still unfolding and thought by many to be two-thirds to three-quarters of the way through.
Beyond 2010 will be the recovery in prices; probably a slow recovery for the next 18-24 months to correct the excesses in housing. There should be no statistical inflation until the correction has run its course, as the losses in housing offset rising prices elsewhere. No one will know the day the correction ends until well after the fact. The Federal Reserve will continue adding liquidity to ensure the recovery, adding until inflation ignites. In 18-24 months, the credit contraction will have run its course and the capital will start to flow.
Once the losses start to diminish, there will be velocity of money as surpluses start to develop. There should be inflation in other segments of the economy such as food and energy, services, taxes, etc., before housing prices start to rebound. Rents should start to rise prior to any recovery as supply tightens. With housing starts at such low levels, any sign of recovery will fuel higher rents as household creation expands. Many believe there has never been a situation where a central bank has been unable to cause inflation. It is a matter of time, and housing will benefit greatly.
There is probably another wave of properties yet to be liquidated. As employment finally starts to gain traction, there will be fewer. However, there still exists a window to position a portion of a portfolio as a wealth strategy or hedge against future inflation. Single family homes are in a clearance stage. Rents allow for a steady cash flow after all expenses and may be poised for a substantial increase. Should inflation ignite, which appears to be the ultimate goal of the Federal Reserve, housing in recovery mode will reward a patient real estate investor. Buy a rental or a vacation home and thank Mr. Bernanke.
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