By Rick Tobin
Since the official start of the ongoing Credit Crisis (www.thecreditcrisis.net) back in the Summer of 2007, real estate values have experienced wide ranging price swings. With real estate investments, the primary cause of a “boom or bust” cycle for property values is typically related to the available supply of money to get us in and out of the deals as quickly and efficiently as possible.
When money is tight due to higher rates and more challenging bank underwriting guidelines, then property values tend to fall. If money is easier when interest rates are lower and underwriting guidelines are more flexible, then home prices tend to rise in value.
After 2001, the Federal Reserve allegedly attempted to try to stimulate the U.S. economy, housing market, and stock market by taking short term interest rates down to 1% over the next few years. As a result of the low short term rates, adjustable rates and sub-prime credit mortgage loans amortized up to forty (40) years became quite popular between 2001 and 2007.
As a result of the combination of interest rates near historical lows in 2002 through early 2007, home values increased significantly in most parts of the USA. In fact, many home values actually doubled in price during the period of just a few years. Many investor “flippers” were buying, fixing, and flipping homes to other home buyers or investors while pocketing tens to hundreds of thousands of dollars of profit for just a few months of work.
Derivatives: When Trillions Later Equal Zero or Negative
Regardless of the alleged reasons for the start of the Credit Crisis, defaulted sub-prime mortgages represented less than 1% of all non-performing loans worldwide. The bulk of the non-performing debt was related to derivatives such as Credit Default Swaps (CDS). A CDS is really just a “glorified bet” in that the seller of the CDS will compensate the buyer in the event of a loan default or “trigger event.” As such, a CDS is a kind of a hybrid of an insurance and financial instrument.
At their supposed market peak, derivatives like CDS, Interest Rate Options Derivatives, and other complex financial instruments which “derive” (hence the “derivatives” name origin) their perceived value from underlying investments or financial bets such as the future directions of interest rates, reached a potential market value of over $1,500 trillion. This alleged $1,500 trillion value of primarily unregulated derivatives dwarfs all other assets worldwide combined by a multitude of times.
When the value of the derivatives began to implode after less and less buyers of these complex and risky investments wanted to take the risk to buy them, then the Credit Crisis began to worsen shortly after August of 2007. In fact, multiple large banks, investment banks, and insurance companies either completely imploded or were on the verge of collapsing prior to any government or Central Bank bailouts partly because their investments in non-performing derivatives exceeded the combined value of all of their other investments at the time. Additionally, many banks only had a tiny fraction of cash assets on hand as compared to their derivatives investments exposure.
As the financial markets began to “freeze up” due to the imploding and seemingly worthless trillions of dollars of derivatives, then lenders began to figuratively “slam their brakes” on making loans to consumers and small to medium sized businesses. This lessened supply of available capital coupled with the near insolvency of many of the largest U.S. financial institutions, led to much tighter underwriting guidelines and higher interest rates.
Just a few years prior to the official start of the Credit Crisis in 2007, the Federal Reserve had raised short term interest rates a total of seventeen (17) separate times in just a matter of a few years trying to possibly artificially suppress the rampant appreciation of home prices. This rapid escalation of home prices was related to the incredibly low interest rates and much more flexible and easy loan qualification guidelines back then with loan products such as “No Doc”, “EZ Doc”, “Stated Income”, “Stated 5/1 Fixed”, “Option Pay ARMS” (adjustable rate mortgages with upwards of four (4) + monthly payment options), and credit lines or 2nds up to very high combined loan to value ranges (CLTVs) without any proof of income in many cases.
Tragically, many U.S. homeowners who chose adjustable rate mortgages for their first or second mortgage loans, their monthly payments may have later recast or doubled in payment amounts after their underlying adjustable index rates increased significantly in the final few years prior to the 2007 start of the “Credit Crisis” which only worsened in the Fall of 2008. In fact, the near financial implosion of the world’s financial markets during the week of September 29th, 2008, as even stated by Fed Chairman Ben Bernanke in front of Congress in the Spring of 2009, was perhaps the most critical and notorious week in the history of world financial markets.
As mortgage payments began to increase or double in payments, foreclosure filings then increased significantly across America. More foreclosures, in turn, led to declining property values in neighborhoods nationwide, and the deflationary asset spiral worsened in 2008, 2009, and 2010 as median priced home values declined by 30%, 40%, and 50%+ in both prime and not so prime areas, unfortunately.
Japan vs. the USA: “Pop” goes the Asset Values
In the 1980s, Japanese real estate values skyrocketed partly due to a booming export industry related to lots of high tech gadgets. As the insanity of the market peak reached the upper limits in the 1980s before the Japanese real estate bubble went “pop”, the Imperial Palace (the Emperor of Japan’s main residence situated on over 1.3 square miles) was once valued by some financial analysts as being worth more than ALL real estate combined in the state of California during the same time period.
This comparison of all combined California real estate values as compared with only a 1.3 square mile Imperial Palace region in Tokyo is quite shocking when one considers all of the prime and expensive coastal real estate between San Diego and San Francisco which includes affluent regions such as Malibu, Pacific Palisades, Huntington Beach, Newport Beach, La Jolla, Santa Barbara, Big Sur, Carmel, and other expensive regions along the not so cheap California coast.
During the “Japanese Asset Price Bubble” time period between 1986 and 1991, stock values on the Nikkei index rose tremendously too. The asset bust which followed the “Asset Price Bubble” lasted for more than a full decade as both stocks and real estate values plummeted during this “Lost Decade.” Just like here in the USA, Japan’s financial leaders tried to take their interest rates as close to zero as possible in order to try to stimulate the stocks, bond, and real estate markets once again.
The Nikkei 225 stock index for the Tokyo Stock Exchange, which is Japan’s version of the U.S. Dow Jones index, hit an absurdly high level of almost 39,000 on December 29, 1989 during the peak of the Japanese Asset Bubble Boom. On March 10th, 2009, the Nikkei index fell to a low near just 7,000 which is almost 82% below the market peak almost twenty years earlier in 1989. In early May 2013, the Nikkei index is closer to 14,000.
As a comparison to the boom and bust cycles of the U.S. stock market in recent years, today’s Dow Jones index levels are in the 15,000 range. It was just a few years ago back on March 9, 2009 that the Dow reached a Credit Crisis low of 6,443. How in the world did the Dow Jones more than double in value with a weak job market? The answer is called “Quantitative Easing.”
Japanese home prices increased approximately 160% over the period of just six (6) years shortly before their housing bubble burst in the early 1990s. By comparison, the median priced home in the United States appreciated almost 130% over a similar six (6) year time period between 2000 and 2006. It was the combination of cheap and easy money which helped fuel both housing booms.
Our ongoing six (6) year long Credit Crisis (2007 – 2013) has potentially been even more severe of a market downturn than even The Great Depression (1929 – 1939). As it pertains to real estate values back near their market peaks in 1929, after years of “The Roaring 20s” economic boom which boosted both stocks and real estate prices, home values only fell about 26% during the depths of the economic depression in the 1930s.
A major reason why home values did not drop as much as the 30% to 50%+ market drops from their peaks in recent years is that homeowners in the 1920s typically had to invest 50% down payments in order to qualify for a 5-year mortgage which ballooned or came all due and payable in 60 months. In the earlier years of this 21st Century, 100% loans were very popular so the banks usually had more financial exposure and risks associated with residential properties.
If the property values appreciated significantly shortly after the acquisition of the home, apartment building, or industrial storage building, then the property owner kept all of the future equity as profits. On the other hand, if the values dropped so significantly at a later date and the mortgage debt exceeded the current property values, then many property owners just “walked away.” The rampant escalation of foreclosures nationwide, in turn, then led to massive price declines for homes, raw land, hotels and motels, office and medical buildings, and other types of properties.
Here Comes Inflation to the Rescue
The past several years, many economists have whispered or shouted “We don’t want the USA to go into a deflationary spiral like Japan back in the 1990’s.” Japan’s peak boom real estate prices and subsequent bust was equivalent to about a 64%+ price decline. In turn, American peak real estate prices fell 30 – 50% + for many homes, and upwards of 1,000%+ price declines for many land deals during the ongoing Credit Crisis.
What is the antidote to a deflationary asset spiral? The answer is INFLATION. How does America, and other nations worldwide, help create more inflation for asset prices like stocks and real estate when wages are either stagnant or continuing to decline right along with seemingly higher unemployment figures? One of the main answers is related to taking interest rates down toward near ZERO levels like they also have tried in Japan.
When 30 year mortgage rates hover in the 3% and 4% rate ranges right along with 5 to 10 year fixed commercial property mortgages (i.e., apartments, industrial, office, retail) for prime properties, then borrowers may better qualify for much higher loan amounts. Increased loan amounts then, in turn, leads to increased sales prices.
The numerous financial bailouts and strategies implemented by the Federal Reserve, and other Central Banks worldwide, along with various governments have tried to create even more money “out of thin air” in order to both try to drive interest rates downward even more as well as try to increase asset prices. Programs such as “Quantitative Easing” (or “create money out of thin air to buy up stocks, bonds, and real estate mortgages”) have succeeded in driving up the U.S. Dow Jones stock index above 15,000, gasoline prices up to $4 to $5 + partly since oil is traded in “Petrodollars” (“Oil for Dollars”), and increased inflation for consumer goods like groceries, clothing, and other items right along with home prices.
Buy Discounted Assets with Cheap Money, & Let Inflation Improve their Values
Between 2012 and 2013, home prices have increased between 6% and 30%+ in various regions of the USA due to the near record low mortgage rates, declining supply of available homes for sale partly due to many 3rd party investors purchasing the foreclosed properties before they become available for sale to the general public on the MLS (Multiple Listing Service), and more motivated individual and institutional investors in search of finding yields greater than their negative net returns offered by their banks’ savings account rates now.
Inflation and deflation are both “double edged swords” depending upon which side one may be on today. For example, a U.S. Dollar created one hundred years ago in 1913 was worth a true Dollar. That same U.S. Dollar, after factoring in 100 years of inflation, may now be worth just 3 to 4 cents, sadly.
On the other hand, the median priced home in the U.S. back in the early 1950s was worth approximately $17,000. Depending upon the location of that same home today, it may now be worth $200,000 (inland) to $1 million + (coastal). While inflation may be the enemy of a currency, it may also be a great ally and friend to investments like real estate.
After the Great Depression ended in 1939, those savvy investors who had either cash or access to cash were able to find some exceptional real estate investment deals for a fraction of their market values just a few years later. Many families were able to create the bulk of their families’ generations of wealth by buying their discounted investments either during the depressed economic time periods or shortly thereafter.
Let’s hope that the financial markets continue to improve so that more real estate investors will soon benefit as well just like so many investors have in the U.S. stock market in recent years as the Dow Jones has more than doubled in value since early 2008 in spite of a questionable economy. Historically, commercial real estate cycle booms tend to follow the recovery of residential real estate by 12 to 18 months so hopefully commercial real estate recovers much sooner as well which may then help improve our job market.
Author: Rick Tobin
Rick has an experienced and diversified background in both the Real Estate and Securities fields for the past 25+ years. He has had hundreds of articles published nationally in magazines, newspapers, internet sites, newsletters, and other sources, and has also appeared as a guest on various television shows as well as in seminars about real estate and financial information.
Rick has an extensive background in the financing of residential and commercial properties around the U.S. His funding sources have included banks, life insurance companies, REITs (Real Estate Investment Trusts), Hedge Funds, and foreign money sources.
He has purchased numerous investment properties in multiple states, including government and tax foreclosures, All Inclusive Deeds of Trust (AITDs), Land Contracts, Lease Options, and he has purchased significant amounts of mortgage investments. He has worked in the development of hundreds of residential properties, including single family homes, townhomes, condominiums, and apartments.
Contact Information: Rick Tobin – 12424 Wilshire Blvd., #630 Los Angeles, CA 90025 Email: email@example.com Phone: (310) 571 – 3600 ext. #203 CA DRE #01144023
Ricks’ website: www.thecreditcrisis.net