The Real Estate Bubble Part 3 — The Future

As this is written, February 7, 2008 California and indeed the country now acknowledge the gravity of the situation.    The real estate market has all but dried up.  Values have fallen dramatically over the past several years and the bottom is nowhere in sight.  Foreclosures are at record highs (and that does not include the fact that many banks and financial institutions are choosing to actively work with delinquent homeowners, allowing them to live in their homes so as not to flood the market with foreclosures, further depreciating values).  Some of the largest loan companies in the country have closed and others are on the verge of collapse.

Within the past few days, with the earnings reports of the banks and other financial institutions who underwrote or purchased all of these funny loans, the world has been shocked by what is being disclosed.  Some of the most profitable financial institutions and companies (who have made shameful amounts of money in the past several years from these loans and credit card fees) are on the verge of collapse.  Indeed, several have only been saved with the assistance of foreign investors, who now own significant portions of American financial institutions.  The economy is now acknowledged to be in trouble for the first time since this all began.  And the million-dollar question which no one can answer is how deep the hurt will be.

The world economy is also deeply affected by this and stock markets around the world have seen significant selloffs along with all of the American exchanges.  The Federal Reserve has granted a 1 1/2 point reduction in the fed rate.  And the government of the United States has decided to give away $600 to qualifying taxpayers to stimulate the economy.

THE FUTURE

The United States is in considerable trouble and is facing a very difficult road ahead.  But the intention of this discussion is to identify the future in California real state.  Although much of what happens in California will be repeated throughout the United States the following pertains to California only.  It is also my humble opinion for those who care to read it.

The economy of the state of California has largely been fueled by a distortion in the actual value of real state on a true economic scale versus the inflated values on the books today.  It is no longer in dispute that these values are fundamentally too high.  There has to be a reckoning to bring these values back to a realistic range.  Payday has started and it is going to be tough.

Home values will continue to decline.  The money for these purchases came from equity that didn’t exist.  How much we do not know but we do know it is continuing to disappear.  As it disappears more and more people will find out that the home they purchased has now decreased in value to below the value of the mortgage loan.

Credit card defaults will skyrocket.  Many people not in trouble with their home loans will not survive their credit card payments, even at the minimum.  There will be no equity this time to bail them out.

Many people will walk away from their homes and rent.  As more and more homes become available on the market in the form of foreclosures existing homeowners who have to sell their homes will be forced to compete with the falling prices of the foreclosures, which will continue to escalate.  The real estate market will continue to disintegrate as values fall.

Many Californians will also find that they cannot afford the toys and other “stuff” they have purchased.  Personal property in the form of cars, boats, and motorcycles, etc. will become available at bargain prices.  Buying used items will become more practical than buying new, affecting retail businesses.  Simply stated, the lack of disposable income and the inability to borrow for purchases of nonessential items will severely impact companies across the board, both large and small.

While the pressure and scrutiny continues on the financial institutions, now in trouble, there will be no easy out loans without government or other outside intervention.  And if we do see government or outside intervention, it will only serve to slow down the inevitable, making it worse for all involved.

Commercial properties of all types will be affected.  Businesses will continue to scale back and rethink expansion, cutting jobs, store locations, new equipment orders, etc..  Many businesses will fail and occupancy rates will drop.

Office, retail, industrial and warehouse properties will get very aggressive with lease rates to attract new and keep existing tenants.  As these new leases containing reduced or free rent, tenant improvements and other incentives are offered by the landlord to new tenants, existing tenants will renegotiate their leases.  This will further exacerbate the commercial market resulting in reduced income to the property.

Owners having built or bought their properties in the past several years, or those who have leveraged their properties to buy or build without adequate capitalization will be in trouble.  Many will not be able to make their loan payments resulting in foreclosures in the commercial sector.  Many are in trouble now, hoping that this is a problem that will go away soon.  But it will not.

As in the residential side, commercial foreclosures will begin to determine market value and the new construction boom will largely be a thing of the past.  Developers and investors with cash will find many bargains.

Those affected will be spread across all areas of the economy.  The effect on the state will be staggering.  Unemployment will rise as jobs are lost and cutbacks are implemented.  Taxes will decrease as retail sales decrease (cars, boats, motorcycles, etc.)and property values decline along with corporate profits.

While I do not have an educated guess as to the length of the current crisis, based upon the last crisis in the 1989-90 meltdown I believe it will far exceed the five or six years of devaluation we saw then.  And I believe it will be far more reaching than the meltdown 17 years ago.