What To Call it? Credit, Confidence or Confusion Crisis?

Looking for Signs the Worst May Be Over, Investors Seem Content To Wait it Out

While investor enthusiasm sent capital markets soaring after the Federal Reserve Board cut the federal funds rate last week by 50 basis points to 4.75%, the full impact of the dramatic action is still not at all clear. The latest numbers this week on home building, real estate sales and business indices continued to show worsening conditions. But, adding to the uncertainty, those numbers tally events and opinions prior to the rate cut.

All of which has prompted a lot of discussion about just what the markets are dealing with: a real credit crunch? Investor uncertainty? Or a lack of confidence?

In a wide-ranging lecture at Wharton School of Business at the University of Pennsylvania, Sam Zell, the master real estate investor (and current media tycoon) who built a fortune on real estate cycles, said he believes the current turmoil in financial markets is more an emotional reaction to yet another period of excess rather than a true credit collapse.

Zell said markets currently are spooked by problems with U.S. subprime lending. However, they still have capital to deploy, unlike during other real estate busts when financing could not be arranged at any price.

"We're not really in a quote 'credit crunch.' I think what we are in is a 'confidence crunch,'" said Zell, who funds the Samuel Zell and Robert Lurie Real Estate Center at Wharton. "I would argue the excess liquidity that existed eight weeks ago still exists today. It has a different risk premium on it, but the actual amount of liquidity has not changed."

Zell said the slump should come as no surprise. "Over the last three years, people were flippant. They bought anything they wanted and were proud that they didn't do due diligence. I think they have all been chagrined and are scared out of their minds."

Zell predicted that markets would stabilize soon, although they will become more risk averse and less leveraged than in recent years. Zell added that going forward it would not be possible to replicate the Blackstone deal earlier this year that bought out his Equity Office Properties for $39 billion in the largest leveraged buyout in history.

David Doupe, West Coast managing director for Jones Lang LaSalle’s Capital Markets Group, who has also seen a few real estate cycles, agrees that the market dislocation is likely temporary barring a recession, but will probably blunt the blistering escalation in values of a few months ago in core assets and will probably weaken pricing of value add or development-heavy projects.

“I’ve been in the business 30 years, and I believe there’s going to be a period here of bid-ask spread -- where sellers and buyers are not going to be agreeing on pricing -- but I think that’s going to be fairly short term in duration,” Doupe said. “Our view is the credit crunch will probably go away, meaning there will be available credit within two or three months, four at the outside.

“I’ve been in New York this week meeting investment bankers on this very topic, and the general prognosis is that the debt market will re-price itself and become active again, albeit at a higher cost of capital.”

Brian Catalde, a homebuilder from El Segundo, CA, and president of the National Association of Home Builders, seemed to agree that money is sitting out there just waiting to be invested.

"Builders are expressing concern that home buyers are getting spooked by the many headlines they are seeing on mortgage market issues and their continuing effects on the housing market and home prices," Catalde said. "Indications are that consumers are trying to time the bottom of the market before making their purchase, which historically can be a very tricky thing to do and is typically not an advisable strategy. The bottom line is, with the inventory situation what it is and the selection of units and deals to be had, now is a very good time to buy a home."

Clearly, though, NAHB members aren't confident about homebuyers buying into that message about now being a good time to buy.

Concerns about the substantial and growing inventory of new homes for sale and the effects that deepening mortgage market problems are having on buyer demand caused builder confidence to decline for a seventh consecutive month in September, according to the NAHB/Wells Fargo Housing Market Index, released this week. The index dropped two points to 20, tying its record low reached in January of 1991.

Builder confidence in the current rental apartment and condo market also dipped amid concerns that an excess supply in the for-sale market is creating a shadow inventory of available rentals, according to NAHB.

Housing starts fell 2.6 percent in August to a seasonally adjusted annual rate of 1.331 million units as the downswing in the housing market continued, according to figures released this week by the Commerce Department. Starts were down 19.1 percent from a year earlier, falling to the lowest level in 12 years.

(Incidentally, the National Association of Realtors last December had forecast 1.51 million housing starts this year, down from 1.81 million in 2006).

"We believe that the Federal Reserve Board made the right move [last week] in lowering the interest rate," said Pat V. Combs, president of the NAR and vice president of Coldwell Banker-AJS-Schmidt in Grand Rapids, MI. "Making borrowing more affordable will make money more available and this could go a long way in helping turn around the sluggish housing market."

"The housing market has been correcting itself and restoring affordability. With interest rates on many conventional loans still at near historic lows and today's rate cut possibly making loans even more affordable, we believe the housing market will begin to recover over the coming year," Combs said.

NAR senior economist, Lawrence Yun, seem to suggest, however, that the credit crunch is real.

"The unusual disruptions in the mortgage market, including a significant rise in jumbo loan rates, resulted in a fairly high number of postponed or cancelled sales, with many buyers having to search for other financing when loan commitments fell through," Yun said. "Lower sales contributed to a buildup of unsold inventory."

Yun expects similar results for home sales in September.

"Once we get through these disruptions, we'll get a better sense of where the actual market is in late fall as conditions begin to normalize," he said.

Combs said, though, that the good news is that the mortgage picture is improving.

"Mortgage interest rates have been declining and loan availability is improving," she said. "Movements to enhance the FHA loan program and to raise the limits for conventional financing could provide additional relief, and it looks like the worse of the mortgage availability problem is behind us. The abundant choice of homes is permitting buyers to better negotiate price and terms. There are good opportunities in the market now, especially for first-time buyers."

The latest home price numbers show that those opportunities might be even better if buyers wait, since house prices are continuing to fall, according to data through July released this week by Standard & Poor's for its S&P/Case-Shiller Home Price Indices.

"The decline in home prices clearly continued into the summer months," says Robert J. Shiller, chief economist at MacroMarkets LLC. "The year-over-year decline reported for the 10-city composite is the lowest since July 1991. The lowest annual decline in this index, which dates back to January 1987, was -6.3%, which was reported in April 1991. The further deceleration in prices is still apparent across the majority of regions, with 16 of the 20 metro areas showing a drop in their annual growth rate from what was reported in June."

While five of the metro areas - Atlanta, Charlotte, Dallas, Portland and Seattle - are still registering positive annual returns, all five have shown deceleration in their rates of growth during the past year. Both Atlanta and Dallas are getting closer to joining 15 other metro areas in registering a year-over-year decline in home prices.

The latest numbers from homebuilders aren't encouraging. Lennar Corp posted a record quarterly loss this week weighed down by charges and write-offs in a deteriorating housing market, and said it will cut more jobs in the fourth quarter.

Lennar posted a third-quarter loss of $513.9 million. Revenue fell 44 percent to $2.34 billion. New orders fell 48 percent.

The Federal Reserve Board this week gave indications that their work in giving a boost to the economy may not be done.

Speaking for the first time since the Fed cut its benchmark federal funds rate last week Charles Plosser, president of the Federal Reserve Bank of Philadelphia President said the central bank already anticipates weaker economic growth in coming months.

"It is important to understand that the economy is expected to grow more slowly in coming months, despite last week's decision to reduce rates," Plosser said. "Therefore, I will not be surprised to see weaker statistics making headlines."

Written by Mark Heschmeyer

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