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Timothy Myers: Let the good times roll again!

Posted: May 4, 2013 2:00 a.m.
Updated: May 4, 2013 2:00 a.m.
 

One of my coworkers during my time working for Ernst & Young found himself working for KB Homes during the middle of the residential real estate boom, putting together the analyses or so-called "land packages" for the acquisition of property for the building of tract homes.

This amounted to a painstaking and complex process where the analysts would take the price of the land, gross it up for the estimated costs of grading, infrastructure and fees, factor in the costs of tract building based on design, and then add in KB’s desired profit margin to come up with a price for the eventual sale of the proposed homes.

The company hit some type of internal crisis in late 2003. Based upon its cost estimates, the analysts found that no family earning the mean income in Los Angeles County could afford one of their homes.

In other words, such an average family did not earn enough to qualify for a standard mortgage to acquire the home, let alone meeting the principal, interest, tax and insurance payments to stay in possession.

So how did KB keep selling homes, in fact hitting a sales record in the first quarter of 2006? Everyone lucid knows the answer.

Investors, hungry for yield in an era of what seemed extremely low interest rates, gobbled up subprime, Alt A and other exotic mortgage products, putting families in homes they could not possibly afford when teaser interest rates reset, and leaving them with little choice when the values of these homes would not support conventional mortgages after the coming bust.

Add to this rampant speculation the scale of which no one probably captured and the nation cooked up a ticking time bomb. My favorite anecdote relates to a coworker who learned that the lady he hired from time to time to deep clean his second home in Palm Desert once personally owned (and lost) five residences in that area.

The subsequent bust and the required de-leveraging caused the Great Recession that began in 2007, and "ended" about two years later.

Since then, however, the U.S. economy clunked along the bottom with very low growth rates, not unexpected in a recession caused by a financial crisis.

Economists and analysts looked for some signs of life in the housing industry to find the bottom point and perhaps the corner that the economy could finally turn.

Have we turned the proverbial corner? Recent headlines in the Mighty Signal quote real estate industry folks absolutely giddy and nearly giggly with the state of the market in Santa Clarita, with a dearth of homes available for sale and (again anecdotal) tales of hungry buyers consulting with real estate agents so that homes have multiple offers the minute they hit the MLS.

Can we uncork the champagne? Probably not, but we could safely switch from Pabst Blue Ribbon to a nice craft beer like Samuel Adams. Again, one can find the answer in the pages of the Mighty Signal.

In about 2005 a community columnist/financial planner wrote that houses cost too much in the area, and, indeed, the nation. He based this on something called the "rental equilibrium" rule, explained thusly:

Like KB homes, an investor will pay a certain price for a residence if they can expect to collect rental income that covers the cost of carrying that home and allows a reasonable profit.

Once the price of homes exceeds this equilibrium, the reasonable people abandon the market, leaving only those driven by emotion, speculation, and hopes for increased values.

Santa Clarita, the state of California and pretty much the entire nation completely outstripped the rental equilibrium in 2005; the writer correctly calling the tipping point.

When did rents return to equilibrium? Actually, based on statistics compiled by the Economist, the U.S. actually found rents well above the cost to carry a residence some time in mid-2009, but problems with de-leveraging and bank liquidity prevented folks perfectly able to purchase and carry a home based upon the rents they paid from buying.

So perhaps the recent signs of life show that people can finally make a rational economic decision buying rather than renting, and if one can maintain prices within a certain range more sustainable factors can drive the housing market forward, like people moving from rental to home ownership and younger people forming their own households, something also delayed by the Great Recession.

After five long years of suffering, anything would seem like a boom!

Timothy Myers is a Valencia resident. "Myers’ Musings" publishes Saturdays in The Signal.

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