Over the past two weeks 51 San Francisco apartment buildings which had been acquired by the Lembi Group were deeded back to the bank in lieu of foreclosure. The bundle of 1,500 apartments had been losing $3 million a month.
∙ Lembi gives 51 buildings back to UBS [Business Times]
Amateur, johnny-come-lately landlords might want to reexamine their assumptions when the pros start walking away from their buildings.
That’s only a 2k/property/month loss. Many on this site would call that an outstanding opportunity.
An outstanding opportunity.
Just kidding, it’s a joke bro!
From the article:
“The portfolio the Lembi Group gave back included about 1,500 apartments, most of which are located in Lower Pacific Heights, Nob Hill, Russian Hill, the Marina, the Tenderloin and the Western Addition.”
Sounds like there are more than a few primo SF apartments in there.
“The two-year short-term loan on the properties, valued at between $300 and $400 million, matured in September. Lembi said the buildings were losing $3 million a month. He said the deal with UBS released $400 million in personal guarantees.”
Sounds like even $200-266K per apartment is not a low enough price to attract investors. I know that rent controls are a big issue. But still.
diemos… it’s 1500 units, not properties. So that’s a $2,000/unit/month loss. That’s some serious damage! That’s what you get when you throw underwriting out the window when financing commercial properties. But for normal folks apartment buildings will continue to be one of the strongest commercial assets in the Bay Area. I mean where are all the bears going to sleep?
As has been oft-noted, the only way most (all?) SF RE investment purchases have penciled out over the last several years is if one builds in generous assumptions regarding future appreciation and/or rent increases. Looks like both of these trends are now negative. Just because it requires $6000/mo in rent to break even doesn’t mean any tenant is going to pay that. I expect we’re going to see lots of walk-aways like this from the many involuntary landlords around town who planned to flip but decided to rent for a while until the market turned back around (going to be a long wait).
I’m most curious about why UBS would release $400 million in personal guarantees. Either it decided the guarantees are worthless (i.e. the Lembis don’t have it) or it extracted some other value in the deal in exchange for the release.
If they’re losing $2k/unit per month, how much is expected rent? That seems like an insanely high average renting price. Even with those neighborhoods I wouldn’t buy anything with an average expected rent of anything over $1500/unit per month. Deflation, look it up.
“I’m most curious about why UBS would release $400 million in personal guarantees.”
Maybe the personal guarantee has been replaced by the taxpayer guarantee? Maybe Lembi has some pull with Pelosi? Didn’t a tax cheat just get nominated to be Treasury Sec, and doesn’t UBS have some large issues relating to its own wealth management tax fraud issues (would Geithner be overseeing the IRS – well, yes, I think he will!)? All questions IMO that are very pertinent in the banana republic we are becoming.
“If they’re losing $2k/unit per month, how much is expected rent?”
They were presumably expecting capital gains that are no longer materializing. ‘Real estate only goes up’, remember, especially in ‘Real SF’.
the lembis have been around in this biz for 3 generations and i would not count them out but wow, that’s a big hit!
this should loosen up the multi-unit market big time as the lembis were among the biggest fish in the pond.
if/when ubs starts to liquidate i bet we’ll see some deals.
Trip.. remember, with rent control, even if market rents are declining, it doesn’t mean you’re monthly income will decline. Most units are not at market rent anyway. So maybe the “potential” declines a bit but the actual can improve if you’re lucky enough to have one of those old tenants move out. And most apartment financing has some fairly conservative underwriting which results in 50% to 60% LTV off of the actual income at funding so that being said, I’d be pretty surprised to see bank owned apartment buildings in SF. East Oakland? Yes. Stockton? Yes. SF? Nope. We’ll except for Lembi’s 51 buildings that is. But he’s a special case. Like I said, no underwriting = big mess.
Oh jeeze, I said rent control back there didn’t I? Hopefully this doesn’t degenerate into another one of those drawn out arguments for/against rent control.
Maybe the personal guarantee has been replaced by the taxpayer guarantee?
As if lies from property salesmen and ego-stricken owners were not enough, now we get flooded with lies about the downturn. Loans are coming apart, banks are going away never to return, but we are supposed to pretend the government money is going to this stuff. There is no evidence for government involvement in this deal at all, only an agenda.
This is coming from the same naive political camp who thought blowing three trillion plus in Iraq would make it just like Europe after the last world war and wouldn’t have much impact on us. This analysis isn’t just completely, utterly, and totally wrong, it is purposefully crafted deception from idealogues. Not only are such assertions junk, they are crafted to distract. We have known since Nixon that guns and butter is a bad recipe, but we had to go and try it again. No government money went into this deal, and Nancy Pelosi was not involved.
This kind of deceipt is at the same moral level as the mayhem from kids who tipped over garbage cans and broke shopkeeper windows in Oakland in protests recently. There is no real information, understanding, respect, or desire for an improved future. It is all about lashing out at imagined enemies and ignoring the cries of folks near you who get damaged instead.
This bubble took a long time to get as big as it did, and conservatives cheered securities deregulation and hedge fund liberation and all the rest of it until the game finally fell apart. The only way to avoid paying for a bailout is to avoid a massive bubble in the first place. Once the economy is thrown into chaos then all bets are off and the chips on the table are all lost.
“the lembis have been around in this biz for 3 generations and i would not count them out but wow, that’s a big hit!”
It is quite common to see a huge swing in the fortunes of a family over 3-generations.
Generation 1 – The Entrepreneur makes a fortune
Generation 2 – Enjoys benefits of said fortune
Generation 3 – Squanders what is left
well said Mole Man!!
you are right rillion. but the lembis still have 3 generations involved in the day to day operations.
SF Apartment values have been skewed for the past 5+ years by the Lembi’s buying splurge. How else did cap rates of 5, 4 or 3% become “normal” When comps are based on their inflated purchase prices, everyone’s values get out of what. These guys bought multiple buildings at a time in the city, transactions of 20-25 million a pop for 5 or more buildings. Agent’s at M&M made their fortunes from Lembi money – and now the gravy train has stopped.
SF Apartment building needed a correction – now its time for some shopping.
I heart moleman
UBS now getting into the landlording business?
My best guess is that they’ll try and unload them eventually either as TICs or whole building.
This could great news for serious and reasonable prospective landlord flabbergasted by the insane price points of these past 5 years.
I for one will be happy to snatch one or 2 of these buildings when they come on fire sale. But they have to comply to rule #1: be cash-flow positive from day 1 with a less than 10-year mortgage and 50% down. Otherwise it’s dead money.
Not so fast, SFS.
You may want to decide how many OTHER purchasers lost their heads and bought in competition with the Lembis, and ask yourself how soon those OTHER buyers will ALSO throw in the towel and hand the properties back to the banks.
This could merely be the start of an unraveling asset bubble in SF apartments. I wouldn’t want to buy in to that too soon.
I’m not saying there won’t be deals to be had, but you may find the better deals can be had down the line when the amateurs bow out.
tipster,
I agree with you 100%. This will take several year to unwind, just like what I saw in the mid-90s in Paris with banks unloading their unprofitable REIT protfolios on the fools. Once the sales were done, there no buyers left and the market was crashing some more.
But I am patient. I can wait for the good deals.
If the Park Lane is included in the package, that’s about as “real” as it gets in San Francisco.
http://www.parklanesf.com/
The story I heard is that a bidding war broke out when the property sold in 2005, resulting in a much higher-than-anticipated price, due to Walter Lembi’s desire to occupy the penthouse apartment.
The 33 unit building last sold for $38 million.
Tipster, fair point re waiting. But remember rates are very low right now – I just refi’ed at 4.875% 30 year P&I. So waiting may not be advantageous.
SFS, I don’t think 50% down will be needed for alot of properties to make them cash flow +ve at these rates – I know my 2unit is now strongly cash flow positive, and I don;’t have as much as 50% equity in the place.
I have been waiting for this to happen with CitiApartments for some time and it’s finally starting. CitiApartments seems to charge more than the market rate on its units. I don’t take pleasure in seeing a company fail, but I would take pleasure in seeing SF rents return to a more reasonable level.
I don’t see how these numbers can be the full story. Losing 3M/month (36M/yr) on a value of 300-400M is 9-12% p.a. Even with a 3% cap rate on the incoming rents, that implies 12-15% carrying costs. I can’t see that with current interest rates. Even if all the buildings were standing empty, it’s still a stretch to see 9-12% carrying costs. Am I missing something, or is the article not giving the full story?
That said, what’s the speculation as to how this unwinds? I’m guessing the bank wants to unload the buildings, not get into the landlord business.
You will not find rates on commercial apartment buildings with 5+ units under 5%. No way, no how, probably never again. Last time was in 2003. You guys up there are thinking residential. It’s a different game with commercial. Rates at most shops still lending on apartments are in the 6% to 6.5% range for fixed rate money. Some short term 3 year stuff might go as low as 5.5% but that’s it. ARMs are under 4.5% but I can’t recommend taking an ARM considering the inflation that must come in our future.
The Lembis were allowed leverage that no ordinary borrower would ever get because the banks that funded them were STUPID! The majority of owners had to show actual cash flow to support the loan at time of funding. Some small shops may have underwrote off of “potential” rents but not many.
You’re not going to see a rash of bank owned deals in SF. I work for the largest apartment lender in the country (well… used to be) and they only REO’s we have are in the East Coast, Florida mainly, with the exception of some pieces of crap in Oakland and Stockton. 2009 will be worse that 08 but it will be in subprime areas.
Think of the rent declines after after the dot bomb in the Bay Area. How many bank owned did you find there? Few. Our Bay Area portfolio didn’t even go delinquent. Apartments in this market are solid. Unemployment will bring rents down but when you’re still trying to bring your tenants up to market rents because of rent control, as in SF, lower asking rents won’t hurt your cash flow. Not to mention if you’ve got an ARM you’re got low rates right now anyhow and should for a year or two.
Values will come down bringing cap rates up and down payments will get smaller but I doubt much better than 40% in SF. But for people not selling, who cares? They bought the buildings with rates similar to today’s market and I doubt they’re monthly income is decreasing at all so they’re fine.
Who knows what sort of analysis the Lembis and their lender did but it was faulty in a big way.
The monopoly they have on SF rentals is incredible. I agree with anon1. I don’t like seeing any business fall, but hopefully some of these units will return to market rate, and not the premium that Citi seems to charge.
Boo,
Finally someone that knows what they are talking about.
CAP Rates Folow the Bond Market. This is a very easy concept.
More risk requires more return. If the cap is less than simple interest, who would make that investment on an income property or any investment?
Boo, you have restored my faith in Socketsite.
Thank you.
Paul, two responses:
“CAP Rates Folow the Bond Market. This is a very easy concept.” WTF?
“If the cap is less than simple interest, who would make that investment on an income property or any investment?” The Lembis. And I suspect many others in San Francisco who were counting on the “guaranteed” appreciation.
I agree with Paul, we got the best posting from Boo. The Lembi deals were funny money stuff and no one knew how they were financing their voracious hunger.
I know, I was outbid by them. They paid an ungodly price for some apartments I would have paid a ridiculous price for.
There but for the grace of God…
REPornAddict,
The 50% down are MY method for building fast equity using rents. I always combine it with short term debt. I used to borrow over 4 or 5 years in the 90s in Paris, but the price point of my purchases allowed for it. 10 years will be a big step for me. I have never known where I’d be in 10 years. A lot of people that bought in 2005-2007 know exactly where they’ll be in 10 years: in their houses because they’re stuck!
A 30-year mortgage has always been a horrible way to build equity when discounting for appreciation. Common wisdom always assumes 20% down and a 30-year mortgage are the way to go. But common wisdom told us that RE always goes up and that a 60-Year old should be 60% in stocks. How’s that working for older folks these days?
What I am getting at is that a 30-year mortgage is a rip off, imho. With a 6% interest rate it will take you 10 years to reimburse around 10% of your capital. Whether you work in construction, teaching, sales or engineering, you’ll be working 30 to 50% of the next 30 years for your bank…
My advice: paying interest is bad. Make your mortgages as short as possible if/when prices will allow it. Just not right now.
anon,
If you have simple interest from a bank at 3% and an investment at 3%, who is going to take the investment?
If in the above example, simple interest goes to 10%. CAP rates must follow, because no one is going to buy the investment at 3% CAP. CAP rates must go up.
The only thing that matters in income property is the income, lease and strength of tenant.
This is a very simple concept, if you cannot follow it you should not be investing.
“for normal folks apartment buildings will continue to be one of the strongest commercial assets in the Bay Area. I mean where are all the bears going to sleep?”
LOL!
Paul,
I agree with your last post. Which is why I think RE has to go down. Incomes are just way too small to justify high RE prices. And you cannot say that the sales market iis disconnected from the rental market. If rental properties were selling for a lower price than residential ones to bring rentals to profitability you’d hear a giant sucking sound from the hordes hunting for residential moving into units previously designed to be rentals, removing the demand for residential.
All markets are connected. Rents are poised to go down throwing RE prices into an ever deeper vicious circle.
where are all the bears going to sleep
They’re already sleeping in rent controlled apartments, thank you. And they’re paying cheap rent because their landlords have minuscule property taxes thanks to Prop 13.
And some of them are also landlords, by the way.
This is actually good news for apartment owners in the city. UBS isnt going to dump these properties on the market. They will be sold privately (if and when they are) and as a portfolio. They may sell some buildings individually, but most likely in chunks. This will keep the market and pricing for the city stable.
SFS,
“What I am getting at is that a 30-year mortgage is a rip off, imho. With a 6% interest rate it will take you 10 years to reimburse around 10% of your capital. Whether you work in construction, teaching, sales or engineering, you’ll be working 30 to 50% of the next 30 years for your bank…:
I kind of see what you are getting at.
But, you do have the option to pay more capital if you like – whereas a 10 year I/o you could have paid off 0% after 10 years.
Plus, wityh wage inflation, and fixed mortgage outgoings, I doubt that the mortgage will still
be 30-50% of pay in 20 or 30 years.
What I am getting at is that a 30-year mortgage is a rip off, imho. … you’ll be working 30 to 50% of the next 30 years for your bank…
I’m not sure that’s true, if you assume inflation. At 3% inflation, the real value of your mortgage payment will have fallen by 35% once you’re halfway through a 30-year mortgage. The delta between current mortgage interest rates and my expectation of future inflation rates is rather modest.
Snap, what REpornaddict said. I’m a slow poster…
Nothing to see here. Clearly, the Lembis just paid too much. 😉
Boo wrote:
> The Lembis were allowed leverage that no ordinary borrower
> would ever get because the banks that funded them were
> STUPID!
It was the Lembi’s who were STUPID (I would not call the UBS guy that originated the loan probably personally made about $2mm on the deal STUPID)…
> The majority of owners had to show actual cash flow to support
> the loan at time of funding. Some small shops may have
> underwrote off of “potential” rents but not many.
The majority of loans used real income and make believe super low expenses to get most lenders to “think” they had cash flow, but not many SF apartment loans since 1999 had any cash flow…
> You’re not going to see a rash of bank owned deals in SF.
Once it looks like massive appreaciation is a long way off you will have a lot of property given back to the lenders.
> I work for the largest apartment lender in the country
> (well… used to be)
Sounds like a WaMu guy…
> Think of the rent declines after the dot bomb in the
> Bay Area. How many bank owned did you find there?
Almost none since Greenspan lowered rates and cash came out of stocks and in to highly leveraged real estate causing prices to rise dramatically (you don’t have many REOs when values are going up 20% a year).
> Apartments in this market are solid.
My family has owned Bay Area apartments since the 60’s and stopped buying in the late 90’s when real cap rates (not the fake cap rates the lenders believe) got too low. Real expenses keep going up and cutting in to cash flow.
> Who knows what sort of analysis the Lembis and their lender
> did but it was faulty in a big way.
Old Man Frank is the one that made the family money and he is rock solid (if he is still alive). Frank’s son Walt is an idiot and almost lost all his Dad’s money when he ran Continental Savings in to the ground (it was taken over by the OTS). I last saw Frank around 2002 and he was really slowing down (He started Skyline Realty after he got back from WWII). I heard that it was Walt’s grandkids that went on the big buying binge (with Walt’s help) since they all thought that “real estate always goes up” and none of them could underwrite their way out of a paper bag or have any clue what it really costs to renovate an apartment unit…
Does anyone know if the city of San Francisco is still pursuing the lawsuit that they filed against CitiApartments in 2006?
funny money loans, yes.
but “and none of them could underwrite their way out of a paper bag or have any clue what it really costs to renovate an apartment unit…”
don’t believe it.
California has stopped being interseting as a multifamily investment for a long long time.
When the multifamily guys started going,”But Paul, look at the replacement costs. I know the CAP seems wrong, but its an excellent conversion candidate, see look how it pencils out when you convert it.” I could not believe anyone would buy into it.
San Francisco has looked particularily unattractive because it has been so pro-renter.
On a side note, I agree rents mirror residential prices. They have to in the Bay Area, because they are representative of jobs and population and housing is limited.
The thing I wonder about real estate in the bay area is that if the Fed is forced into a period of high inflation (this may be the only way out of our very serious economic condition; the other scenario unfortunately would be deflation I think), shouldn’t prices follow suit?
shouldn’t prices follow suit?
No, Paul. The inflation rates that would be necessary to “inflate away” the debt problem would destroy the capital markets (even worse than they are destroyed already 🙂 ) along with the value of highly leveraged assets like houses.
Deflation for a while, in which the nominal and real values of houses go down. And then after enough debt has been destroyed/defaulted/shifted onto the taxpayer, inflation will kick in and houses will go down nominally a little bit more (due to rising rates), and then down in real terms a whole lot more. (But that will be ok so long as you are repaying the debt with fixed rate mortgages that approximate your rental equivalent cost anyway.) That’s my bet fwiw.
OT – you’re getting your chance to pick up oil a whole lot cheaper here than when we last “talked” about it on SS!
i was half expecting somehting like this to happen to the lembis. a few months back i noticed that many of citiapartment rental ads were offering to give renters an 8% discount on rent if they paid 6 mo’s of rent in advance. clearly they would only offer this antic if they were hurting for cashflow.
like others, i am waiting to see what, if any, impact this will have on apt bldgs prices in the city. a lot of sf landlords have stabilized bldgs. only those who brought too many of the over priced stuff in the last 3-4 years are at real risk.
it’s too speculative to say if USB (lembi bank) will dump those 51 bldgs or sell them as a package deal. but the fact they were willing to take the bldgs in the first place, as opposed to just foreclosing, speaks to the desireability of SF apt bldgs- they knew they could sell them, etc. just ask USB if they would have done the same for multiunits in fresno, phoenix, san jose. no way jose.
in my opinion, the primary drivers affecting future SF apt bldgs values will be: 1- how bad will unemployment hit SF/bay area and it’s effects on SF rents. and how long will this last. 2- how quick/how bad will the future inflation hit be? if apt bldg mortgages hit 8-9%, all bets are off.
the next couple of years will be really interesting for sorting out these questions. personally, i am still mostly interested in bldgs that have some significant improvements/upside to them. you have to be able to turn over a certain % of RC units, or else it’s a pretty futile proposition. but as for the question if SF apt buildings are going to go back to 1990’s pricing, i.e. $100-150k/unit, i’d say the jury is still out.
I’m getting ready to buy oil (as soon as the world ends (S&P 500-550?).
Oil is getting very attractive to me right now (5% in). I really don’t know too much about oil, but I know a little about market effects on value versus the actual value of a asset/comapny.
Reagrading “inflating away”, I may agree with you on a national / global sense, but (I know this sounds stupid) the Bay Area economy is unique, and different micro markets are going to behave differently.
The part of the bailout that pisses me off is that the government should require the banks to lend money to those industries that the United States has an advantage over the rest of the world (probably going to happen in the Bay Area), instead of just hording the money.
“but (I know this sounds stupid) the Bay Area economy is unique,”
Paul, what is strange to me is if you visit some other sites similar to this that look at real estate in other cities (Chicago, Seattle, the Westside of Los Angeles, even Manhattan), I have noticed that realtors ALL argue with bears that their area and economy are different.
“the Bay Area economy is unique”
Yup. The bay area economy is a unique and precious snowflake … just like everywhere else.
“Old Man Frank is the one that made the family money and he is rock solid (if he is still alive). Frank’s son Walt is an idiot and almost lost all his Dad’s money when he ran Continental Savings in to the ground (it was taken over by the OTS). I last saw Frank around 2002 and he was really slowing down (He started Skyline Realty after he got back from WWII). I heard that it was Walt’s grandkids that went on the big buying binge (with Walt’s help) since they all thought that “real estate always goes up” and none of them could underwrite their way out of a paper bag or have any clue what it really costs to renovate an apartment unit…”
I used to work for the Lembis in an executive capacity. I will not respond to speculation about their business plan, $, investment decisions, etc.
However, I do want to clear up that the third generation of Lembis (actually, only one is named “Lembi”) were not involved in the decision to buy all of these buildings. It was Walt, with Frank’s agreement. The third generation is in their 20s and out of college for only a few years. They have important operational responsibilities (i.e. operating the buildings on a day-to-day basis and marketing), but were not involved in the decision to purchase and are good (amazingly humble and unspoiled considering their families) kids. BTW, I am assuming that by “Walt’s grandkids”, you meant Frank’s grandkids–Walt has no grandkids.
PresidioHtsRenter, your statement made against the third generation is HIGHLY irresponsible and unfair to them. If you don’t even know whether Frank is alive (he is), how the hell can you know inside information regarding who was behind purchasing the properties? While I normally don’t like getting into an internet flaming match, you should consider deleting your post (if you can) in fairness. You are simply wrong.
44yo,
“but as for the question if SF apt buildings are going to go back to 1990’s pricing, i.e. $100-150k/unit, i’d say the jury is still out.”
ok. lets do a test. 4 unit edwardian building in nopa for $600k.
3 unit victorian in the castro for $400k.
sound interesting? anyone? how about a 2 unit victorian in ‘lower pac hgts’ for $390k?
OK, maybe I am wrong, it’s just my belief.
Chicago, Seattle, the Westside of Los Angeles, even Manhattan
And there’s nothing different about those areas, right? No difference at all between those areas, San Diego, Phoenix, Miami, or LA, or [insert area hit very hard by real estate downturn 2 years ago here] ?
There is a difference. The difference is 18 months or more of a competitive real estate market.
Seattle, west side LA, Manhattan, San Francisco and Chicago mortgage brokers were not hip to the same exotic loan packages, right?
Fluj, the post was regarding Paul’s claim that San Francisco had a “unique” economy and therefore might not see the same declines as other urban areas.
Try Cribchatter.com in Chicago to see an almost perfect reflection of some of the dialogue here.
The non-bears posting there even call the prime parts of Chicago “Real Chicago” and also claim that the huge diverse Chicago economy will be immune because it is “unique” , especially when they go on and on about the huge concentration of milllionaires and billionaires living in downtown Chicago highrises. Recently there has been shock expressed by the last die-hard boosters that prime Lincoln Park condos and mansions are now seeing declines, on a very similar timeline to what we are seeing here in the city north of California.
Or try some of the Southern California blogs, where they go on about how Beverly Hills, Malibu, Laguna Beach and Brentwood are unique because everyone in the world wants to live there, plus the non-bears write about how the L.A. economy will be immune because they have such a huge concentration of wealth, the entertainment indurstry, and those mysterious “rich foreign buyers” who will save the “Real L.A.” neighborhoods because they are so “desirable.”
San Francisco is “unique” all right, but not for reasons that will prop up SOMA condo prices. This city survives today because it is close to where the real jobs are 30 miles south of here, and because of a huge tourism industry. San Francisco is no longer “the city” of the West Coast and has not been for 50 years, and can no longer claim to be #1 in trade, port, banking, commerce, entertainment, media, or culture. San Francisco does have the best restaurants and coffee, as well as perhaps the largest provincial urban population in the country that refuses to admit that we are not the “only game in town.”
anon – you’re sure reading a lot into Paul’s comment. I didn’t take it as that at all. He simply said that “micro markets will perform differently”, which is probably true. All of the places you mention ARE unique – some will fall more than others, some will fall less than others. All will fall, but different markets will perform differently over the short term and long term.
Agreed, but I cannot tell you how many people I know who would be shocked that our love of the Bay Area and Northern California is not shared by every visitor and buyer here. I think what I find disgusting is that there has been an accepted “premium” to buy in the Bay Area. I agree it should be more expsensive here than Kansas, and I also agree that micro markets will perform differently, so my question is, should a SOMA shoe box condo have the same psf price as a condo on Russian Hill or Cow Hollow? Absolutely not!
Catching on REpornAddict’s and El-D’s responses.
Yes, inflation usually do the trick of bailing you out of a mortgage payment too big for your income.
But not always. Ask the Japanese how the 90s worked for them. Overall deflation and asset depreciation sucked the life out of the economy/people.
As a rule of thumb in today’s world: information travels faster than anyone thinks it does. Assume everyone reads from the same playbook and do not follow the flock.
1 – The first false assumption from this playbook was that prices would always recover and go higher. Therefore, even if you overbid/overpaid for a place, you’d be OK 2-3 years from now.
2 – The next false assumption to be debunked is that inflation will make your payment smaller 10 years from now. Sure, looking into the past this is what happened to my parents who bought in 1970 and were mortgage to the gills at 40%+ of income. By 1985 their mortgage payment was less than 10% of their incomes through career advancement and inflation.
The problem with playbooks is that everyone acts as if they were the rule of law. When too many people chase the same good idea, it stops being a good idea. What works for a small number of people does not always work when you scale it up to the majority.
What if we were entering a long era of 0% inflation? What if unemployment stayed high enough to put a negative pressure on everyone’s wages? In short, what if today’s situation was here to stay for 5 or 10 years or more. Inflation might not bail you out from a high mortgage.
As the Lembi schemes collapse, funders and LLC investors will realize the extent of the fraudulent and illegal activities they have been supporting. The tenants of Lembi-schemed buildings have been aware of the true nature of the Lembis for years. Think of all the lawsuits, hearings, articles, protests, etc., that have typified tenant response to the Lembis. Now it’s the funders and investors turn to fight in court and in the press. Tenants have always wondered who the hidden owners and investors were who funded the nightmare CitiApartments (mis)managment and tenants will have a good laugh as funders and LLC investors try to recover something from the thieves. Is there any wonder that rent control ordinances in California were defended in June ’08 and landlord harassment protections added to the S.F. Rent Control Ordinance in Nov. ’08? It’s the crooked landlords and owners like the Lembi’s who make all landlords and owners look bad. Reaction to the Lembis has been unequivocally negative and now that the smoke and mirrors phase is over, apologists should stop making excuses. The Lembi model was basically a Ponzi scheme where money from rental operations was used to pay over- inflated prices for new acquisitions in the mistaken belief that the apartment bldg. market would always be rising and that they could illegally force out rent controlled tenants in their newly bought buildings. When these two conditions failed, the Lembi Ponzi crashed. The former Citi employee who posted should feel deep shame and remorse for his aiding the Lembi thieves, not making excuses for them. There is no excuse for them or the persons who supported them.
SFS,
I agree with 1, certainly. Profit from 2 a 2 or 3 year hold is unlikrly, even impossible in the current climate. But then, I didn’t claim that it was.
and although nothing is guaranteed, I think that the odds are very much that inflation will make 30yr P&I payments lower in 10 years. Japan is the oft cited example, but are there any other examples of deflation over a 10 year period?
and yes, unemployment is a risk, but even in a position of zero inflation over 10 years earnings should rise due to career development and the fact that earnings growth outstrips inflation.
so I would be amazed if over 10 years fixed payments grew as a % of income.
so I would be amazed if over 10 years fixed payments grew as a % of income.
Prepare to be amazed. As for other examples of zero (or very low) inflation over a long period, don’t than further than the US, 1929-mid-1940s. Or the US post-Civil War until 1900.
yes, we shall see – and I am open to being amazed.
however the inflation rate hasn’t been negative since 1955, and only twice since 1939.
as for wage inflation, does anyone have a source for historical data of this?
One other point, not sure what the extent of Japan’s deflationary pressure was – did it equate to around a cumulative 5% drop in prices?
not sure where hard data is on this, but I don’t think it was more than 10%, and with inflation positive again this will soon be wiped out.
i guess I am saying its more likely that cumulative inflation will hit 30% (say) first rather than -30%. +/- 5% over a few years isn’t a huge deal either way.
LMRiM,
Post Civil War to 1900 is a particularly interesting period. The Monetary History of the United States spends quite a bit of time on the period but concludes it was a difficult period to understand.
During the period the US industrialized, productivity increased greatly, and living standards increased greatly. The key was persistent deflation combined with income growth. Prices at the end of the period were a fraction of prices at the beginning but income went up, as the productivity increased enough to make up for the lower prices.
There are certainly some parallels with Chinese industrialization and great increases in productivity there – on paper. But I’m a little worried their numbers are all made up which will contribute to the scope and duration of this crash.
Jay,
I definitely agree about China. It’s a mess – how could it be otherwise? Central planning always makes a hash of things, and central planners always lie to cover their tracks and hide their incompetence. Always. Nevertheless, I think that at least a good part of these facts have already been reflected in Chinese equity prices. I think the secular story there (China increasing as a world influence) is still intact, but they need to go through their own depression. FWIW, I am starting to accumulate Asian equities, but very slowly and deliberately – just index exposure for now.
About “deflation”, “inflation”, I would just reiterate my strong belief for anyone who cares that these terms are best thought of in terms of aggregate money supply or credit supply. Changes in these are more likely to be reflected in leveraged asset prices, not the malleable CPI-type stats that are commonly looked at as “inflation” (that’s really “price inflation”). Looked at this way, it’s clear that the US had a tremendous inflation 1982-2007, even though during the entire period price inflation was on a secular decline (disinflation). Japan 1990-present has had basically flat or slightly down cumulative price inflation (CPI-type measures), but stunning deflation (down 60-80% for real estate, down ~75% for their stock markets).
We are set for deflation in the US, regardless of what price inflation does. Asset prices for leveraged assets (like real estate) will decline precipitously (they already are declining), and I doubt that any wage- or price-inflation trajectories will alter that too much. In fact, it’s easy to imagine that mass price inflation (say 10-15% per year for a while) will lead to even greater nominal and real falls for real estate, as interest rates rise and budgets are squeezed mercilessly by rising prices (and taxes) for essentials. Hyperinflation would only help the situation in that debt would be wiped out, although I’m pretty sure TPTB don’s want this.
LMRiM – I was thinking similarly about asian index funds (but including China). I’m sure I’m like many of us here in that I just can’t fathom what’s going on in this country – although I will be celebrating Paulson’s last day on the job tomorrow. Hopefully Bernanke won’t be far behind.
I’m just catching up with SocketSite after a nice holiday break. On the topic of the Lembi’s, I’m in agreement with most of the perjorative comments (which seems to be the vast majority). I don’t know any of them personally, but I do know of a few of their recent (06-07) acquisitions. If Walt is calling the shots (and it appears that he is/was), then PresidoHtsRenter’s characterization of him is accurate. If you consistently (and knowingly) outbid the next highest bidder by 25-30% for a cap rate of 1-2%, then people will tend to call you an idiot. (And the next highest bidder was an idiot too.)
I know we’ll be hearing more about the current sales numbers – but the January MTD sales for MLS are really low (in aggregate). The overall median price for SFH and condos is under $600K at this moment (actually $599.9K for Jan MTD). That’s back at 2003 levels (not considering mix, etc). Mean psf for SFH’s is under $500. Cherry pickers could look at 1 Daniel Burnham Court #609. Nice looking short sale of a 2BD that closed for $560K. It previously sold for $647K in October 2000.
As for Marin, there has been one sale so far this month in Tiburon. 941 Owlswood went for $2.175M after selling for $2.60M in May 2007. (The net sale proceeds should just about cover the $2.0M in mortgages.)
Good to see that you’re still on here, FSBO.
Thanks for the data point on Tiburon. Tiburon is going to be toasted. 50% down on the $2M+ market (which is most of it) by 2011. The $1M crap shacks in the flats might only fall 30% – the schools and demographics of the neighborhood ensure that many will stretch to reach the “lower” (lol) rung of the ladder. Not a single house of the 5 or 6 in our area that have been for sale since we moved here in July has sold. Most can’t seem to take the the losses.
laughing millionaire- i find your constant neg rationalizations on the housing mkt strangly biased, and this notion that we’re going to have, as you refer to it, asset deflation, just off the mark. what makes u think that the cap mkts will not come back, presumably the lynch pin to your asset deflation argument?
and how exactly did the usa have ‘tremendous inflation 82-07’? what we had during that time were 2 key factors: 1- liberalization of credit mkts (especially in the ladder half) and incr in productivity, mainly due to technology. basically money & productivity got alot more efficient, if you will, and the advancement of many 3rd world nations came into the fold as well. this vision that RE is going on a weird, long 10 year slide is wrong, IMO.
and japan is not a good model for the usa- a neg populaiton growth, a closed society that does not innovate (at least not outside it’s quirky, japanesque ways.) china and india ate their lunch (wrt innovation/new industries& svcs), but japan will remain a stable powerhouse, akin to germany.
of course the money supply is not going to grow in the next 2-3 yrs, as we stablize the financial mess that was created, and the ROW (rest of world) stumbles along too. but credit will open up again, and is the cornerstone of capitalism, now a global phenomena.
and, finally, RE will come back again as a desirebale asset class. it’s desireable even now, if you choose the right property/right location/right price, and of course if u can get financing. i have personally chosen to stick w/SF residential. yes it’s expensive/over priced often, but at least the downside is not as harsh as miami condos or vegas track homes. good RE is very flexible, and maleable as an asset, and if you know how to work with it, you can make it in think and thin times. at least that’s been my experiences with SF RE, so much so that all i do now is manage and live of my investments.
44yo hipster,
We all make our bets on the future. Best of luck to you in your chosen path. I’ve stuck with trading markets since my mid-20s, and I’m a bit younger than you. I haven’t worked for anyone in over 10 years (retired after trading professionally for about 6 years). I live off my investments as well. Sounds like we’re both ahead of the game 🙂
44 year old Hipster wrote:
> laughing millionaire- i find your constant neg rationalizations on
> the housing mkt strangly biased, and this notion that we’re going
> to have, as you refer to it, asset deflation, just off the mark. what
> makes u think that the cap mkts will not come back, presumably
> the lynch pin to your asset deflation argument?
I’m a 45 year old who is not very hip but I agree with LRMiM that we will “continue” (not “going to”) to have asset price deflation in real estate. I’m not a bitter renter sitting on the sidelines and I’m looking at a huge paper loss in wealth as I keep increasing the market cap rate on my personal (and family) apartment and rental home portfolio spreadsheet.
We can still have inflation while watching the price of real estate drop for years and years since the bubble drove the prices so far above inflation. In addition to working in the family real estate business I’ve been collecting (and racing) cars since I was in High School and I can tell you that we will also see a few years of deflation in the value of collector cars and we may even see a $1mm 1 br TIC in SF or a $2mm 2 br in Burlingame before a Hemi Cuda sells for over $1mm…
P.S. I am surprised to find out that LRMiM is younger than me and that any 44 year old types without using the shift key (I thought it was only teens)…
Hey guys- yes we all have our specific strategies, bourne from our personal experiences and worldviews. And ultimately, if you are fortunate enough to live off your investments (our case) then you are indeed in a rarefied position in life. (although it will be’interesting’ to see those glib forbes mag #’s on the # of new millionaires globally!). Guess the millionaire next door publishing industry will go on haitus for a few years…
Overall the socketsite form provides for stimulating and sometimes even thought provoking analytics. So kudoes for the thoughtful commemts.
I will continue in my resolve to invest in SF RE. It will certainly be interesting to see if this buyer/seller detente will come to pass and if multiunit bldgs really take a tumble. Cross that with the question of available future credit and interest rates amd we may be for quite a ride, even in the real SF. All i know is that i am watching several key parameters in determining when and if i pull the trigger on another acquisition.
And…thanks for bearing w/my lower caps moniker, although 44yo hipster is an oxymoron if i ever saw one! Cheers.
The multi-unit HAS to take a tumble. Prices today do not make sense for rental investors, as the Lembi debacle has shown.
Same cause, same effects. Overpriced real estate leads to overborrowing which leads to foreclosure which leads to lower prices.
I know this is not a very deep analysis, but this one has worked for me so far…
BTW, I’m pretty close to those ages, though a bit younger. But I am not in early retirement like you guys (yet). I love doing what I do too much plus I need the salary for when I’ll start purchasing bargain basement deals again. Plus do not underestimate the power of the current crisis. I prefer keeping my day job.
Yes the lembis did indeed go out on a limb. Ive met walt and old man frank. They outbid me on a property in 2005. They had wall st money, and they went overboard, and im sure they did not expect this credit freeze.
But my point is, one can speculate all day long on how low prices will get, and for how many years, but im starting to see interesting deals right now. 605 haight st. That property will cashflow with zero down (i.e. If you finance the down payment)- a nice feat in SF. I dont know the specifics of that bldg, but my point is that things are starting to change.
I know some of you guys think the SF market will tumble 50% and remain low for years and years, but i just dont see that happening. Maybe -20% max in real SF, the nadir sometime in late 09 to mid 10. Only time will tell who is right. Peace out.
What’s the old saying?
What comes around goes around.