What's in store for property markets in 2012?

The Florida mayhem of 2006-2008

Before we look forward to 2011 and 2012, let´s look backwards for a few paragraphs. In 2006, the property market in Florida all but collapsed. Investors who were expected to continue their property buying binge left the market en masse. A depressed economy and rising unemployment also ensured that local first time buyer demand took a nose dive.

When this demand dried up, the builders who couldn´t service their loans to the banks had their assets seized. The banks packaged these up and mostly sold them to pension funds, hedge funds, big corporations and high net worth individuals. The banks that couldn´t sell quickly enough became insolvent and were put out of business by big insurance companies and the FDIC. Big insurance companies who insured too many banks with a high property exposure also went bust. From 2006-2008 it was bloody mayhem.  

Things have been somewhat calmer since then. With prices discounted by 60-70%, demand picked up rapidly and the existing housing stock fell dramatically. New foreclosed properties were still coming into the market in significant numbers in 2009 and 2010, but they were very quickly absorbed by the market. The two graphs below for the Orlando housing market illustrate this quite clearly. 

Strategic Defaults

A strategic default is when a person decides to stop repaying their mortgage even when they can afford to continue doing so. Why would somebody do that? You´ll lose your home and your good credit history will be badly damaged.  

If you dig a little deeper, the logic becomes apparent.  

Let me illustrate by way of an example. Mr Smith bought a 3 bed condo in a nice residential area of Orlando in 2006 for $260,000 and he took out a $230,000 mortgage which is costing $1500 per month to service. He has a nice job and has no problem paying $1500 per month.  

However, he knows that half a dozen identical 3 bed condos in his community, which weren´t sold in 2006 have recently been purchased by cash buyers for $99,900 each and they´re renting out for $1000 per month. When you take the interest into account, his mortgage is probably 4 times the size of the current market rates for that property.  So he decides to stop paying his mortgage and instead saves $1500 per month. 

It takes the bank 9 months to get round to kicking him out, during which time he lives rent free. After he gets kicked out, he simply rents one of the identical condos around the corner and pays $1000 per month to his landlord. He won´t get a mortgage or a car loan for 3-7 years, but he doesn´t particularly care as he´s done nothing illegal, he´s free of that huge 20 year debt and he doesn´t mind renting for a while. 

The moral hazard that traditionally prevented people from doing this is disappearing fast. Ten years ago, a person who got kicked out of his house for not paying a mortgage would feel huge shame and embarrassment. His friends and family would pity him and quietly shake their heads at how bad things had turned out in his life. Not anymore. In 2011 an increasing amount of these neighbours will be wondering how they can do it too.  

In the USA, in Ireland, in the UK and lots of other countries, it is becoming socially acceptable to stop paying your mortgage. People will understand and won´t think much worse of you. In the US, they might even admire the way you got yourself out of a huge debt. There are now websites offering casual and professional advice to people that want to default on their loans and declare bankruptcy.  

What are the consequences of these defaulters?

As you might expect, lenders in the USA hate the fact that a person can choose to walk away from their mortgage. There is no law against doing it. These lenders are lobbying HARD to get the rules changed so that people don´t have an incentive to walk away. For example, they´d like it if a strategic defaulter couldn´t get another loan for 20-30 years instead of 3-7 years. That would prevent a lot of them from doing it.  

It´s not easy to prove strategic default though - you´d need to show beyond a reasonable doubt that the person wasn´t suffering financial hardship when they stopped paying their mortgage.  Imagine a bank trying to do that to 5000 customers. Better still, imagine a state court system trying to handle 10 banks doing it to 50,000 customers.

Additionally, nobody knows what percentage of people are defaulting because they´re broke versus people defaulting because they don´t feel like repaying a debt bigger than the value of their home. Come to think of it, there isn´t even an official definition for a strategic defaulter.  

One thing is for certain though. With the previous chaos in the market abating and the supply of distressed stock dwindling (see graphs above), they represent one of the few ways which will continue to generate discounted houses that investors can pounce on. The flip side is that if it becomes too big a problem, I think loop holes will be closed and people will no longer be incentivised to do it.  

Don´t expect the authorities to announce a date for closing these loopholes either - they´ll just do it and tell you afterwards. Otherwise, people would simply rush to default before a deadline. 

So, I think I can safely predict that when banks finally restructure their property portfolios and the levels of foreclosures slow to a manageable trickle, they´ll start lending to normal people again. That´s when property prices in the popular areas will start increasing and that could conceivably happen this year. 

Why Florida? 

Don´t forget - Florida isn´t a giant property bubble like Dubai. A property boom didn´t just appear out of the blue. The real estate market was tipping along quite nicely based on firm fundamentals between 1990 - 2002 prior to the unprecedented buying binge that occurred worldwide from 2003-2006.  

A high quality of life, lots of space, great schools, universities and employment opportunities, a diverse and high tech economy encompassing large multinationals and government agencies of every description,  a world class financial and tourism sector - all these played a part in attracting wave after wave of honest-to-goodness professional workers relocating permanently.  

Guess what? They´re still here. If you know where these people live, work, play and go to university you are well on your way to making a wise investment decision. These are the locations where our target market of middle class professionals rent and buy their first homes.

If you like the idea of purchasing a property that used to cost $200,000 but now sells for $70,000 and rents out at an 8% net yield.

In conclusion, prices aren´t falling anymore in the areas we source property - it is the supply that is falling. The window of opportunity to purchase a) in the best areas and b) at the bottom of the market will probably close sooner than a lot of industry commentators think.

Speaking of which, we´d love to hear YOUR views on the market via our blog, facebook, twitter and linked pages. You´ll find us by clicking on the icons below.

Property Markets - What´s interesting, what´s not

Renewable Energy investments will continue to increase in importance in 2011. I´ve been on a steep learning curve with them this year as they are deceptively complex products that come in a very wide variety of structures. I think solar is best suited to regular €50,000 - €150,000 investors and we´re looking forward to promoting these in the new year.

Wind, hyrdro and biomass are more suitable for high net worth individuals. The low entry level (€20,000) forestry products such as teak, bamboo and agarwood strike me as a fad. I´ve looked into about half a dozen of them, some promoted by companies I respect, and I just don´t like the concept. My gut tells me to stay away.