Guest Post: Inconvenient Observations on Residential Real Estate: US & Mexico
Jim Karger, Dollar Vigilante
Beaten-down US residential real estate markets, such as Las Vegas and Phoenix, have seen sharp rebounds in home values this year, mostly due to a diminishing number of foreclosed homes entering the market. On the surface, that appears to be good news. Unfortunately, it is not the result of fewer homes in foreclosure, but rather, banks intentionally not foreclosing on homes already in default. Indeed, by some estimates as many as 4 million homes currently in default (some for as many as 3 years) have not been put into the foreclosure pipeline, resulting in a massive shadow inventory north of the US-Mexico border.
Charles Hugh Smith observes: “This is a risky game the banks are playing, as this visibly artificial restriction of inventory undermines the belief that this recent surge in home valuations is legitimate, i.e. a balancing of actual supply and demand. Squeezing inventory does not magically enlarge the pool of qualified homebuyers; it ‘games the system’ so those buyers are paying more for the homes that they would otherwise be worth if the market weren’t being manipulated. This helps banks by raising the prices they’re getting for the few foreclosed properties that reach the market, but it certainly doesn’t help buyers.”
It seems the banks’ strategy is to manipulate prices higher by keeping inventory off the market, believing the gains on homes sold will exceed the losses incurred on their non-performing loans. Longer-term, the banks hope that their manipulation of prices will result in a change in buyer psychology, causing would-be buyers to believe a bottom is in, increase sales and then release the shadow inventory at higher prices while mortgage rates are at all time lows.
Smith opines, and I agree, that the banks’ plan is ill-conceived, to wit, they “cannot fix an unhealthy, dysfunctional system by hiding reality behind an artificial reality facade. All you’re doing is increasing the instability of the system, which is not allowed to self-correct.”
Watching the US market, I am reminded of the technical differences, but substantive similarities, to certain real estate markets in Mexico that are supported in large part by Americans and Canadians who either have relocated to Mexico or have second homes here.
Because leverage was never an issue in the Mexican housing boom, there is little “shadow inventory” held by banks or any other lenders for that matter, and thus no artificial lender restriction of inventory.
But, because most homes in Mexico are purchased for cash, there are no carrying costs in the form of principal or interest payments, and because taxes and maintenance are comparatively low, many owners who want to sell elect not to sell if only because there is little cost associated with holding the property. Still, other properties on the market are de facto off the market based on their pricing. Indeed, in Mexico it is common to put homes on the market for prices far in excess of a price at which they will sell. Like banks north of the border, some owners in Mexico want to wait out the market and eventually sell for what they paid during the boom that occurred between 2003 and 2008.
What has resulted is an inventory imbalance that continues to grow as more sellers put their properties on the market at prices for which they will not sell. Going forward, without reductions in price that act to balance supply and demand, the inventory will continue to stack up like so much cordwood.
Just as banks in the US are able to hold inventory due to their ability to borrow from the Fed for virtually nothing, many sellers in Mexico continue to price their properties far in excess of the current market for the same reason — they can. Both are hoping for higher prices, and while some debate whether the expatriate housing market in Mexico will improve, there is little evidence that it will do so in the near term.
Exacerbating the expanding supply problem is diminishing demand caused by the negative press in the US and Canada associated with the drug wars and, ironically, due to the inability of many Americans to sell their properties in the US, oftentimes a prerequisite to moving to and buying in Mexico.
From discussions with some agents in Mexico, the higher end of the market is the weakest. One agent suggested that might have to do with perceived security problems, to wit, the rich can afford to live anywhere and do not need to live where they believe there is a risk of violence or kidnapping. Another agent suggested it might be the result of many Americans’ losses in the last stock market meltdown. Or, it may be that the last high end real estate boom in Mexico was in large part financed by the US bubble, i.e., buyers took equity out of their US homes to buy here, an opportunity that no longer exists.
On both sides of the border, market pressures are mounting. Prices above market are caused in the US by banks that hold properties out of the foreclosure pipeline, and in Mexico by sellers holding their properties off the market or maintaining unrealistic asking prices. Both act as dangerous restrictions on the markets’ ability to reduce inventories and find a bottom. If history proves valuable, both markets will eventually break down as the effort to maintain a false normalcy fails and the self-correction manifests itself acutely as the banks there and the sellers here finally capitulate.
For those looking to bottom-feed, there are increasing numbers of capitulation sales in several Mexican markets which sometimes indicates a bottom is near.
So, what does “capitulation” mean? I define it as an acute, oftentimes precipitous, drop in asking price to market value. In San Miguel de Allende, I have seen houses originally listed for over a million dollars on the market for years finally capitulate (and sell) at $600,000 U.S., even less. Those kind of dramatic drops have been seen in every Mexican real estate market where there is a large presence of Americans and Canadians. My brother owns property in a country club community on the water near Playa del Carmen. The inventory there is stacking up and he knows of several capitulation sales.
In lower-priced homes, there seems to be less inclination of sellers to price their homes wildly above market. But even in homes priced less than $200,000 US, I have seen situations where owners, after having their home on the market for years, have thrown up their hands and taken 30%+ haircuts. I have a beachfront lot near Zijuataneo that I bought five years ago from a distressed developer. I paid 50% of what he was selling the same lots for 3 years before I bought. Today, I would have to discount 50% from what I paid for it to sell it. So, I won’t. Yet. Why? I am not ready to capitulate. Under different financial circumstances, I might.
What all this does not mean is that every home on the market in Mexico is overpriced. They are not. Some friends of ours who decided to downsize put their home on the market in San Miguel at $899,000 US and sold it two weeks later for $849,000 US. Why? They priced it to sell, not to sit. They priced it where other homes of that caliber recently sold, not at a price in hopes a sucker would come along. What sellers are finding at all levels of the market is that there are not many suckers left. Rather, there are shoppers, many of whom have had to take their own baths on properties that declined in value from the time they bought until the time they sold. They are hip to the game and having been burned, they are reticent to bid near ask.
The key to success is straightforward: What the seller paid and what the seller wants are irrelevant numbers. The only relevant number is the current market value today. That requires work to discover, especially in Mexico where amounts paid and amounts recorded on deeds often differ dramatically. Unfortunately, some real estate agents don’t want to work hard or want an easy sale. Finding the right agent is difficult, but it pays dividends. In the end, it is up to the buyer to take responsibility and find those in the know inside the market of their choice, to ask questions, to see a lot of homes, make a lot of notes, to hire a lawyer they can trust who closes a lot of real estate, to auger down to the real market value of the home they want to buy. Then, and only then, are they ready to negotiate.