Investing Caffeine

Tilson on Housing, “The Fat Lady Has Not Sung”

June 11, 2009 at 5:30 am 6 comments

Whitney Tilson, founder and Managing Partner of T2 Partners LLC , was early in identifying the subprime housing collapse, so his thoughts are definitely worth monitoring. His thoughts are consistent with my belief that real estate will continue to suffer the slow water torture decline, whereas the equity market collapse occurred in waterfall fashion with most of the pain behind us.

Click Here for Entire Presentation (Worth the read!)

Although we have absorbed much of the pain in “subprime” mortgage resets, Tilson feels due to a tsunami of Option ARM (Adjustable Rate Mortgage) resets in the Alt-A mortgage market, millions of foreclosures awaiting to be digested in the coming years, coupled with a stagnant economy and an excessive overhang of housing inventory, all factors point towards continued pricing declines in the U.S. housing market through mid 2010.

Here are some worthwhile snapshots from the presentation:

As you can see, on the timeline above we are currently off the screen on the left side, implying we have a good three years of Alt-A resets, whereby homeowners will be forced to pay higher monthly payments as teaser periods expire.  For those not familiar with the Alt-A mortgage market, you can mentally place these mortgages in the middle of the risk spectrum – more risky than bread-and-butter traditional conforming mortgages held by Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB), but less risky than subprime mortgages targeted at those homeowners in the lower-income demographics. From a loans outstanding perspective, Tilson shows the Alt-A market at about 65% larger than the subprime market.

Home prices in California have already shot below trend line but Tilson provides examples in prior market bubbles where prices have declined more than -50% below trend…scary thought.

The glass is not completely empty however, if you review all Tilson’s findings:

• As shown in the California pricing chart, prices are much closer to historical trend, meaning we have already suffered through a great deal of the pain. He sees another 10-15% drop.
• Home price to rent ratios have returned to normal levels, meaning affordability for potential homeowners is improving.
• Existing home unit sales appear to be troughing and months of inventory appear to be peaking. As prices continue to decline, these data points should coninue their moves in the right direction.

I do not want to discourage diehard real estate fans from pursuing investments, but I’m spending more of my time finding opportunities in the equity markets and in certain areas of fixed income markets. The housing markets are no doubt influenced by regional factors, and I know that fact firsthand as a southern California homeowner, but nonetheless, I agree with Tilson there is still significant pain to be felt in the U.S. housing market until the fat lady sings.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in Fannie Mae, Freddie Mac, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Entry filed under: Profiles, Stocks. Tags: Alt-A, housing, housing bubble, mortgage, option ARM, subprime, Whitney Tilson.