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Housing: The party's over, now the bills come due

By Doug McInnis

Page 2

At the end of the line are the buyers of bundled mortgage securities. When things go right, these buyers stand to earn a lot of money because subprime mortgage securities carry high returns in exchange for high risk. The buyers of these securities include hedge funds, insurance companies, and big banks. They stand to lose if a lot of loans in bundled securities go bad.

Collateral damage
Segments of the economy that the housing boom helped could suffer with the downturn. The boom provided a bonanza for builders, materials suppliers, and appliance

"As people perceive that they suddenly have much less household wealth, it will have ramifications for the economy as a whole."- David Funk, director, Cornell Program in Real Estate
"As people perceive that they suddenly have much less household wealth, it will have ramifications for the economy as a whole."
David Funk, director, Cornell Program in Real Estate
makers, and provided a lot of jobs for construction laborers. In addition, Wall Street firms brought in billions of dollars in fees for packaging and selling bundled loans of all types – including prime, Alt-A, subprime, and home equity. If the market for bundled securities shrinks, so will the fees and commissions Wall Street once earned.

The consumer-driven economy could also take a hit. "The economy over the last five years was bolstered by an immense infusion of spending from people tapping the equity in their homes," says David Funk, director of the Cornell Program in Real Estate. "As people perceive that they suddenly have much less household wealth, it will have ramifications for the economy as a whole."

But the pain brought on by the housing crunch is likely to vary by region. Naples, Florida, for instance, is awash in subprime loans. That could spell trouble. But some areas have avoided the boom-bust housing cycle, among them San Diego. "It hasn't been overbuilt, with the possible exception of downtown," says Roger Joseph, MBA '76, chief executive officer of San Diego-based Franklin Croft, which specializes in commercial real estate. "There's been a leveling-off of housing prices in San Diego, but there hasn't been an overall decline in market values."

There are also niches within the owner-occupied homes market that remain strong. The market for green homes is rising, in part because of rising energy costs and concerns over global warming (see sidebar, "Green Homes"). The areas devastated by Hurricane Katrina continue to rebuild. There is also a strong and growing market for downtown-area housing in a number of cities – some of it in downtowns that used to empty out at five p.m. Detroit is one example. Hartford, Connecticut is another.

Housing starts and home sales charts
New home sales have seen less of a decline than single-family housing starts or housing permits. The National Association of Realtors sees that as a positive sign of thinning inventories, thereby assuring no major oversupply across the country.
Source: National Association of Realtors, www.realtor.org/research.nsf/pages/EcoIndicator

"Within the last ten years, a decision was made to try to revitalize downtown Hartford, which had been an eight-to-five city, " says Anne Agonis '01, MBA '06, who makes commercial property investments for Hartford Investment Management Co., a unit of The Hartford. "This should add about 2,000 rental and condo units downtown. Brokers have indicated that the high-end condos are selling for upwards of one million dollars. They're targeting the 18-to-24 crowd, young professionals, and baby boomers and retirees looking for an alternative to suburban living."

Meanwhile, the rest of the real estate industry is, by and large, in good shape. The industrial and retail real estate sectors are strong. The apartment rental market is actually strengthening. One reason: as overextended borrowers lose their homes, they've got to go somewhere. This is helping to push rents up and could spur new construction of multifamily units.

And there may be some benefits in letting the air out of an overheated real estate market. Falling home prices may make it easier for first-time borrowers to buy homes, and the falling numbers of new home starts may ease future labor and construction materials costs. "As the bubble starts to lose some of its pressure, it will be interesting to see what happens to labor and constructions costs," says Funk. "One would expect it would have some deflationary pressure on both labor and materials."

Every boom must eventually end, and some people are more than ready to see this one end too. "There was an 11 percent appreciation in home prices is 2005 alone," says Funk. "Many people in the industry would like to see a correction in home prices just to restore some rationality in the residential market."

Green homes: a low-tech solution to high-energy bills

David Wax, '04
David Wax, MBA '04

In the midst of a widespread housing downturn, green home building is gaining traction. By 2010, green building features will be incorporated in up to 10 percent of new homes, according to estimates from the National Association of Homebuilders and McGraw-Hill Construction. That's up to five times the level of 2005.

But many buyers are put off by the sticker price of photovoltaic energy, geothermal heating and cooling systems, or other high-cost green home technologies. David Wax, MBA '04, CEO and cofounder of Independence Energy Homes, understands this problem and has a solution for it: Whenever possible, avoid the technological bells and whistles in favor of more prosaic solutions.

"In the world of energy efficiency, the sexier stuff is not the most cost-effective," says Wax, who teamed up with a group of Cornell graduates to form the Boston-based company. "If your goal is to reduce energy use, you look first at passive solar, insulation, and overhangs to block the summer sun and let in the winter sun. After you get every possible therm out of the house by doing the cheap things, then you look at high-technology renewable energy.

"The point is that better design and better materials are always cheaper than better technology. There are homes where you can save 30 to 50 percent of the utility bill just by doing passive things like installing better insulation. Then you don't have to buy as big of a technology package."

Wax and his business partners first worked together at Cornell when they teamed up for a U.S. Department of Energy Competition to design a fully-functional solar home. Eighteen schools competed. Cornell placed second. "The second-place finish was the platform from which we launched the company," says Wax.

Independence Energy Homes doesn't actually build homes. Rather, it offers energy-efficiency design services to contractors. Its current projects included a development of 150 homes in Texas, and another of 364 homes in California.

To come up with a design, the firm's architects, engineers, and financial experts work together in one big room, which helps to insure that technology and architecture mesh. The financial experts then crunch the numbers to make sure the plans make fiscal sense when all the variables, including federal, state, and local tax incentives, are included.

In Independence Energy's custom design work, one size doesn't fit all. "An overhang in Wyoming and an overhang in Texas won't be the same because the sun changes its position with changes in latitude," says architect Stephanie T. Horowitz '05 (BArch), the company's design principal and cofounder.

In a typical, mass-production home, the heating and air-conditioning contractor will recommend a utility system based on the home's square footage. "We use a much more calculated approach," says Horowitz. "A 100-square-foot room that has no windows is very different from a 100-square-foot room that has a whole wall of south-facing windows that get a lot of sun."

In making such calculations, "We all work together," she says. "And we think about heating and cooling and passive solar from the beginning. It's not an afterthought."


A house of cards begins to tumble

February 26 - Former Federal Reserve Chairman Alan Greenspan warns U.S. recession possible by year end, decries reduced aversion to risk. (Wall Street Journal online)

February 27 - Stock prices plummet on Shanghai exchange, sparking a sell-off of stocks in the United States. Dow Jones plunges more than 400 points. (Wall Street Journal online)

February 28 - The sharp drop in the Dow Jones average signals investors may be taking a second look at their appetite for risky investments. (Wall Street Journal online)

March 1 - The Commerce Department reports new home sales fell in January, the biggest drop in 13 years, (New York Times online)

March 2 - Federal prosecutors and securities regulators are investigating alleged accounting errors and stock sales at New Century Financial Corp., the country's biggest subprime lender, the company disclosed. (New York Times online)

March 13 - Stocks plunge by more than 200 points as troubling financial news mounts. Late mortgage payments hit a 3.5-year high. Foreclosures hit record levels. General Motors Corp. reports it will put $1 billion into GMAC, its former finance unit, to cover rising mortgage defaults. (Associated Press online, Reuters online)

March 14 - Regulatory reports show some mutual funds held mortgage-debt securities from New Century Financial and other subprime lenders. (New York Times online)

March 15 - Greenspan said problems at subprime lenders aren't likely to hit the broader economy unless home prices take another big drop (Associated Press online)

March 19 - Fremont General notified some of the 2,400 employees in its subprime unit that they would lose their jobs by May 18. (Associated Press online)

March 22 - Credit counseling services are overwhelmed as home mortgage problems grow. (Reuters online)

March 23 - Mutual funds invested in real estate slump sharply on concerns over mortgage defaults. (Wall Street Journal online)

March 29 - Housing crisis reaches higher on the food chain. Reuters online reports foreclosures of homes mortgaged for $400,000 and up.

April 2 - New Century Financial Corp. files for bankruptcy protection and fires 3,200 workers. (Associated Press online)