Surviving the housing bust ...

by Mike Larson

Indeed, a couple of years ago, while everyone else in the world seemed to be rushing out to buy the next biggest McMansion, all I did was sit by my computer, write reports about the dangers, and tell folks around the office to sell their investment properties ... or at least stop buying!

I warned about a bust in housing sales, and it happened. I warned about a downturn in housing prices, and that happened next.

I warned about the corruption, shenanigans, and, above all, the risks in the wildest mortgage lending in history. Now, that reality has also burst onto the scene.
...
Today, one of the gravest threats to your wealth — not just in real estate but in other sectors as well — stems from the spreading housing bust in America.

Strangely, as recently as the middle of 2005, all you could read about was how housing would boom forever. Anyone who predicted a crash was considered a crackpot.

But with each passing week, more evidence is emerging that the bust is in fact here ...
Existing home sales dropped 17% from their September 2005 peak through spring 2007. That left them at the lowest since June 2003. New home sales plunged even more sharply — 29%.
For-sale inventory ballooned — to a record-high 4.2 million existing single-family homes, condos, and coops. Another 500,000+ new homes were also sitting on the market as of spring 2007, looking for buyers.

Existing home prices recently dropped nine months in a row — the longest stretch of negative year-on-year readings in history. New home prices plunged by almost 11%, the sharpest drop since 1970!

Meanwhile, we've witnessed a ...

Mortgage Meltdown!

In the mortgage sector — especially in the highest risk "subprime" mortgages — things are in turmoil.

Just recently ...

Fremont General, the nation's fifth largest subprime lender, was cited by the FDIC for 14 violations related to its mortgage business. Its operations were virtually shut down. Its workers were sent packing. And its stock plunged 32% in a single day.

New Century Financial, the nation's third-largest subprime lender, revealed it was the focus of a criminal probe about its accounting and securities trading. In just a single day, its stock lost over two-thirds of its value. Not long afterward, the company tumbled into bankruptcy.
HSBC, the biggest bank in Europe, announced a whopping 51% surge in bad loans at its North American unit, and a stunning $10.6 billion loss related to surging delinquencies and mortgage losses.

What's next? Well, until recently, surging defaults and foreclosures were mostly among the lowest tier of borrowers. Now, we're seeing the crisis spread to medium-quality loans (called "Alt-A") and home equity loans. Soon, even the traditional mortgage industry could be impacted.
To most of Wall Street, all this has come as a shock. But ..'we'... first warned about this precise crisis two years ago.

For example ...

In ... April 2005, we talked about how money from new-fangled, high-risk mortgages was pouring into the most overvalued real estate assets of all time. We .. gave .. a list of 25 stocks that "will likely get taken apart as the real estate and mortgage sector unravels." Sixteen of those fell. The average decline was 36%. One plunged a whopping 90%.
And in June 2005, under the headline "Final Stage of the Real Estate Bubble," ..we told.., with no punches pulled, that housing was on the verge of a massive decline. Plus, we gave .. explicit instructions to dump residential real estate investments.

Since then, as I've just related, sales have plunged and prices have dropped. The likely consequences:

1. Fluff investments should sink like an over-baked soufflé. These include stocks that were driven higher mostly by hype and cheap money — in companies with lousy earnings or shaky business models.
2. Stocks in the weakest sectors will get slammed further. These include the housing and mortgage companies we've told you to avoid like the plague.
3. Commercial real estate could get in trouble next. Until recently, U.S. real estate troubles were largely confined to the RESIDENTIAL sector. But COMMERCIAL lenders have been making high-risk mortgages, too. Commercial buildings have been "flipped" in recent months just like Miami condos once were. And commercial values have been stretched to the max.
In other words, we could see a similar speculative blow-off and downturn in commercial real estate like the one we've already seen in residential.
4. At the same time, crisis will breed opportunity. More conservative, higher dividend stocks in stronger sectors are likely to ride out any crisis the best ... and come roaring back the soonest.
5. Solid companies in high-growth economies will be even more attractive. On a day-to-day basis, their stocks seem to move in tandem with ours. But if you back away from the minor fluctuations and look at the bigger trends, you'll see they consistently outperform their U.S.-based counterparts.

Four ways to protect your home equity ... and your wealth

Here are several steps you need to consider that are designed to protect your home equity and your wealth ...

#1) Protect your primary home. If you own your own home, it's your primary residence, and you're not overleveraged with a big mortgage or an ARM whose payment is heading higher, you may just want to stay put. You have the flexibility to ride out any downturn, even one that lasts years. But recognize that you will likely lose a chunk of your home equity. If you can live with that, fine.
#2) Consider renting if it's right for you. If you're not tied down by family considerations — run the numbers on selling vs. renting. In many places, renting is cheaper than buying or owning even after you factor in the tax advantages of owning. And don't forget to include the cost of upkeep, mortgage interest, taxes, and everything else when calculating ownership costs.
#3) If you absolutely MUST buy a home, be especially careful. Don't use a high loan-to-value (LTV) mortgage. Even if you can still get one, and even if it might seem like a seductive option, don't. In a market downturn of any reasonable severity, you'll end up owing more than your home is worth. If you change jobs or have to move for any other reason, you're stuck. You might even have to pay money at closing just to unload your house.
#4) Sell residential real estate properties purchased as investments — especially condos. Too many investors are in a state called "cash flow negative," and many are losing money hand over fist. The prospect of big price appreciation is now gone. What are they going to do? They're going to try to dump their properties. That means you're going to see inventory overwhelm demand. You're going to see fire sales. You're going to see protracted price declines. Sell.

Above all, remember this: Real estate downturns can last a long time, and they can dole out much more pain than you think. This is not the time to leave yourself exposed. But it is a great time to prepare. .....

P.S. For early warnings on trends that could derail your portfolio, as well as some of the best investment opportunities in the world, consider subscribing to Safe Money Report.