Luxury Homes on the Block

Subprime lending. It’s enough to strike fear in the heart of the most credit-worthy homeowner.

Indeed, scores of homeowners and banks, reacting to recent mortgage defaults, are scrambling to sell off housing, often at a loss. In watching congressional hearings and reading media reports, it seems the subprime problem is germane to the low end of the market.

But there is something of a fire sale in the luxury sector as well.

"Even wealthier households use ARM products to finance the purchase of luxury homes in expensive areas," says Anthony Sanders, real estate finance chair at Ohio State University, of adjustable rate mortgages at the center of the subprime saga. "The rate resets combined with declining house values are creating a problem even in this sector of the housing market."

As a result, some high-end homeowners are selling short in the panic. Like lender EquiFirst--which took a $76 million buyout offer Monday from Barclays Bank when in January the offer stood at $225 million--luxury homeowners faced with default pressures are selling for less than their mortgages.

Enter the auction. In the auction world, those sales, deemed pre-foreclosures, are big business. In a pre-foreclosure, the homeowner can use the sale proceeds to pay off the mortgage debt even though these proceeds may be less than the amount owed.

Homeowners' desire to rapidly liquidate real estate holdings has made real estate auctions the fastest growing auction category, according to the National Auctioneers Association. A quick sale may mean less money, but bankers and homeowners are increasingly willing to accept that caveat, according to J. Craig King, president of J.P. King Auction Company, an auctioneer of luxury homes.

"If the bank forecloses, they have to take it into inventory and figure out how to sell it," he says. "Foreclosing just makes it the bank's problem, and they've got enough problems."

Many of the luxury sector homes currently on the block--either due to relocation or market and payment pressures--are second and third homes. Definitive data does not yet exist on luxury homes in the subprime fallout--due to the prematurity of such a market state--but according to King, the most market activity exists in second home markets like South Florida or Colorado, or locales where the housing market drastically over-expanded in the early 2000s like Las Vegas or Los Angeles.

Other deals may be had in places such as Nantucket, Mass., Naples, Fla., and Scottsdale, Ariz.

Not So Bad, Some Say

While lenders like New Century Financial and SouthStar are tossing in the towel, the overall lending situation, while not booming, is hardly cataclysmic.

Though "early payment defaults on subprime loans through mid-2006 have risen to more than triple the rate of early 2005," says Frank Nothaft, chief economist at Freddie Mac, the accompanying 2006 fourth-quarter delinquency rate of 1.9% on commercial bank loans is still below the national average in the late '90s.

Jonathan Miller, president of Miller Samuel, a New York-based real estate appraisal and consultancy firm urges perspective.

"No matter which real estate market sector you're discussing there's a problem of perspective," he says. "Most of the people in the business now haven't been in it long enough to see a full market cycle."

Which means second home buyers worried about the bottoming out of the market may be better served to refinance and wait it out. In late March, mortgage rates came down, with the 30-year rate dipping to 6.16% from a February high of 6.34%, based on long-term bond yields dropping and a flat inflation prediction by the Federal Reserve. Both Fannie Mae and Freddie Mac report good market liquidity in the prime lending market, and their share of new ARM mortgages is expected to fall by 13% in 2007, according to the Federal Housing Finance Board.

While the subprime fallout may get worse before it gets better, those with the cash to finance in the prime lending market should temper their worries.

"There have been reports of households frantically trying to sell their luxury homes," says Sanders. "Instead, they should have a glass of chardonnay, a slice of brie and chill out. The housing market will turn."