Housing Bubble Blog

[grudk]

Not to belabor the point, but here's a solid and intelligent article from the "Economist' on the topic.

'Most booms are followed by busts'

http://www.economist.com/agenda/displayStory.cfm?story_id=3886356

[jyl]

Since we're telling cautionary stories -

A guy I know bought a house in a nice area of LA around 1990, for $350K. Big corner lot, lots of trees, etc. He put nearly 50% down. Three years later that house was appraised at under $250K. His job in LA ended and his next job was out of state. They moved, rented the LA house, finally sold it a few years ago after having put nearly $100K into major renovations and losses on the rental. They got, I think, around $500K. In other words, after holding on for >10 years and enduring years of negative cash flow, they broke even, after transaction costs. The only reason they were able to hang on that long is that he makes a lot of money.

Another person I know bought a condo in West LA, also around 1989/90. The value crashed, he way way upside down on the loan, and around 1993 he simply stopped making mortgage payments. The bank never said a word (which makes me think the rate of non-performing loans back in the early 1990s was a lot higher than the banks were admitting). After another year, he tossed the keys on the doormat and left the state.

Another person I know bought a house in the Twin Peaks area of San Francisco around 1990. Nice place, great view. He really stretched - took a first mortgage, a second mortgage, and a third. Not long afterwards, the marriage broke up he ended up selling the house around, I want to say, 1994. The downpayment was history and they defaulted on the third mortgage.

Yet another person I know lost his job when aerospace crashed in So Cal in the early '90s. He spent 4 years (!) trying to sell his house in Riverside. Those outlying bedroom communities really got killed when the real estate bubble burst, much worse than the prime central areas.

Okay, end of stories, here's some opinion -

I think CA real estate is a good investment in the long run (decades). But not an exceptional one. I posted some data in a prior thread (actually, maybe it was in this one, I'm too lazy to look) showing that CA residential real estate has basically performed inline with the US stock market over the past couple of decades.

CA real estate can sometimes be a great trade in the short term. But it can also be a bad trade in the short term. There is no such thing as a freely-traded asset that is never a bad trade.

The thing that is (financially) special about real estate is that you buy it with huge leverage (you borrow 85%-95% of the purchase price), most of your carrying costs (mortgage interest, property tax) are tax-deductible, and the transaction cost to sell the asset is very high (6% of the selling price).

[ubiquity0]

Originally posted by grudk


http://www.economist.com/agenda/displayStory.cfm?story_id=3886356

"...a recent survey of buyers in Los Angeles indicated that they expected their homes to increase in value by a whopping 22% a year over the next decade"

That is just crazy. Assuming the average LA house is $600,000 today that would mean these new buyers expect it to be worth $4,300,000 in TEN YEARS time!!!

[jyl]

Forget for a second about all the cultural and emotional and peer pressures to be a homeowner (kind of like the similar pressures to own internet stocks back in 2000).

Imagine that you come from Mars, and your interest in California real estate is purely as an investment. (The new, reformed Martians have decided to conquer the Earth economically, not militarily.) By the way, the Martian word for California real estate is "X8YppTH".

So, treating X8YppTH like any other asset, you do your research and find that:
1. Historically, this asset tends to go through boom-bust cycles every 10-15 years.
2. The last bust started in 1991/2. The current boom started in 1996/7.
3. X8YppTH is currently trading at valuation ratios (price to buyers' income, price to rental value) that are at or above prior peak valuation.
4. For the past few years, prices for this asset have been climbing at a rate at or near the highest rates recorded in past cycles.
5. Sentiment toward X8YppTH is very positive, among Earth investors, investment advisors, and the video transmissions that you decode from CNBC. Stories of "X8YppTH millionaires" are everywhere.
6. A growing portion of the purchases of X8YppTH are being made by speculators, traders, and momentum investors.
7. This asset is almost always bought on margin, with 90% of the purchase price borrowed.
8. The cost of borrowing has declined dramatically over the past several years, and is currently at near-record low levels.
9. The cost of borrowing is influenced by many factors, but some main ones are (a) interest rate policy set by an earthling named Alan Greenspan, (b) Earth investors' expectation for future US economic growth, as reflected in the 10-year bond yield, (c) Earth investors' desire for US dollar-denominated assets in the form of mortgage backed securities.
10. The Greenspan earthling states that he will continue raising interest rates. Earth investors' attitude toward US dollars is suspect, as that asset may be in a downward trend. Earth investors' expectations for future economic growth appears cautious, the stock market is not in a clear uptrend and the 10-year yield has barely risen despite Greenspan's efforts.
11. The portion of the X8YppTH purchase price that is not borrowed is typically funded by profits from previous trades of this asset, from profits made in other assets such as stocks, and wages from employment.
12. Few investors have significant profits from stocks over the past few years. Employment is growing slowly, but wages are not growing. However, profits from prior trades of X8YppTH are abundant.

So this is what your research shows. It is neither all positive nor all negative. You have to weigh the pros and cons. What does the logical Martian conclude about X8YppTH?

[CamB]

John - that's an outstanding piece of analysis. It applies (essentially 100%) to New Zealand too, the only additions I'd make (applies to NZ - I dunno about US) are:

13. Around 3-4 years ago, excess demand for X8YppTH occured on the back of strong net immigration, a trend which has reversed to below the long run average over the last 12 months.
14. The physical cost of making a X8YppTH has increased markedly, especially as the employment rate for the humans responsible for performing this task is approximately 100% (and prices have risen accordingly) and the costs of the raw materials required to make X8YppTH - especially those containing oil - have risen strongly.

There aren't too many "positives" in there...

I've effectively put my money where my mouth is now - I'm making an investment decision by NOT entering the housing market (I am in a position to do so) and I am going to try and rent where I want to live at a yield of 5% or less...

[RickM]

This just in:

New Home Sales Hit Record High in March
http://story.news.yahoo.com/news?tmpl=story&ncid=&e=16&u=/ap/20050426/ap_on_bi_go_ec_fi/home_sales_3

US existing home sales rise 1.0 percent
http://news.yahoo.com/news?tmpl=story&u=/afp/20050425/ts_alt_afp/useconomyhousing_050425160941

[turbo6bar]

Interestingly, the median price decreased 9%, though. Methinks buyers are viewing this as the last chance to buy before rates increase.

The housing market is a big machine. It takes a lot of time to move. I don't think we will see any major changes for at least 8-12 months, and that assumes long-term rates actually increase.

[RallyJon]

Brian, one question: what's the house on Linda Isle worth today? Sounds like your client and the owner were having a contest to see who could make the dumbest financial decisions.

[350HP930]

Originally posted by RickM
This just in:

New Home Sales Hit Record High in March
http://story.news.yahoo.com/news?tmpl=story&ncid=&e=16&u=/ap/20050426/ap_on_bi_go_ec_fi/home_sales_3

US existing home sales rise 1.0 percent
http://news.yahoo.com/news?tmpl=story&u=/afp/20050425/ts_alt_afp/useconomyhousing_050425160941

Stock trading volumes also hit record levels as the market was headed into a crash.

[CamB]

Plus, I reckon that if prices do go down, prior to a decent crash (I said "if") I expect to see a dead cat bounce in prices (even a dead cat will if thrown from high enough).

[jyl]

This is an interesting discussion. Guess it'll continue until the housing market either rolls over, or doesn't.

I was thinking today about what could make California real estate aka X8YppTH keep going up indefinitely. It's good discipline to challenge your own views.

Here's a scenario.

US economic growth remains weak, and investors continue to expect weak growth ahead. Inflation falls from the current 3.1% level, and investors expect low inflation or even deflation ahead. For some reason, foreign investors continue to desire US dollars. Under this scenario, the 10-year bond yield could remain low, even if Greenspan keeps raising short-term rates - the yield curve would just become flatter and flatter.

(In fact, if economic growth stalls and inflation subsides, Greenspan could cease raising rates after he gets the short rate to a neutral level, whatever he thinks that is.)

If the 10-year yield doesn't rise, then mortgage rates wouldn't have to rise.

A weak economy would also tend to keep a lid on the stock market, so investors might continue to see X8YppTH as a more exciting investment.

But the hurdle I then come to is affordability. For investors to keep trading up to higher-end X8YppTHs, new investors have to keep buying the low-end, starter X8YppTHs. But with the economy stalled, wages and employment are not going to be growing, hardly anyway. How close are starter X8YppTHs to being unaffordable, in the main California markets like the SF Bay Area, Los Angeles, and San Diego? I'm not sure. After all, less than 100% of X8YppTHs are being financed with nothing down, adjustable-rate, interest-only mortgages - it can always go higher, until you get to 100% . . .

I think the bulls on X8YppTH are, implicitly, betting on a prolonged period of (1) low economic growth, (2) low inflation, (3) foreign capital inflow into the US, (4) and ever more liberal financing.

[grudk]

Sooner or later, housing costs and wages have to normalize. You can't have a prolonged situation where fewer and fewer people can afford a 'median' home (it's now at 17% in L.A.). So, either inflation erodes housing values and wages adjust, or values come down (more land released for building, etc).

I think that the 'speculative' element in home buying is a FAR bigger factor in this than anything else. And once prices stall or head south, we are going to see some pain.