Sizing the Housing Bubble

[Alex]

Housing in NYC is surprisingly still strong. Listings are up, but no one is selling except at high prices. Unless people have to sell quickly, they are still getting their price. All new construction is at tippy top dollar - 1500 a sq ft at minimum.

That's not what many people on this Forum want to hear here. Many are 'not so secretly' hoping for a huge correction in housing prices. I live in L.A. and in my area houses are still selling at top dollar. Yes, they are taking a bit longer to sell, but to the chagrin of many here, there is no panic. Maybe in places like Michigan or Ohio it will happen, but I doubt New York or LA will see much of a dip.

 

[wabmester]

That's not what many people on this Forum want to hear here. Many are 'not so secretly' hoping for a huge correction in housing prices.  I live in L.A. and in my area houses are still selling at top dollar. Yes, they are taking a bit longer to sell, but to the chagrin of many here, there is no panic.  Maybe in places like Michigan or Ohio it will happen, but I doubt New York or LA will see much of a dip. 

I have to admit that I do get a perverse pleasure from watching train wrecks happen in slow motion. Basically, I see this as a contest between economics and emotion. Economics always wins in the long-term.

You may have noticed that the California Association of Realtors stopped posting their monthly affordability index at the end of 2005. That's because it essentially went to zero.

It's an economic fact that people in a region with a median income of, say, $60,000 can't afford houses with a median price of, say, $600,000. So, what happens when prices get that high? You exhaust the pool of new buyers. You get some overhang from upgrade buyers who are essentially exchanging their inflated equity for somebody else's inflated equity, but eventually that game of musical chairs stops.

To me, the question isn't how this will end, it's how fast and how hard.

 

[cute fuzzy bunny]

Its really a conundrum isnt it? All the people moving to my area are all "coming up from the bay area" or, up until a year or two ago, left the sacramento area for cheaper real estate up here and bit off a longer commute.

The frickin bay area must be empty by now...and who can afford THEIR old houses when the affordable ones up here are in the mid 400's to mid 500's?!?

Must be some exotic loan instruments and a HIGH speed train wreck about to happen...

 

[justin]

I'm involved in the planning/rezoning/approval stages of new residential construction for a number of developers in NC (a non-bubble area). We've seen a noticeable uptick in new developments. Especially near the coast. Those new neighborhoods will have finished houses within a year most likely. I don't think any of those developers are sensing a slowdown in the local markets. It's pretty much "get it done as fast as you can" at this point. Of course, like rewahoo, houses around here frequently sell for $140,000. The median sale price is a lot higher though. Tons of folks from up north and out west putting their equity to work here due to their jobs relocating here, or snapping up a vacation home on the coast.

 

[wabmester]

Tons of folks from up north and out west putting their equity to work here due to their jobs relocating here, or snapping up a vacation home on the coast.

Or speculating.

Places like North Carolina and Georgia seem reasonably valued to me. I've only been to each area once, but they looked pretty, the weather was nice (when I was there), and they have good job centers.

Texas is another story. I personally know investors who have moved their investment dollars from areas like Riverside, CA to Texas. The prices in Texas sure are cheap, but they seem about right given the property taxes, unlimited land availability, weather, and past overbuilding.

 

[LOL!]

A different kind of housing bubble may be created with gasoline prices going up: Homes that are closer to jobs will go up in value; homes further away will go down in value.

A colleague told me she was spending $300 a month on gas. I said, "Wow, if you lived where I do, you could spend $25 a month on gas and use the $275 savings for part of your mortgage payment."

 

[mb]

SF Bay Area RE prices are outrageous but I have always been surprised at how resilient they are. They do of course have corrections but in the past the drop has been less than what I have expected. Examples are the dot.com bust and the early nineties down turn. In the former Silicon Valley lost somelike 150,000 jobs (although I suspect that most of them were renters) and RE dipped slightly and then shot straight up when interest rates went down. I think that is it is because prices have been so high for so long that there are a lot of people that want to move up to a larger house or a better school district. Remember we have a lot of families with incomes of $200k/year plus living in 1200 sq ft houses and it's not because they are trying to save money for RE. The creates a huge latent demand. When they see a dip they take the opportunity to move up and that moderates the price drops.

MB

 

[Rich_by_the_Bay]

A different kind of housing bubble may be created with gasoline prices going up: Homes that are closer to jobs will go up in value; homes further away will go down in value.

Interesting point -- I could easily see that happening in Tampa. Or else, the downtown businesses move to the burbs.

 

[cube_rat]

SF Bay Area RE prices are outrageous but I have always been surprised at how resilient they are. They do of course have corrections but in the past the drop has been less than what I have expected. Examples are the dot.com bust and the early nineties down turn. In the former Silicon Valley lost somelike 150,000 jobs (although I suspect that most of them were renters) and RE dipped slightly and then shot straight up when interest rates went down. I think that is it is because prices have been so high for so long that there are a lot of people that want to move up to a larger house or a better school district. Remember we have a lot of families with incomes of $200k/year plus living in 1200 sq ft houses and it's not because they are trying to save money for RE. The creates a huge latent demand. When they see a dip they take the opportunity to move up and that moderates the price drops.

MB

I concur, mb. The prices here are still outrageous in the bay area BUT the houses are staying on the market longer. Prices will soften with inventory not moving as quickly as in the heydey 2-4 years ago

You are also correct about the folks making $200+ living in tiny quarters. We belong to that category and are waiting patiently on sidelines with our cash

 

[califdreamer]

SF Bay Area RE prices are outrageous but I have always been surprised at how resilient they are. They do of course have corrections but in the past the drop has been less than what I have expected. Examples are the dot.com bust and the early nineties down turn. In the former Silicon Valley lost somelike 150,000 jobs (although I suspect that most of them were renters) and RE dipped slightly and then shot straight up when interest rates went down. I think that is it is because prices have been so high for so long that there are a lot of people that want to move up to a larger house or a better school district. Remember we have a lot of families with incomes of $200k/year plus living in 1200 sq ft houses and it's not because they are trying to save money for RE. The creates a huge latent demand. When they see a dip they take the opportunity to move up and that moderates the price drops.

MB

I've been amazed at how well home prices have held up in the Bay Area as well.  

In the Spring of 05 I had my house on the market here in SD and had a very good non-contingent offer after 21 days for the price I wanted.  I thought the market was at a peak (and I may have been right) and planned to sit it out and rent.  I just couldn't go through with it since I enjoy the neighborhood so much.

I don't know what will happen.  I went through a period of thinking we'd absolutely be looking at a 20-40% drop, but now I'm not so sure.  I wonder if the San Diego market will hold up much as the Bay Area market has.

Interesting tidbit in the paper this week:  The median price for all homes (new, resale, condos) in SD County decreased around 1% in June 06 vs June 05.... the first year-over-year home value drop in ten years.  

 

[Alex]

When it comes to predicting, you have to be a little bit humble, a trait that few of the bubble advocates on this forum seem to possess. I don't have a crystal ball and I certainly don't know anyone else who does. But I do know that "Economics" is not an exact science! So when Wab says

Basically, I see this as a contest between economics and emotion. Economics always wins in the long-term.

I have to wonder what exactly he means? Remember, ALL real estate is LOCAL. There is no national real estate market. People want and need to live where there are jobs and recreation. Good weather helps too. Generally, two conditions are necessary for price softness in a given area: an oversupply of homes available for sale, and adverse economic conditions – generally a weak local job market. Sometimes these conditions occur against a backdrop of overall economic weakness, recession or high interest rates. I don't see either of these happening in Los Angeles and while the Fed is raising short term rates, long-term rates have not been rising.

Obviously, there are no easy answers here, but I think the economic concept of "Strong hands" vs "Weak hands" applies - those residential real estate homeowners who live in their homes are the strong hands - investors and speculators are the weak hands. Real Estate Bubbles have very little effect on financially sound home owners. You have to live somewhere. If you don't panic and sell during a local market downturn you will not be affected.

 

[wabmester]

I have to wonder what exactly he means?

Well, I told you exactly what I meant. Regional incomes are the limiting factor in regional housing prices. The ratio of home prices to income is at a historic high on a *national* basis. True, it's even crazier in some regions than it is nationally. LA, where you think things are different, is one of the most out of whack markets in the nation by any metric.

Some areas, like SF and Manhattan have persistently high prices due to some unique circumstances, but even those markets are well above their historical craziness.

 

[REWahoo]

The prices in Texas sure are cheap, but they seem about right given the property taxes, unlimited land availability, weather, and past overbuilding.

Are you saying the weather here in Texas isn't as nice as it is other places? Are you taking into account the documented fact that yesterday's high temperatures in South Texas were 20 degrees cooler than they were 1,400 miles north of here?

San Antonio, TX - 97
Pierre, SD - 117

 

[Scrooge]

San Antonio, TX -   97
Pierre, SD -          117

Give it another page or two and it will get even hotter in this thread! 

It's been my observation that people I know can get defensive about their real estate decisions to a greater extent than about other investment decisions. I wonder if it's the (usually high) share of their portfolio that is at stake that does it? Or is it that people get emotionally attached to their houses while stocks and bonds feel more ephemeral 

 

[REWahoo]

Give it another page or two and it will get even hotter in this thread!

It's been my observation that people I know can get defensive about their real estate decisions to a greater extent than about other investment decisions.

Maybe so, but I have no such delusions. Anyone who wants to live in my particular part of the world needs to be on some of those medications being discused in another thread. Not a good place to live, work or retire. Go buy yourself one of those bargains in the Carolinas or Georgia.

 

[Alex]

Well, I told you exactly what I meant. Regional incomes are the limiting factor in regional housing prices. The ratio of home prices to income is at a historic high on a *national* basis. True, it's even crazier in some regions than it is nationally. LA, where you think things are different, is one of the most out of whack markets in the nation by any metric.

Some areas, like SF and Manhattan have persistently high prices due to some unique circumstances, but even those markets are well above their historical craziness.

We'll just have to agree to disagree. the regional income figures do not factor in current equity and net worth of the buyers or the amount of down payment.

I have been hearing about a 'real estate bubble' in Los Angeles for over a decade. A good friend of mine moved here from Texas about ten years ago. At that time he stridently refused to buy a house. Laughing at my wife and I and saying that he would wait for these " crazy prices to come down". Well, ten years later and he is still renting, and waiting, and he's still laughing too - only now he is laughing at himself for being so f'n stupid. Oh BTW, his apartment rent has not come down either, it has doubled! - he is now paying 3K/month for his 3br/2ba place in Marina Del Rey.
.

 

[wabmester]

I have been hearing about a 'real estate bubble' in Los Angeles for over a decade.

Well, I doubt it has been "over a decade," since prices were still falling in LA during the 1990-1996 period, but you're right in that people were calling this a bubble as early as 2002 or so.   That's when prices started to separate from the fundamentals.    It's hard to predict when a bubble will pop, but we have pretty clear signs now.   If the correction had happened earlier, there would have been much less pain than we're potentially looking at going forward.

As you can see from digging into the data a little bit, this isn't just any bubble.   It's the largest asset bubble this country has experienced.   My worry isn't that my house will lose value.   I'm worried that we're about to experience something similar to what Japan experienced from 1990 to the present.    A long, painful correction with severe economic impact.

 

[Scrooge]

Oh BTW, his apartment rent has not come down either, it has doubled! - he is now paying 3K/month  for his 3br/2ba place in Marina Del Rey.

Cheapskate! I was paying almost $3k/mo for a one bedroom apartment in the Bay Area last year! Well, OK, a minor correction -- my client was footing the bill 

 

[lazygood4nothinbum]

A different kind of housing bubble may be created with gasoline prices going up:  Homes that are closer to jobs will go up in value; homes further away will go down in value.

this was already becoming a factor here, before gas prices started to rise. perhaps there's some psychology to it, not just economics.

a friend and i kept noticing this very thing. he lives in (what used to be) a much nicer area and in a much nicer house but 10 or 15 minutes further away from downtown fort lauderdale than my house. our houses started off miles apart in value, but now mine has almost caught up to his, also my area has seen more redevelopment because the land was (originally) cheaper than his area to so developers could afford to build and make profit.

hmmm, so i guess maybe my area's nicer now. go figure.

Interesting point -- I could easily see that happening in Tampa. Or else, the downtown businesses move to the burbs.

doc, the hottest area, i think, in your area is right next to downtown already: hyde park. i think i've toured every street in there (they think i'm a stalker). man, those are great houses.

 

[honobob]

Well, I doubt it has been "over a decade," since prices were still falling in LA during the 1990-1996 period,  ]

Not sure how LA compares to the Bay Area over that time. but here prices have been stable since 94-95 and pretty much soaring since.  At the worst my value dropped <9% after doubling in just two years.  The dot.bomb hurt some high end properties and lofts because the buyers for those types of properties diminished.  Those recovered rather quickly. Have not seen a bubble "bust" in CA and I've been here 25 years.  I thought I topped out at $600K for the near future but a neighbor just sold for $625K!

 

[wabmester]

Not sure how LA compares to the Bay Area over that time. but here prices have been stable since 94-95...

If "stable" means "flat," then that is still depreciation in real terms. And that is a possible outcome of the current bubble. If prices simply remain at current levels for the next 15 years or so, then inflation and wage hikes will put us back on course. It would still have an economic impact in terms of consumer spending, but it certainly wouldn't be as painful as falling nominal prices.

 

[Scrooge]

If "stable" means "flat," then that is still depreciation in real terms.   And that is a possible outcome of the current bubble.   If prices simply remain at current levels for the next 15 years or so, then inflation and wage hikes will put us back on course.

That's pretty much what happened to my Mid-Atlantic house throughout the 1990s. And then - bang! - it went all the way up along with the rest of the real estate market. That's markets for you

 

[honobob]

If "stable" means "flat," then that is still depreciation in real terms.   And that is a possible outcome of the current bubble.   

1986 Base year
1987 Up
1988 Value DOUBLED
1989-1991 Still all good
1991 Bubble Burst? Less than 9% down

1991-1995 Enjoying Prop 13 Tax limitations Four years of no double digit appreciation, considering suicide.
1996-1998 inching up again
1999 Neighbor sold for over 3X what I purchased
2000 100K up
2001 Add another $50K
2002-2006 Bubble Burst May 2006? Property worth 7.35X purchase price 20 years ago. Property taxes are $6400 LESS each and every year than the new neighbor pays.
Not sure what your point is but I'll buy all the CA houses you can sell me in 15 years at todays prices.

If you count the leveraging.....I'll celebrate the next "bubble" bust with Alex ...with bubbly!

 

[wabmester]

1986 Base year
1987 Up
1988 Value DOUBLED
1989-1991  Still all good
1991 Bubble Burst?  Less than 9% down

1991-1995 Enjoying  Prop 13 Tax limitations Four years of no double   digit appreciation, considering suicide.

Here's a graph of LA housing prices from 1975-2005:

As you can see, from 1987-1997, prices just kept up with inflation.   Historically, that has been true with just about every market in the nation since the 1940's.   Houses are stores of value.   They simply track inflation (and wages) over the long term.   If that's your idea of a great investment, more power to you.

I'll leave it as an exercise to the reader to determine what will happen to LA's home prices once they revert to the mean starting from 2005 or 2006 levels.   My guess is that as long as you don't plan to move for 10+ years, you'll come out even if you were to buy today.    Not my idea of a great investment, and almost a sure way to drive the economy into a long recession.

 

[califdreamer]

Back in January I started a thread about a real estate presentation I attended in LA. The speaker, Robert Campbell, shared these statistics with us:

Last 5 yrs, CA home prices up 130%... income up 20%... rents up 25%.

Historical appreciation trend for CA homes is inflation plus 2% annually (obviously the app'n rate has been much higher during the boom).

Home price to rent ratio in CA: Historically 5.2 times, currently 9.5 times. If this statistic reverted to the mean, house prices would have to fall 42%.

Campbell is a housing bear and back in January predicted CA home values to drop as much as 40% perhaps over a period of years.

I would've pasted the thread to this post but I don't know how

Moderator Edit: Here is the link to the Robert Campbell thread.
http://early-retirement.org/forums/index.php?topic=5521.0