Sizing the Housing Bubble

[wabmester]

For years, we've been arguing about whether there's a housing bubble or not.    Even today, people will still try to argue that only isolated pockets of the country are a bit frothy.

Now that it looks like the bubble is about to deflate, I've been trying to get a handle on the size of the problem.    I gotta tell you -- I am blown away by the size of this thing.    I need somebody to calm me down and tell me I'm looking at bad data or something.

I lived through the SoCal bubble that popped from 1990-1996, so I know bubbles.   Prices dropped about 20% during that decline.   At the end of the decline, prices had basically reverted to the historical mean on an inflation-adjusted basis.    Take a look at this chart of San Diego prices, and you can see that bubble compared to our current bubble:

San Diego

Here's the same chart on a national scale:

National

Here is a chart of housing stocks compared to the S&P500 and NASDAQ bubbles of 2000:

Housing Stocks

Finally, here's a chart of the total housing value vs GDP:

Housing vs GDP

The interesting part of this last chart isn't so much the exponential curve -- take a look how housing is way off it's normal relationship to GDP.   We were at 160% of GDP last year, whereas we're normally closer to 100% GDP.    I believe Japan was at about 140% of GDP when their real estate market crashed for 16 years....

So, my worry is that this isn't going to be a pleasant sideways deflation.    By every metric, this appears to be bigger than anything we've experienced before -- even bigger than Japan's bubble.

Tell me I'm wrong.

 

[macdaddy]

"what's different this time"

100 million people added to the US population by 2050

increased demand from India and China continues to push commodity prices (= new home prices) upwards

access to relatively cheap money continues

rents have started to pick up

most families in desirable areas are dual income which has now been priced into houses ("one spouse can't afford to stay home" "not even an option")

those are a few points in support of continued high home prices. i'm not saying prices won't decline, but i think a crash of greater than 20% is unlikely. particularly in san diego/california, lots of people move in, but home owners tend not to move out, thus the area becomes very crowded, with limited supply, and prices are driven up. at least in boston, the cap rate on rental apartments is still 4.5% plus inflation, and rents continue to rise, which is some kind of supporting fundamental. i think the separation into rich and poor continues... the areas with the most foreclosures are all in the midwest and south, places where the median home price is barely over 100k. not the places where it's 600k. which seems counterintuitive at first.

i think we're likely to just slowly inflate our way out of this mess over a period of 4 or 5 years with some small YOY price declines. then you'll find that your professional level salary has increased by enough to let you slip into one of those 300k condos or 500k starter homes. unfortunately for the americans who don't have a skill set, their jobs will still pay $7.50 an hour, and when they look up they will see a lot of hispanic faces around them, speaking in a language they don't understand...

-devil's advocate

 

[wabmester]

I've just looked at some of Shiller's housing data.    It seems that housing values have been stable in real dollars since WWII.   They've basically been a store of value that has tracked inflation for 50 years.

So, it's *really* hard for me to swallow that it's different this time.   Cheap money has meant that *builders* have benefited, and supply has met or exceeded demand.    This is not demand-driven appreciation.

If we revert to the mean, it *will* be ugly.   There is no way around that.   Even if prices just move sideways, they'll have to move sideways for *decades* to unwind the excesses of the last 8 years.

We will see the jobs created by the housing sector virtually disappear.    We'll see consumer spending dry up.   I think it's very likely that we'll see something like Japan's *long* *slow* decline, but on a larger scale.   I hope I'm wrong.

 

[Martha]

I hope you are wrong but I think you are right.

I know the Phoenix area market is softer, where we are investors in apartment to condo conversions that are in the process of being sold. Sales have been steady for our units, but our developer says that sales of condos in less prime locations are slowing down and the apartment to condo conversions have stopped. I am glad our units are prime units in great locations, but even those could be seriously effected by a drop in the market.

 

[astromeria]

"particularly in san diego/california, lots of people move in, but home owners tend not to move out

California has a net outmigration of citizens--the population is growing due to foreign immigration. Californians who lose their jobs or retire often move out of state--I've even read about problems getting rental trucks back into the state. The burgeoning population of other Western states consists of a plurality of Californians (too lazy to search for the data, but I've seen it several times over the past few years, including this year).

=astro, CA homeowner who moved out and knows others who did likewise due to voluntary or other early retirement

 

[Sheryl]

=astro, CA homeowner who moved out and knows others who did likewise due to voluntary or other early retirement

Yup.  Californication is happening on a large scale here in WA.  I also am too lazy to find statistics on a Sunday morning,  but we know that much of the building boom in our area is due to in-migration from CA, and our (relatively) (but not for much longer) cheap real estate. 

Our small town has over 1,000 housing units planned or under construction for the downtown, which up until now had less than 100 units.

The developers are in a mad race, whipping their architects to go faster, faster, faster, because they KNOW that not all of those units can sell.  IMO, it's not a matter of if the bubble will burst, just when.  It won't be pretty here, but we can go back to some sort of sane life, perhaps.

 

[mb]

Yup.  Californication is happening on a large scale here in WA.  I also am too lazy to find statistics on a Sunday morning,  but we know that much of the building boom in our area is due to in-migration from CA

California has a net outmigration of citizens--the population is growing due to foreign immigration. Californians who lose their jobs or retire often move out of state

=astro, CA homeowner who moved out and knows others who did likewise due to voluntary or other early retirement

Yup, kinda hope about 30M or so CAers will migrate to Washington, Texas, Minnesota, Colorado, Florida, etc.  Then I'll be able to buy something on the beach 

 

[lazygood4nothinbum]

fort lauderdale area now has an 11-month supply yet the prices are still insane. a crummy looking 3/2 around the corner from me on just 5500 sq ft parcel for sale for 1/2 mil. i just hope they stay insane for another year or two until i sell-out.

condo projects are still being planned & developed. just a few blocks south of me i see another "sold" sign on a cluster of 6 new $1mm houses and the same developer just cleared another site a few blocks north of me for another 5 or 6 $1mm houses.

seeing less advertising for condo conversions and i read that over the last two years we lost 20-25% of our rental stock. construction stats are up in all categories, single family, multifamily & commercial. still high rate of in-migration & immigration. frankly i've no idea which way it is going. too many mixed signals.

 

[Brat]

Our small town has over 1,000 housing units planned or under construction for the downtown, which up until now had less than 100 units.

The developers are in a mad race, whipping their architects to go faster, faster, faster, because they KNOW that not all of those units can sell.  IMO, it's not a matter of if the bubble will burst, just when.  It won't be pretty here, but we can go back to some sort of sane life, perhaps.

I think in some market segments will loose value.  There are so many condo projects on the boards in the NW overcapacity looms.  Make sure that clients don't get behind on their fees because some will walk away.  If they don't do that they may shelve the drawings for a couple years, tough to do if all they have is an option on the site.

There are some areas where the market won't slump, IMHO.  Silicon Valley executive's homes for example.  The turnover there is effected by their quirky property tax laws so excess capacity hasn't been much of an issue. 

 

[mathjak107]

real estate is a very local thing.it depends on the job market.here in long island new york homes fell an unheard of 20-25% when grumman closed up in the 90's.....after the crash of 1987 my co-op fell from 75,000 to 57,000 in a year.....homes in new england plunged by 45% in the 90's.....texas got devestated in the early 90's...its hard to say what will be now...the more likely scenerio is prices may fall about 10% in most areas but may take a year to sell or longer

 

[bobbee25]

Baby Boomers, inheritances, ....... money, money, money

6.5%, I remember 12% and being grateful when we refinanced at 8%.

Housing is expensive, have ya filled your gas tank lately. Have you noticed CEO pay scales.......

Housing in New England dropped 45% ... not in my part.

 

[mathjak107]

my sister bought a home in great barrington in the 90's....she got a little more than 1/2 for it and was happy to find a buyer..they were devistated in that area economically

 

[nvtashak]

Californication definitely has been occurring in the last 8-10 years in the Reno/Carson City and Las Vegas areas of Nevada.
Prices aren't dropping by a lot here (yet), but housing definitely is taking longer to sell, due in part by owners not being willing to drop their prices one bit--those places are still on the market.
Noticed that the Help You Sell/Assist to Sell discount brokers seem to be doing a brisker business--$3k versus 6% broker commission. Though today's paper lists one of them charging more for properties over $200k.
My place -- further out from Reno/Carson City but still in commute distance--(acre and outbuildings and older dw) was under $50k in '99 and technically had basically doubled in value late last year; if its value drops 50%, well I've been housed here for seven years....not quite sure how to do the math on investment opportunity cost of lost interest and inflation versus property taxes/insurance/utilities/maintenance and improvement like new furnace versus cost of comparable rental, but as long as it and I hold together, expect to be here for at least another seven years plus.
Nice to have it paid off, and homesteaded, whatever it will be valued at this year and the next several. But people with continuing mortgages on those new mini-mcMansions with basically no yard space and they are dependent on volunteer fire department, may see that they bought a place for more than it is worth.
They're still building the mini-mcMansions, new development plans still all the time going to the county in hopes of approval, but where the water is coming from is going to be a good question. If you have water rights for sale out here, you can just about name your price and double it or triple it.

 

[wabmester]

My concern isn't so much about local housing markets.   My concern is about the magnitude of the bubble country-wide.    If you look at housing vs GDP, for example, when we revert to the mean, we'll be looking at something like 7 TRILLION DOLLARS evaporating from the market.

Let me put my Dr Evil jacket on and say that again:  7 TRILLION DOLLARS!

Frankly, I'm ready to put on my tin foil hat and build a bomb shelter to avoid this one.    I'm looking for hedges.    Does anybody know if I can buy puts against the Home Construction index, for example?    It's already dropped by 50% or so, but it still has a ways to go.

 

[cute fuzzy bunny]

Yeah, North America appears to be the 'small pockets' in question.

The value evaporating isnt as much of a problem as the leveraged debt a lot of people have taken on. I can tell you right now that every one of my neighbors refinanced or took out a HELOC and used the proceeds to buy new cars, boats and RV's.

Good luck to them!

Homes here more than doubled in price in 4 years. A fair bit of the bloom is off that rose right now...

 

[wabmester]

Homes here more than doubled in price in 4 years.  A fair bit of the bloom is off that rose right now...

Yup, here's Sacramento:

It looks like the historic mean for that area should be around $150K in 2005 dollars.    Around a 50% fall from today's levels.   So, yeah, you'll get to feel a little schadenfreude for a while when your neighbors first turn upside down.   But then the decline will probably last 10-20 years as we mean revert.   People will feel poor.   They'll stop spending.   We'll have a deep recession.   Then people will start walking away from their upside-down mortgages.   Banks will take a hit.    Fannie Mae will require a bailout.   And this will all happen at a time when the US already has record debts.

I don't like the looks of this thing. It's a monster.

 

[AltaRed]

It will be ugly. That is just the way it is going to be.... the way it has always been.  I've seen it happen in Canada a number of times, particularly in Toronto and Vancouver, and Calgary in 1983 (like Houston).  Calgary is going through a huge increase in escalation due to the robustness of the oil industry.  It too will crash in the not too distant future - could be 2 years, or 5 years.

I don't understand comments otherwise...that is simply denial.  Housing simply cannot get way out of whack with the local economy.  The question will be how well those leveraged homeowners can stick it out versus having to bail.

 

[cute fuzzy bunny]

Yep, thats us.

Homes were 150-175 around here just 4-5 years ago, and according to our buyers agent when we bought the place, you couldnt give the homes away.

Last year, people running around with their checkbooks in hand offering 400-425+.

Today, maybe 350, 325. Buyers are waiting to see where it stops.

Here's the rub though...there really isnt any infrastructure here. Crappy one lane roads that are choked with traffic now that the areas been through a building boom. Crappy restaurants. A crappy mall.

Other areas that have solid retail/restaurant/roadway infrastructures around here are still holding onto their prices. The bay area sales are still good.

Rather than a big drop, we might just see a long sideways period.

 

[JB]

I agree with you but these graphs can be misleading. Prices could increase because wages are up, interest rates are down, and rents are up too. Low interest rates is a factor. The cost to buy/rent seems to be a better metric. Around here rents have been inching up, but nowhere near what houses have done. Bernstein wrote a good piece on the bubble but I can't find it now. I think his analysis indicated that prices are high but not in bubble territory.

 

[wabmester]

Prices could increase because wages are up

Nope, nominal increases in wages have been low for years.   Wages have barely kept up with inflation.

interest rates are down, and rents are up too.  Low interest rates is a factor.

Rents are one of the largest factors in the CPI, and rents have not been rising very quickly, which is one reason why inflation has been so low.

Interest rates are certainly a psychological factor, but historically, prices have not changed much with changing interest rates.    The biggest impact of interest rates is on construction loans.   The low rates of the last several years have financed a huge increase in the supply of homes.

Also, a lot of people feel they are protected by constrained land supply.    Just take a look at what happened to Tokyo in 1990.   It was a free-fall.    And Tokyo probably has the tightest land constraints anywhere.

 

[JB]

Yup, I agree, my point is that there 'could' be real economic factors that cause house values to increase.

The kicker for me was when a friend in New York who is recent retiree said: 'buy a house, can't go wrong, right?'

 

[mikew]

From the economist last year.
http://www.economist.com/finance/displayStory.cfm?story_id=4079027

Another worrying lesson from abroad for America is that even a mere levelling-off of house prices can trigger a sharp slowdown in consumer spending. Take the Netherlands. In the late 1990s, the booming Dutch economy was heralded as a model of success. At the time, both house prices and household credit were rising at double-digit rates. The rate of Dutch house-price inflation then slowed from 20% in 2000 to nearly zero by 2003. This appeared to be the perfect soft landing: prices did not drop. Yet consumer spending declined in 2003, pushing the economy into recession, from which it has still not recovered. When house prices had been rising, borrowing against capital gains on homes to finance other spending had surged. Although house prices did not fall, this housing-equity withdrawal plunged after 2001, removing a powerful stimulus to spending.

Housing-equity withdrawal has also fallen sharply over the past year in Britain and Australia, denting household spending. In Australia, the 12-month rate of growth in retail sales has slowed from 8% to only 1.8% over the past year; GDP growth has halved to 1.9%. In Britain, too, a cooling of the housing market has been accompanied by an abrupt slowdown in consumer spending. If, as seems likely, home prices continue to fall in both countries, spending will be further squeezed.

One of the best international studies of how house-price busts can hurt economies has been done by the International Monetary Fund. Analysing house prices in 14 countries during 1970-2001, it identified 20 examples of “busts”, when real prices fell by almost 30% on average (the fall in nominal prices was smaller). All but one of those housing busts led to a recession, with GDP after three years falling to an average of 8% below its previous growth trend. America was the only country to avoid a boom and bust during that period. This time it looks likely to join the club.

 

[Arif]

I think if home prices start to collapse and you still want to be in real estate then rentals are the place to be. Where are those folks that are upside down in their mortgage gonna live once they foreclose?
There will be a shortage of rentals due to all the condo conversions (or lack of building in the multifamily sector) and rents will rise as a result. Rents are already on the rise nationwide and are headed even higher. http://money.cnn.com/2006/05/30/real_estate/rents/index.htm

In real estate there is always an angle to make money. When one door closes another opens. Happy investing. 8)

 

[Siv]

Very interesting indeed.

If housing prices just level-off or move sideways for a number of years then there is possiblity a number of people will get hurt, especially those who are highly leveraged. Let me remind you a lot of people consider houses as big part of their asset at the moment so once they feel poorer, stop spending...US economy will tailspin. Talking about domino effect.

I'm keeping cash, I think I have time to wait out. Patience...

 

[califdreamer]

I think if home prices start to collapse and you still want to be in real estate then rentals are the place to be. Where are those folks that are upside down in their mortgage gonna live once they foreclose?
There will be a shortage of rentals due to all the condo conversions (or lack of building in the multifamily sector) and rents will rise as a result. Rents are already on the rise nationwide and are headed even higher. http://money.cnn.com/2006/05/30/real_estate/rents/index.htm

In real estate there is always an angle to make money. When one door closes another opens. Happy investing. 8)

Excellent point!

Multifamily is where it's at.