Saturday, April 23, 2005

Air Will Come Out Of Housing "Balloon"

The housing boom poster boy isn't so certain these days, even when preaching to the choir. "'The air will come out of the balloon, but it will not burst,'" David Lereah, chief economist for the National Association of Realtors said.

"Lereah balanced his bullishness with a few warnings about worrisome national and international trends that could cause mortgage interest rates to rise above 8.5 percent, his "yellow flag" level. Those trends included an intractable federal budget deficit, a rise in inflation, a weakening U.S. dollar and proposed reforms to federal taxes, Social Security and Fannie Mae and Freddie Mac."

Creating private Social Security accounts could result in a "massive transfer of wealth" from the bond market, which supports mortgages, to stocks, he said. Tax reformers have talked about eliminating the deductibility of property taxes."


At 9:42 AM, Anonymous Anonymous said...

It's going to burst. That's usually the way air gets out of balloons. You can only stretch the metaphor so far, Mr. Lereah.

Today's sign of the apocalypse:,-AL,-A,-N000285528,-ACP,-N000803405
2 beds, 1 bath, 0 parking, in an okay san francisco neighborhood. List: $699k. Purchase price: $970k (click on map link to verify).

At 10:05 AM, Anonymous assumptionsRus said...

Just for fun: assuming 20% down payment on $970K purchase price, here are the monthly costs associated with this home that would rent for b/w $2,500-$2,750:

Mortgage (conventional 30yr): $4,650
Taxes/Insurance: $1,025
Loss of Income from Down Pymt (@ 30yr T-rate of 4.5%): $735
Maintenance/Garden/Etc: $250

Gross total = $6,660 (250% of rent)

Tax benefit approx $1,100 a month assuming 30% bracket. Plus $775 a month in equity build.

Net total=$4,785 (180% of rent)

This does not take into account any capital repairs that could be incurred.

A buyer using I/O ARM could reduce monthly mortgage costs but then no equity build. So math looks even worse on balance sheet, if not on P&L.

After five years, with trad mortgage, buyer would have accumulated $54K in equity and realized $67K in tax benefits. But he/she would have paid $240K more than renting would have cost (assuming 3.5% annual rent increases). Net: a loss of $119,000 over the first five years of ownership. This would have to be made up in appreciation less any capital repair/replacement.

If this home is held for 30 years, the math works out better, but there are many unknowns in that equation.

Clearly, buyers today are ASSUMING a minimum of 5-10% asset appreciation annually, otherwise these prices make no sense. But given a 300% gain in home prices in SF since 1998, how realistic is that assumption?

At 10:15 AM, Blogger Ben Jones said...

(Clearly, buyers today are ASSUMING a minimum of 5-10% asset appreciation annually, otherwise these prices make no sense. But given a 300% gain in home prices in SF since 1998, how realistic is that assumption?)

Great analysis. When you consider that the real growth in home prices over the last 150 years is less than 1% annually, these buyers are taking a huge risk.

At 10:30 AM, Blogger goleta said...

Just like it is for stock market, a burst is much better than a 10-year gradual deflation. Who wants to buy a house when you know you'll have to sell it at a loss? Not to mention property tax, mortgage interest, home owner insurance, and the cost to maintain the house? The rising level of green house gases and the deforest of the world, which is partly due to the global housing boom, is resulting in more solar energy being trapped on the surface of the Earth. More and more unusual and violent weather patterns are happening everywhere in the world and it'll only get worse.
The cost of maintaining a home will get much more expensive and many homes will be lost.
A recent research shows glaciers in Antarctic are retreating faster and that means sea level will rise faster.

When the rising sea level combined with the increasing energy being trapped in the air and water, the storms and floods are going to be more powerful. Expensive houses with ocean, lake, or mountain views are exactly the ones closer to where most of the damage will be.

At 10:31 AM, Blogger John Law said...

I don't understand why so many people think things just level off.

At 10:33 AM, Anonymous hellboy said...

Kind of off topic, but man is this an example of appraisal abuse/inflation! How does a house go on the market presumably appraised at close to $699k and sell for almost $300k above and get financed? Sure if the bidder wants to pony up the cash over the appraised price then party on; but the banks and appraisers just shouldn't be doing this( an aid to over bidding )?

At 10:37 AM, Blogger desi dude said...

how many of you frequent financialsense web site?

I was browsing through their commentary during 2000, stock mania
here is ont hing that i found interesting

Boomer Theory Justifies the Rise

The higher stock prices are being justified by the paradigm of technological transformation. Technology is advancing and the markets, despite high prices can only go higher. One theory that justifies all of this is the "Boomer Theory." Baby boomers worried about their upcoming retirement will continue to fund their retirement plans, 401(k) plans and other savings. This will supply a continuous stream of new money into the stock market. With constant demand for stocks coming from worried boomers fretting over their retirement needs, their only outlet for all of that money appears to be the stock market.

In less than a decade, an onslaught of boomers will hit the retirement market. Unlike their parents, who held lifelong jobs with one company and had guaranteed pensions, the boomers have been more mobile. The old defined benefit pension plans, which guaranteed a pension at retirement have been replaced by today’s popular 401(k) plans. The boomers will only have their 401(K) plans and their savings to get them through retirement. Since they don’t have many years left to fund their retirement, boomers will look for higher returns afforded by the stock market to make up for time and lack of savings. Because the stock market has been the vehicle of choice for higher returns, the boomers will continue to flood the market with their retirement savings. This desire to fund their retirement shortfall is forcing boomers to be more aggressive with their investments. As we've seen the sector of choice for higher returns this decade has been technology.

In the above paragraph, replace tech with house, what do we have???

At 10:38 AM, Blogger Ben Jones said...

(a burst is much better than a 10-year gradual deflation)

I agree and lets hope that is what happens. If the decline dragged out until the baby boomers retire, we could see prices go down for 10 plus years.

If the market forces are allowed to do their thing, the better outcomes will emerge.

Right on as usual. I can't get that crazy purchase out of my head. What are they thinking?

At 10:39 AM, Anonymous Anonymous said...

In San Francisco, people are making outrageous offers to sellers to get them to sell their houses without bidding wars. This is likely what happened here.

What bank was willing to sign off on 970k for that house?

At 11:08 AM, Blogger deb said...


An article in today's Economist concerning the global housing bubble contains this stunning claim:
"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."

Let's run those numbers real quickly. The median household income in Los Angeles, according to Wikipedia, is $42,189, while DataQuick lists the median home price as $420,000. The NAR Affordability Index puts Los Angeles affordability at 17%, meaning that only the top 17% of wage earners can afford the median priced home. (As I've mentioned before, the problem with the Affordability Index is that it accounts neither for "creative financing" nor for income from home equity gains. However, since those two factors are very likely ephemeral, the Index actually provides a good idea of who should be buying, if not who IS buying).

Now let's project 10 years into the future. As of last month, per the BLS, incomes were increasing at a rate of 2.6% per annum. Assuming that trend continues, the median household income in Los Angeles would be $54,535.

Not bad, except that at the anticipated home price growth of 22% per year, the median LA home price would be over $3 million. The Affordability Index would put Los Angeles at an impossibly low 3%--and even lower if rates were to rise from their current rock-bottom levels.


22% a year... unrealistic expectations, nah!

At 11:23 AM, Anonymous Anonymous said...

Great analysis.

At 11:51 AM, Anonymous dontpanic said...

Regarding the SF home, the math indeed works out better if buyer holds for duration of 30yr mortgage. Obviously, at that point, the home would be owned free and clear. There would be no mortgage to pay. Of course, no tax benefit either.

But who owns homes for 30 years anymore? Folks are much more mobile and the avg holding period in Calif over the past decade has been about 5.5-7 years.

So if the buyer of this SF home ends up staying the avg length of time (5.5-7yrs), this is a very bad deal. Very little equity build (none if he/she goes the I/O route). And with rents less than 50% of ownership costs, the monthly loss would be staggering.

Nothing short of a continued bubble for many years to come could close to making this purchase financially sound.

I rent in NorCal. When I did the math on my home, I discovered that it would have to appreciate 35% over the next five years in order to simply break even when evaluating rent vs. buy. So I chose to rent figuring that another 35% gain in so short a time is unlikely. And, of course, if my home went down in value, oh boy. I could be out hundreds of thousands if I had to sell in the next 5-7 years.

I feel sorry for those panicking to buy today in Calif. Just remember, over 70% of the homes sold in SoCal in '93 and '94 were sold AT A LOSS. Why? Too many people panicked in '89 and '90 and bought at the top. They tried to ride out the ensuing correction but thousands weren't able to. So they panicked and sold (or were forced to by circumstances.)

As before, so again.

At 11:57 AM, Anonymous will said...

I really wish I could see the bids on that house, to see how it got so high. My suspicion is there were just a few, or maybe 1 "stratospheric" bid(s) - Like the person who bid 60K over the next highest bidder in my story in NJ and the young "real estate mogul" in the NYTimes a few weeks ago who's M.O. seemed to be offering 10% more than asking price as his first offer, it looks likes textbook "marginal players" (aka crazy people) at work. It's shocking how a relatively tiny percentage of people can wreak such havok in the last days of a bubble.

At 11:58 AM, Anonymous theycallhimflipper said...

I may have posted this before, but check out what is being sold in LA as a "vacation cabin". This will be a nice souvenir of the housing bubble, much as I treasure my analyst reports of and others from the dotcom days. By the way, the last drkoop report I have is from a white-shoe investment banking firm from 1999. Says to expect drkoop to exceed $5 billion in revenue by 2005. Turns out they were a little off.

"Vacation cabin" link. Perhaps a coat of paint and some granite counters could turn this into a great "flipping" opportunity:

At 12:01 PM, Anonymous theycallhimflipper said...

Follow-up to the "vacation cabin" post:

Oh my god. I ran across this dump two weeks ago and it was listed for $150K. Now it's $265K. Jeebus. Guess i shoulda put a bid in while it was still a bargain....

At 12:08 PM, Anonymous wowser said...

I've figured out how they can get $500K for that shack: Use the power of suggestion by planting tulips all over the lot.

Of course, granite counters are a must. As are SubZero appliances. Also point out that the home has been designed to adhere to Feng Shui principles.

At 12:29 PM, Blogger Nayrab said...

Yes, I too saw this dump listed for $150,000 two weeks ago. Makes me wonder if a flipper has already bought it and is asking for $100,000 more. It would not surprise me anymore. What does surprise me is that there are people dumb enough to fall into the bubble trap.

At 12:35 PM, Anonymous doglover said...

Seeing that shack just got my mind to thinking: is there anything I own that I could convert into valuable real estate?

There's a broke-down treehouse on our lot. I could invest in a few nails and some paint and sell it as a "urban idyll" or "aerie in the sky". That might be good for a couple hundred grand.

Then there's always my dog's rectum. It might not sound appealing at first, but with some recessed lighting and a few built-ins, it could become a "cozy retreat". Plus there's the novelty value of being the first to live in a dog's ass. The mind reels with the limitless possibilities.

At 12:46 PM, Anonymous Anonymous said...

First anon here again. I just looked the 970k SF house up doing a public records search. It was appraised in 2004 at 550k.

What kind of appraisal was that? Tax appraisal? Does that kind of appraisal have anything to do with purchase price?

At 5:10 PM, Anonymous Anonymous said...


Wow... your dog's ass sounds pretty good... maybe you should hold onto it and rent it out... if so, is heat and hot water included?

At 12:59 AM, Anonymous Anonymous said...

desi dude,

I love that "Boomer Theory" article. This is similar to the kinds of arguments made about the NASDAQ that it was a "new economy" and all of the day traders were laughing at Buffett and others because those guys didn't "get it."

In any event, the Boomers won't have a very pleasant retirement, that's for sure.

On another note:

EXPLOSIVE ASSET APPRECIATION DOESN'T GIVE WAY TO MODERATE GROWTH. I wish that guy from the NAR would shut up with that already.

At 2:11 AM, Anonymous Anonymous said...

My God, what a load of self-serving crap! This can only be described as a circle-jerk...a bunch of guys whipping it out and comparing size. There's hardly a grain of truth in anything they say. And bragging about "innovations" like interest-only loans! These guys have no shame.

At 7:32 AM, Anonymous Anonymous said...

that guy from the NAR isn't going to shut-up... he will say whatever he has to to make is seem like everything is booming... it's his job... i just find it curious of how he's trying to manage expectations with the release of the latest existing home sales due out next week...

At 1:12 PM, Anonymous doglover said...

I don't think i'd rent out my dog's ass. I'm looking for more of a flipping opportunity. My main question now is whether I should do a condo convert or go the time-share route. Any suggestions would be welcomed...

At 3:16 PM, Anonymous Anonymous said...


Go for it. This is the New New Economy, where we can monetize anything. Pretty soon we'll have to restate the GDP to include box office sales, burgers flipped, and Wal-Mart shoppers greeted.

At 4:27 PM, Blogger Ben Jones said...

(This is the New New Economy, where we can monetize anything. Pretty soon we'll have to restate the GDP to include box office sales, burgers flipped, and Wal-Mart shoppers greeted)

I love it, the New New Economy! I think they already have recatagorized burger flippers as manufaturing.

At 12:09 PM, Blogger Avanti1965 said...

Playing devil's advocate:

The Los Angeles real estate market is far from the Bay Area market. Why on my block in the last couple years we've have 3 new renters, refugees from the Great Bay Area!!!

At 12:11 PM, Blogger Avanti1965 said...

The Bay Area is not Los Angeles. Prove me wrong (I'd love to be wrong), but Los Angeles area (i.e., Los Angeles, Orange, Ventura, Riverside and Santa Barbara counties) aren't going to crash. Price will soft land, dip around 7% by 12/31/05


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