A Minefield Of Myths
There are loads of major media reports on the housing bubble these days. Most survey the situation and promptly tell us not to worry. This WSJ article includes a couple of myths that need to be addressed.
"Real-estate prices can't tumble on a flurry of panic selling, as happens when a stock-market bubble bursts. After all, everyone needs a place to live. 'Stocks have a single market, low transaction costs and the capability of people to pile on nationally,' Robert Curran at Fitch Ratings, 'Housing markets are all local. Transaction costs are large. To sell your assets you have to move.'"
Does he mean that homeowners are trapped in their illiquid "market", and therefore can't panic? If an asset is overpriced, does being in a local market change the odds it will return to its' true value?
"Homes may not appreciate as quickly, or at all, for a while. Nobody likes that." I invite the writer to visit the comments section of this blog to see opposing views on that.
The story ends with a familiar theme, we're OK as long as we're OK. "Mr. Mayer says people shouldn't fret too much about drops in housing prices, unless there is "an appreciable downturn in the economy" or another major terrorist attack. 'Then we need to worry,' he says." By then, of course, it will be too late to do anything about it.
42 Comments:
I've decided to not pay more than three times the local median household income for a 3br/3bth single family detached home.
In a few years, I'd be ready to buy. At that point I'd do the above calculation and offer any sellers that price. If all us last few buyers would do the same everywhere in unison, the housing bubble could quickly be deflated.
"Homes may not appreciate as quickly, or at all, for a while. Nobody likes that."
.... How long do you all think it will take for the drop to happen, and then how long after that until it starts appreciating again? I think it could take years - 10? - before prices reach these levels again.
I think this bubble would burst a lot quicker if the media wasn't running a "there is no bubble" propaganda campaign to sell more real estate advertising in their news papers.
Anon: you are a very smart man.
I agree that all of us should get together and temper our offers. The problem is that there are still a bunch of idiots who would pay 20% more than us because they expect the price would go up 20% in the next year.
Where can I find data on what percentage of new homes are being purchased with ARM's, and what are current foreclosure rates? Thanks.
Jim in Venice,
(How long do you all think it will take for the drop to happen, and then how long after that until it starts appreciating again? I think it could take years - 10? - before prices reach these levels again)
After the oil bust in the 80's, almost nobody was buying. The was no price. And things were so bleak that it was hard to remember how long it had been bad. 10 years is a possiblity. Thx
(Where can I find data on what percentage of new homes are being purchased with ARM's, and what are current foreclosure rates?)
You have come to the right blog. Check out the many posts on that data. The percentage of ARMs varies, with areas above 80%. Foreclosure also varies but is increasing. All these numbers are changing month to month and I try to stay up on the situation. Thanks for taking the time to comment..Ben
"Real-estate prices can't tumble on a flurry of panic selling, as happens when a stock-market bubble bursts. After all, everyone needs a place to live."
The writer fails to take in to consideration the 25-30% of flippers, speculators and 2nd home owners who haven't the slightest intention of living in these homes.
This is the most outrageous quote in the article: "'Housing booms end with a whimper, not a bang,' says Karl Case, an economics professor at Wellesley College."
Really? I've lived in Japan since shortly after the housing boom here burst, and I would be pleased to show the good professor just how wrong he is.
It's been nearly 15 years after RE prices started to fall here, and guess what? They are STILL falling. It is so bad now that anybody who buys a home does so with the expectation that it will DEPRECIATE in value. Banks have been lending money at 2.5% fixed interest rates, but that has failed to stem the collapse.
Professor, this is what can happen after a housing boom. The fact that previous US housing price "corrections" were mild means absolutely nothing. The previous "corrections" happened when sensible people still were running the US mortgage lending system. Now it is run by idiots (just like in Japan during the RE bubble). IMO, the end result will be the same.
(I've lived in Japan since shortly after the housing boom here burst, and I would be pleased to show the good professor just how wrong he is)
Great insight, thanks for commenting. Please keep us up to date on the Japanese market.
Ben
Educate me: did the Japanese bubble burst in and of itself or did the economy trigger it ?
How does that compare to what is happening here ?
How come the Australian and UK housing busts seem to slow to adjust prices ?
It doesn't seem like all of a sudden prices are going to drop 20% here. Or am I wrong ?
We should start a pool: when will the house price decreases start ?
we had a posting here a few days ago about the collapse of the Australian bubble--that seems to blowing up with quite a bang. What was it? Down 40% in less than a year? Go look through the blog archives for April.
At 7:47 PM, John Law said...
it's amazing how ignorant people are of pre-WWII economic history.
It's amazing how ignorant people are of post-WWII economic history. Last time, it took 70 years to get people believing in an endless free lunch again. This time it only took about 3 years...
"Real-estate prices can't tumble on a flurry of panic selling, as happens when a stock-market bubble bursts. After all, everyone needs a place to live. 'Stocks have a single market, low transaction costs and the capability of people to pile on nationally,' Robert Curran at Fitch Ratings, 'Housing markets are all local. Transaction costs are large. To sell your assets you have to move.'"
Wrong assumption sir. Sir you are assuming the person will "sell" the house. A home owner does need a place to live but he does not need to sell the house. Go into FORECLOSURE. Here is how the game will be played:
Take out a loan (bad credit no problem), Put no money down, make a few minimum payments here and there and live in a nice place with low rent.
House price decline and you are upside down.
Put off the foreclosure as long as possible.
After the homeowner is forced out by foreclosure he wins. He lived in a new place at a low price. Cheaper than renting!
Winners:
Renter-Lived in a nice place at a low price.
Realtor-Made money on the sale
Home builder/Seller-Made big profit
Loan Officer-Made commission
Loser:
Holder of Bond
Score:
4 made money. 1 Lost.
Question Ben: Does anyone know how long it takes to be forced out by foreclosure?
(4 made money. 1 Lost.)
4 made a small amount of money, 1 lost a huge amount of money.
Oopps! forgot about the seller.
3 made a small amount of money.
1 made a big amount of money.
1 lost a big amount of money.
realist-
the 100 year loan is about as ridiculous as an 80/20 interest-only arm. No money down, no equity building, pure debt vehicle.
An 80% correction in some areas of California still wouldn't make properties have a positive p/e. Some rents are less than 1/3 of what the mortgage costs. Also, an 80% reduction wouldn't make the median house affordable by more than 50% of the population.
The Japan/California comparison works in many ways.
(Does anyone know how long it takes to be forced out by foreclosure?)
It varies state to state. In some states you can't evict a pregnant woman, etc.
Just to prove my point, here is a link which has a nice .pdf showing affordability and median incomes.
http://www.cbia.org/index.cfm?pageid=1061
One area shown is Salinas with a median house price of 525k and a median income of 60k. Current affordability is a whopping 5.2% (same as Los Angeles.) Assuming an 80% cost reduction as in your example, the median house would cost 292K. The payment on this house would work out to be $1796 / mo. (30 year fixed, 20% down, 6% + taxes and insurance.) This is slightly OVER 30% of annual gross income. Therefore a person with a median income in Salinas still couldn't afford a median priced house WITH an 80% reduction. L.A. and San Diego are very similar.
>>>the japanese comparison is a "myth". before the japanese real estate collapse, the imperial palace grounds were valued at more than the state of california. prices got so ridiculous that 100 year loans were instituted. this wasn't a collapse, it was an 80% correction.
Enron wasn't a collapse either; it was merely a 99.9% correction.
Regarding 100-year loans, we're there already. An interest-only loan essentially has an infinitely long maturity. At least with a 100-year mortgage you're paying a tiny bit of principal. OK, on a $250K, 6%, 100-year loan you start off at $3 to principal a month and don't get to $5 for about eight years, but an IO loan is materially the same.
"One area shown is Salinas with a median house price of 525k and a median income of 60k. Current affordability is a whopping 5.2% (same as Los Angeles.) Assuming an 80% cost reduction as in your example, the median house would cost 292K."
I'm confused by the math. A 80% price reduction on $535k does not equal $292K: $525k * (1-0.8)= $105k
Am I missing something here???
292 * 1.8 = 525. 292 * 2 would be a 100% cost increase.
Why, oh why, oh why is Salinas so expensive in the first place? Are people moving there and commuting the hour-plus to the South Bay? Just to save about 10% on housing costs (San Jose is at $557K vs. $525K for Salinas), which you just turn around and give back as commuting costs?
I mean, Salinas probably isn't a terrible place to live, but then again there's nothing special about it -- it's not on the coast, the only real industry is agriculture, there are no major employers or cultural institutions or schools there... it's Stockton or Modesto with 75% higher house prices. What's the deal?
I guess a simpler way of looking at it is when affordability is at 0% or thereabouts, it would take a 100% reduction (or 1/2 of current prices) to make a house affordable for a person with a median income. The numbers on that report are VERY frightening.
(Regarding 100-year loans, we're there already. An interest-only loan essentially has an infinitely long maturity)
Excellent point. Thanks.
Chris Cagan of First American (firstam.com) has put out a couple of great studies of the SoCal market. His Oct 04 report had some terrific color-coded charts that tracked the last boom/bust (85-95) year-by-year.
It shows that there was a transition period b/w boom and bust from 89-90 when some SoCal areas were still "hot" while others were dropping in price.
The market really started getting cold in 91 and the worst part of the bust came in 92-93---four years after the top---when every zip code in SoCal was declining in price and foreclosures were rampant. At that juncture, nearly 70% of all homes sold in SoCal were being sold at a loss! The bust bottomed in 95. Cagan believes that the SoCal market topped last summer (2004).
If past is prologue, the current period could be our "transition" year b/w boom and bust. The bust would then pick up steam next year with 2008-2009 being particularly bad.
Of course, our current boom is dramatically more bubbly than the late 80s version so we could see things unfold more unpleasantly. Time will tell.
[Ultimately, Mr. Mayer says people shouldn't fret too much about drops in housing prices, unless there is "an appreciable downturn in the economy" ... ]
In the most bubbly areas of the country (California, in particular), real estate IS the economy.
[Ultimately, Mr. Mayer says people shouldn't fret too much about drops in housing prices, unless there is "an appreciable downturn in the economy" ... ]
In the most bubbly areas of the country (California, in particular), real estate IS the economy.
"I guess a simpler way of looking at it is when affordability is at 0% or thereabouts, it would take a 100% reduction (or 1/2 of current prices) to make a house affordable for a person with a median income. The numbers on that report are VERY frightening."
A 100% reduction results in a price of $0.
"One area shown is Salinas with a median house price of 525k and a median income of 60k. Current affordability is a whopping 5.2% (same as Los Angeles.)"
Affordability is 5.2% in Los Angeles according to whom? Are you the same anonymous who's posting erroneous numbers about 80 and 100% reductions?
one problem with posting anonymously is that we don't know who is credible.
The most important part of the whole discussion is this -- the article tries to convey comforting RE axioms, such as "if you can stay in the place for seven years, you won't lose money." Well the mush of historical figures and probabilities may tell you that, but you can't at all sure, especially with the way above-trend price growth of the last few years that are not really at all comparable to past data. I surprised that ANY econ prof. would be repeat such tripe. No finance prof. would say such a thing with surety about stocks or bonds. Asset prices are subject to risk and financing factors that are simply too unpredictable down the line.
Add to that, when you pay $750K for a place that may be "economically" worth $300K, chances are decent you won't come out on the plus side after a good many years, especially given the property taxes, upkeep, and insurance you've been paying.
The "What to Expect" section is completely glossed over.
Even in housings worst years, prices rarely collapse.
Yeah, but when was the last time we had 23% of the housing stock being purchased by speculators and more than 1/3 of the loans ARMs (many of them interest-only)?
Many sellers are forced, in turn, to either lower their asking prices or pull their homes off the market. They often decide not to sell if they don't have to.
Yes but what if they do have to sell? What about the properties that fall into foreclosure?
If speculators -- those gobbling up homes as hot investments and not as residences -- succeed in driving prices too high in a particular market, the chances go up that home prices could take a tumble
Now they admit that prices could tumble under certain circumstances. Well, I think these circumstances have already been met in most of the largest markets in the USA!
people shouldn't fret too much about drops in housing prices, unless there is "an appreciable downturn in the economy"
The OECD and IMF are predicting a downturn in the world economy. I think that a downturn in construction in the USA will be the catalyst here. I also think that we are now in the beginning stages of it. Just look at the sector ETFs for finance (IYF) or real estate (ICF). Both of these are clearly in a downtrend. Remember, stocks are the most dependable forward - looking financial barometer we have.
Let me see, rising rates, unprecedented speculation, and the sectors stocks are trending down. I wouldn't touch real estate with a ten foot pole!
Remember, all it takes is one house on your block to sell for 50% less and all the houses on the block are worth 50% less! A less liquid market is more risky, not less!
Excellent post John in Seattle.
Less liquidity is a negative, not a positive. Less liquid instruments, such as houses, can hit price "air pockets" much more easily than high-volune, standardized securities that are totally interchangable. "Don't worry, people won't be able to sell there homes in a crunch" is NOT a good thing.
Why do public companies go for a higher equity price than comparable private ones? The liquidity premium -- it's typically 25-30% or so.
It seems like people are forgetting rent when they talk about waiting to get into the RE market. When you wait to get into the stock market you are not _losing_ money. You put your money aside and wait till you feel the market is good. When you are waiting to get into the RE market you are LOSING money every month through rent. Big difference. Sure, the market is going to correct itself, but how much are you willing to lose in the meantime?
Here in SoCal rent near beach is $1800/month. If market downturns in my area, it would have to go down roughly 1800*12 per year of ownership from my original purchase price before I start losing money-- assuming I HAVE to sell. That's a lot of drop.
Stephen,
If you have a mortage, in the early years most of your monthly payment goes towards interest payment. So what you should be comparing is your monthly interest payment and the rent your pay for a similar place.
If your interest payment is much more than what you'd pay in rent, then you are most likely losing lots of money to "own" a home.
In my case, my rent is $1250/mo. A mortgage for my place would cost $2000. So I'm neting about $750/mo.
If housing depreciates, that's a double whammy. If housing stays flat, then the renter still wins out. If housing keeps appreciating, then the renter can just take all the money he's saved and leave the "bubble areas" all together.
I could forsee such a migration happening very soon. Young talented people starting off need to put down roots in a bubble area.
With communication as it is, they can move en masse to low cost areas and build the economic hubs of tomorrow. All the while buying up cheap real estate in non-bubble areas. Did you know $200K can buy a mansion in many towns.
Is it time for the Great Migration?
Not yet, but give this 5 more years, and I might just be willing to spear-head such a movement. All it would require is some organzation and a slew of young 20 and 30 somethings willing to build an economic hub from the ground up.
Any takers?
Methinks Stephen was not a math major.
(but give this 5 more years, and I might just be willing to spear-head such a movement)
We should stay in touch. Great idea!
I'm talking about people buying homes to live in, not speculation or flipping. And to live in for many years.
You don't have to be a math major to understand that if the rent is close to owning (which it is in my area) and you_can_afford_the_house, you are getting a better deal by jumping into a hot market than staying out and paying rent. Even just paying interest on your loan for the first couple years works in your favor with these interest rates. 5.7% fixed 30 and in 2 years I'm practically matching inflation.
If you're sitting out of a market that you can afford the monthly payments on cause you don't like the price, I got news for you: you may like the price when the rates rise and the bubble bursts, but you aren't going to like how much it's going to cost you to borrow the money for the now cheaper place.
Say the average 450K place drops to 350K in 3 years cause interest rates have gone up. The person buying it @ 350K with interest rate of only 7% is paying roughly the same amount as their neighbor who bought it initially @ 450K with today's rates. Money saved = none. Money wasted on rent over the 3 years?
Stephen,
Your rent vs. buy calculation would be correct IF a couple of conditions are met. If the the all-in costs of owning (mortgage P & I, taxes, insurance, upkeep - related tax deductions) are roughly in the same ballpark as equivalent unit/residence rent, it's generally advisable to own if you are staying in area for a while. Be it noted that I think many people underestimate the real costs of owning, to the everlasting joy of the realtors everywhere. If everybody really broke out their home-cost related receipts at the end of the year, most would be shocked.
Back to owning. You also get the embedded call option (with the strike price at your purchase price) in owning that does have some value. You also get the option of adding value to your property -- again, that has some value. You have the added benefits of borrowing against the property and borrowing money at a set price vs. inflation. All these make owning a good idea if rents are in the same ballpark, maybe within 10-20% of buying costs. You could go a bit higher if you think there is a good possibility that homes in your area will appreciate.
The problem is -- the above stated case is available in few places at this point in the appreciation cycle. In many elite areas, rents are 30-40% of the BASE all-in costs of owning. I know of few beach areas in the US where rents are close to buying costs. If you are in one, all the best to you. I hope your investment turns out well.
But whatever you do -- don't believe the hoary old "rent is wasted money" line. There are scenarios where that has a ring of truth, just as it does in certain cases where people overpay for an asset. Rent is a fee for a good provided. Is buying food a waste? How about gas? Why do most commercial businesses rent or lease their space, not buy it? Flexibility, avoidance of forward fixed costs, lack of liability. People can want the same things.
The same logic also overlooks opportunity costs. If you are dumping significantly more money into buying than renting or have liquid assets that can be put to work, you are potentially missing out on something else to do with the money that may be more lucrative. For the past 3-4 years, it's admittedly been hard to make argument that there's a much better place to park money than real estate (unless you were an energy or commodities investor, which I am ;-)). The thing is -- what's in the rearview mirror is not necessarily what's down the road. When you consider the appreciation that's already baked-in the cake, a Fed turning down the credit spigot, a slowing economy, and accelerating primary goods inflation (but interestingly, not wage inflation), and an a homebuilding industry that is building well-ahead of household formation, RE may have serious opportunity costs going FORWARD. Buying at this point in the cycle in areas that have already had substantial appreciation could be troublesome. I have non-real estate assets that pay me about $20K a year in additional income -- real money. This number is rising along with yields. This income largely comes from liquid assets I was able to accumulate from very cheap rent (way below buying costs) over the last several years.
Now I have multiple options. I can take a small slice of this dough and make a downpayment on a place or in the current environment, none at all. I can play both sides of the RE game with nothing down -- buy a place, pay the negative-amortization interest-only costs and other expenses. If the property goes down in value, I can simply walk away. I know the mortgage lending industry -- a foreclosure on your credit record means next to nothing anymore. People still get mortgages after multiple foreclosures, because banks are collateralizing against property (a danger), not people and their attendant earning power. Guess what? If I walk away, I still have my liquid assets in the income they produce. All from doing a remarkably "stupid" thing like renting.
What I am saying is that there are no pat or easy general answers in the rent vs. buy question. It's always personal and particular. If someone tells you otherwise, run. I think the general tenor of this board is that the rent vs. buy equation on a "macro" scale has shifted in favor of renting. That doesn't mean there aren't situations out there where buying makes solid sense.
>>>Say the average 450K place drops to 350K in 3 years cause interest rates have gone up. The person buying it @ 350K with interest rate of only 7% is paying roughly the same amount as their neighbor who bought it initially @ 450K with today's rates. Money saved = none.
This is WRONG. Let's do the math.
Assume we put 10% down on the $450K house, or $45K. Also assume, as in your original argument, that rent increases at the rate of inflation. But you get this back because you earn interest on the down payment, too, if you wait to buy.
If you buy the house now for $450K, you'd get a 30-year fixed mortgage for $405K. This would be a jumbo, and right now you're looking at 6% at best. Monthly payment = $2,416.
After three years in the $405K mortgage, you'd have paid just under $16K of principal, for a total of $61K... but you'd have $389,140 of balance remaining on a now $350K house, so you'd be $39K underwater. Oops.
Meanwhile, if you wait three years and can buy at $350K, you'd get a 30-year fixed mortgage for $305K at 7%. Monthly payment = 1,984. The difference between being $39K underwater and $45K ahead will itself buy you a house in much of the Midwest.
So by waiting you'd have a SMALLER payment and MORE equity.
Stephen,
Even if interest rate will be higher than now, it does not mean that it will stay on that level for 30 years. When it will be low again what will keep you from refinancing?
In my area (SoCal) mortgage payment plus taxes and HOA-s is much higher than rent. What really suprises me that housing prices are 7-10 times of median household income. So, the only way to get into a house here for average person is to take IO or ARM loan and sell it later within 1-5 years. In this case you gain from it only if prices go up. If prices will not go up, it is the same thing as renting.
JJ, Deb, boyinbubble, Stephen,
Thank you for those excellent posts.
No problem Ben -- keep up the stellar investigative and analytical work!
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