patrick.net

Housing is illiquid. I believe the top is in. Declines in prices will be slow. Housing bubble bust take a long time (1990 took 5 years; Japan took 15 years).

The bottom may not drop out until the mortgage defaults are large enough to collapse mortgage backed bonds, collateralized debt obligations and lastly derivatives.

Wait for the bottom to drop out first. Then second, wait until owning and renting cost the same. Last, pick the lowest price tract of homes surrounded by higher priced tracts.

@jeffolie,

Renting is historically always cheaper than owning (at least since the creation of the Middle-class & the Industrial Revolution). I have my questions about how useful rent-to-mortgage ratios really are.

@astrid,

The jury is out on how effective arbitrageurs are at keeping the stock market efficient. I've seen some pretty convincing case studies that posit that there is insufficient liquidity and capital reserves for arbitrageurs to do much to fix broad-sentiment psychology-driven inefficiencies in the market.

As to our model, we are talking about creating a model free of frictions and interventions first to see if we get threshold behavior (big, rare events like bubbles and collapses) to emerge. It may be that government interference is unrelated to preventing bubbles or collapses -- we won't know until we try step-1.

astrid,

I'll look for those later today or tomorrow and post to my blog and cross-link here. I was also schooled by some hard core market fundamentalists. But I also had the fortune of being exposed to some behavioral finance and consumer economics which make compelling cases against the "pure-efficient-market" assumption. A lot of empirical study has gone into the dot-com bubble and why there was not enough aggregate arbitrage power to correct for (now) obvious inefficient pricing.

SQT,

I agree, but what concerns me about rent-to-mortgage ratios is that they have long-term secular trends over time. It may well be that ratios never return to "where they should be" if in fact we are seeing a real widening of socioeconomic gaps. Put simply, if we are pushing more and more people into the "lower end", then we are recreating a land-owning class. At least enough to cause a trending in the ratio. The risk is that people really do get priced out (at least for a major part of their lifetime) if they misread the signals.

Note, I'm not making any judgements about whether one _should_ even bother owning if all that is true. Just a "all other things equal" analysis.

One needs to make the trade-off between lifestyle and $$$ in this case, I know I sound like a realtor now.

If you are looking for the bottom and the deal of the century, don't even start looking until 6 years later. Why 6 years? Two rules of thumb, the tail end of this ARM reset won't be over until 2009/2010, and foreclosure usually has a lag of at least about 6-12 months, that will already put you through 2011, the earliest. We are not Japan, so people don't have that many savings to burn, still, owner-occupier won't let go their homes until all possible options are exhausted. BA is still a predominantly owner-occupier situation (more than 50% for sure), so don't expect people to start getting desperate until then. The other rule of thumb is, BA market after the 1989 crash didn't fully bottom out until 1995, 1996 was the year that things generally started to climb out, that bottoming out cycle was 6 years.

Put in a grander scale, RE bust is only a part of the general problem that this country is struggling with. We have far more time bombs than just RE to deal with, the SS/Medicare/trade deficit/Iraq mishandling will ALL come to head in the next few years, and they will intertwine with each other on the spiral down. Honestly speaking, when all these things blow up together, you may wonder if you want to buy a home in this country. Remember in 1999? Everybody was hoping for YHOO and AMZN to come down a bit so that they could add, every time there was a minor correction of few percent, people couldn't wait to jump in. But when the sh*t hit the fan and the stocks eventually plummeted, did anyone jump in? Anyone? How long do you think that those who bought AMZN and YHOO at historical high will be above water again, even in nominal values?

Of course one needs to weigh the time of waiting against the marginal depreciation of the home value to see if an extra year of wait is worth it or not. After all, it is not all about money. One also needs to take into consideration of the strategic devaluation of USD that will very likely be pursued by the Fed, so that the nominal value of homes may NOT go down that much if not adjusted for inflation and devaluation.

In any case, I don't think anyone should be in the market before 2009. Let's talk again after 2009.

What Randy H says applies to certain desirable neighborhoods, but not most of BA.

My wife's family has been here for two generations, they migrated to BA before it was known as the Silicon Valley. According to what she told me, some old and established neighborhoods here never saw a decent rent-to-own ratio, it never made sense to buy in Saratoga for rental income, appreciation has been the name of the game for many years.

However, it WAS not the case for Mountain View, Sunnyvale, Menlo Park back in the 60s. Her family's landlord actually bought rental homes in these locations mentioned above for good cashflow in 1965 or so, until they became "discovered". Once a place becomes a "hot" location, it does seem that the rent-to-own ratio starts to skew permanently.

There's a UCLA physicist who modeled the RE crash, and he was spot on in timing the turn of the market (first quarter 2006). He was using some kind of momentum/fluid dynamics in predicting when the market should turn, and I personally like his approach better than models with too many assumptions on a plethora of variables.

His name is Didier Sornett, he also has other publications regarding the crash of the stock market. Randy, you may want to check him out. The UCLA website seems to be down right now.

http://www.businessweek.com/magazine/toc/06_15/B39790615housing.htm

This link is to BUSINESS WEEK online magazine.
You can post your comments abot their housing articles and they will print them. POST YOUR OPINION
BE HEARD

Thought I'd repost this as it may have gotten lost in the last thread. ;)

Troll

@Hokies, perhaps you would not notice a huge spike in demand and prices if you were to pull your head out of the dark smelly lower buttock region. Hope this helps.

When should a person buy?

After "The Big One."

After you win "The Big One."

After the housing market takes a "Big One."

And not until then...

Amen!

hokies,

I think the operative word is "some" in your post relative to properties are selling. It is the larger market that is not. There are always anomalies, and that is all you point out, and that is why you are a labeled a troll. The larger trend is the point and the focus here. And that trend has become clear.

By the by, that is a pretty nice condo. If I had 1.5 mil cash layin' around, I'd buy it, if I didn't mind losing half of it.

Hokies posted a condo URL and wrote:

"Went 55K over asking and supposedly closed last week. People are still buying."

The deal did sell for above asking price and it recorded in early March. The title report said that the same unit sold in 2003 for $800K so it has appreciated by almost $200K a year since then. I wish I listened to my REALTOR friends and bought it so I can sell for $2mm in three years (or maybe wait another 5 years and sell for $3mm) since there is no such thing as a real estate bubble condos that were "selling" for $200K in the mid 90's will now "appreciate" by $200K per year from now on... At the current price the buyer will be paying about $1,800 per month in Property Taxes and HOA fees + a mortgage that may be as high as $8,000 a month. Sure you could rent a nice condo in Pacific Heights for $55K a year less but when you add the virtually guaranteed $200K appreciation (since there is no bubble) buying seems like a great deal...

Well said, AptBroker. I agree with you totally. But since I am a total loser without a half-million downpayment, if you buy it I will be more than happy to rent it from you for $1,800/month. Like I said, it's a nice place. I'll sign a five year lease TODAY! I'm a really, really good tenant. I promise. You don't need verification of income, or credit, or anything silly like that, right? Just think of it, you will be laughing merrily as I fork over my pittance to you month after month after month while you bask in the gluttony of never ending appreciation.

I'll buy when I'm darn good and ready to...and not a minute before. The more the realt-whores and trolls tell me to buy, the less likely I am to buy. Maybe it'll be one year...maybe five...maybe not until my kid goes away to college. I would have to find the right house , for the right price, in the right area.

I’m with SQT’s camp too. Using your assumption that the poor are permanently priced out and your point that rent is lower than ownership, it stands to reason that the rich are actually subsidizing the poor through low cost rentals.

Of course this is all true ceteris paribus. As you factor in inflation over time the value of holding real assets, even initially cash flow negative real assets (held long enough), becomes valuable. The proposition I'm forwarding is one of real asset accumulation over time, not one of short-term "point" cash flow analysis. The rich aren't subsidizing the poor at all when looking at it through this lens. The poor are being "taxed" by inflation that the rich have avoided.

Just to emphasize: I'm not denying there is a bubble; I'm a strong believer that theoretically supportable prices have diverged from observed prices. What I am saying is that rent-to-mortgage ratios may not be as useful of a metric as meets the eye. I'd hate to see anyone miss the "buy signal" because they're waiting for rent = PITI when it will probably never happen.

OwnerOccupier,

There’s a UCLA physicist who modeled the RE crash, and he was spot on in timing the turn of the market (first quarter 2006). He was using some kind of momentum/fluid dynamics in predicting when the market should turn, and I personally like his approach better than models with too many assumptions on a plethora of variables.

His name is Didier Sornett, he also has other publications regarding the crash of the stock market.

Thanks, I'll look him up. We talked a bit about fluid-dynamics models in our discussions. Fewlish was a big proponent for Brownian motion based models. I am a believer in any model driven by Cellular Autonoma algorithms, regardless of the underlying physics (I am not a physicist, so I leave this stuff to those more appropriated schooled).

PS
Well said.

Linda, why am I a troll?

Perhaps it's because you are? Then again you might just be a castrated turkey.

Watch when the wealthy start buying RE again. Just like watching the wealthy dump their RE in spring/summer of 2005 was a signal to sell.

I would defnitely recommend buying a house to the wife when:

1) Our PITI to income ratio for a 3/2 1800 sq/ft home in good condition that has a good view of the SF skyline is 20%.
2) A realt-whore says "prices have actually gone down 40% in the Bay Area for the past two years and if you adjust for inflation, it's actually gone down over 50%. Now may not be a good time to buy unless you want to be an owner occupier and are not looking to own for investment purposes"

We don't have a lot of HAHAs and we don't make all that much (for the bay area), so #1 is not too likely to happen unless/until a 40-50% correction occurs in the housing market or I get a hefty raise. I don't know if we'll ever meet a realtor honest enough to say something like #2. But, I do experience periods of optimism in my life, so perhaps #1 and #2 could occur sometime between 3 and 5 years from now. Although dreaming usually isn't considered rational, I am allowed to dream =)

Unalloyed,

Warren Buffet dumped his California coastal vacation property in 2003. He started hoarding silver in 1998. California didn't top out till 2005 and silver didn't bottom out till 2001.

I hope he will still be alive and healthy in 10 years. I will try to time it 2 years after his entry :-)

Another data point, he started shorting USD in 2005, but had to cover when the market went against his position. He is still negative, but has taken a different stragety instead of timing the fall - buying shares of companies that derive most of their revenue overseas. Given his great track record and a bit-too-early timing, we should expect the fall of USD in 2007 perhaps?

In Bay Area I'm waiting for 50% price reductions. Until then I continue to enjoy my cheap and comfortable renting in a beautiful neighborhood with excellent schools. No hard feelings. I'm kind of sorry though for my landlord who's watching the value of his property falling while subsidizing my rent. He probably keeps dreaming about RE prices going up 10%+ every year. Isn't it a cute dream?

Forget timing: nationalise real estate, fix interest rates, control prices and even out the boom-bust cycle! Publicly execute realtors on a weekly basis who have been found to misrepresent property or stretch the truth, to 'encourage' the others...

the really disgusting thing is that realtors and others in the industry are always offered the best deals, are the first to know of a bargain, are always sniffing the wind on pricing, are in bed with developers, etc.

there's been a few real estate agents prosecuted here for really obvious scams of little old ladies, there was recently a prosecution of a network of about 10 mortgage brokers and realtors operating in one area, basically buying property low and selling it high by misleading vendors.

who knows what they're up to? for every prosecution or public shaming, how many more scams and insider dealings are perpetrated at the consumer's expense?

I personally can’t see why a purely rational person would want to own rather than rent. Tying so much of my net worth to one un-diversified investment is not optimal, and there ought to be a discount for that.

that's true, astrid, a study showed that investment in shares outstripped one in property over 20 years. however, unfortunately, you're either choosing to put a big slab of your earnings into rent or a big slab into home equity. when you look at the % of your earnings that will ordinarily go into rent or a mortgage, putting it into a mortgage is probably a better option, except when prices are through the roof, or you just can't get into the market. it's only if you have massive discretionary income left after paying your rent/mortgage that other choices of investment make sense.

and what happens when you're still paying rent into your fixed low income retirement? the reality for renters is that a significant % of their weekly earnings went into rent, they didn't squirrel loads extra away for retirement. peoples' mileage may vary here...

one recent analysis of sydney property suggested you would would make a loss for 35 years of holding an investment property purchased with a 100% loan - after that you would just break even. of course, if you paid cash for a property, you might get a 3% return on it from Day 1 - lower than just about any other investment. the 'bubble' prices in CA, DC, etc, would suggest a similar low ROI...

lovy Says:
"Before this insane appreciation about between 1996 to 2005 what was the rent Vs Mortgage of a similar house for BA."

From 1970 to 1998 you could buy almost any "normal" home or condo in the Bay Area (not including 12,000 sf mansions in Pacific Heights or 500 sf shacks in Stinson Beach) and other than around the 1980 interest rate spike the fully amortized 30 year mortgage payment with a 20-25% down payment was almost always less than the rent you could get for the home or condo...

Different Sean Says:

“a study showed that investment in shares outstripped one in property over 20 years”

And

“one recent analysis of Sydney property suggested you would make a loss for 35 years of holding an investment property purchased with a 100% loan - after that you would just break even.”

How about some links to the studies?

I am certain that there is a Real Estate bubble, but:

1. No major stock market index has done as well as real estate over the past 20 years (sure some study may have found that if you bought Microsoft and Cisco 20 years ago you would have outstripped the returns of the guy that bought an Ohio apartment complex 20 years ago).

2. Even using the lowest annual inflation that Australia has ever had and assumes that is stays that low for 35 years and the worst variable rate loan ever an investment property will cash flow a lot sooner. This does not make any sense at all…

There is a lot of good data in this HSBC document, including rent-to-[PITI] ratios on page 32/33.

@astrid:
You’re assuming that RE will be able to beat inflation more effectively than any other investment vehicle. [...]
As I see it, there are two logical reasons to price owning higher than rent, after factoring in inflation

The demand function for the rental market is different than the demand function for the homeowner market. Elasticities are different, transactional frictions are different, and capital budgeting concerns are vastly different. A rental-income operator can be free cash flow positive over the term even with rent-to-mortgage ratios being 0.5 or lower, primarily an effect of making smart capital budgeting decisions.

Don't forget that what drives rental market pricing is not SFHs or condos for rent by small speculators or distressed owners. Pricing in this market is driven by scale operators and smaller, hyper-efficient (smart) operators (like two regulars to this blog). Rental market pricing is far more efficient than housing market pricing.

These things alone, even without considering inflation at all, ensure that PITI will always be greater than Rent. I can't find the graph again, but I think the last time Rent was greater than PITI was during the Depression, and before that it was when only landowners could vote and only white men could be landowners.

Of course I agree that a properly financially engineered inflation hedge will beat home ownerships as a pure inflation hedge. The cost and complexity of such instruments is beyond most people. In normal, non bubble times, a home is a nice form of long-term inflation protected personal savings.

FAB,

1. No major stock market index has done as well as real estate over the past 20 years (sure some study may have found that if you bought Microsoft and Cisco 20 years ago you would have outstripped the returns of the guy that bought an Ohio apartment complex 20 years ago).

The "stock index beat RE" proposition is based purely upon primary residential home ownership as savings vs. stock index investment as savings, with no consideration given to other opportunity costs. I am not convinced that this will continue to be true in the future, but it has been (barely) true in the past. By barely I mean that, when considering margin of error, savings through home ownership is about the same as savings through a market index.

Since the above ignores taxes, RE is better because of the marginal tax benefit _over time_ and _in normal times_. Like you, I think the current bubble skews everything making all this analysis invalid for now.

Robert Campbell,

Just for clarity, our ideas are oriented towards creating an emergent behavior simulator which might hopefully show some interesting outputs. Since we're all deep in RE related data and thought right now, this seemed a tractable problem domain to explore.

In honesty, I think we're going to run into practical computational limits fairly quickly.

This chart was posted on Ben's blog:
foreclosureforum.com/mb/messages/16791.html

After digesting the details, what I found interesting is the overall (25-yr) downtrend. What does it indicate? It seems to mirror long-term downtrend in interest rates that I belive has occurred over similar period (going from memory on this)....

Bap33,

I don't think you're that far off, but I think your definitions of the 2 types of homebuyers is overly narrow. Homebuyers in your 1st group are not all alike; many are at different stages of life. For a young couple with their first home, perhaps many years from starting a family yet, and with reasonable expectations of income growth there is a very different importance put to resale value than to a midlife family with kids and roots, which is different than empty nesters looking to downgrade.

All of these people have different profiles but none are speculators, investors, or landlords.

Bap33,

I'm not a fan of regulatory solutions unless as a last resort or strategic policy. I'd rather the market be allowed to solve the problem since it is inevitably more efficient and creates less unintended consequences. I think once easy credit and exotic loans go away a lot of SFH rentals will become distressed and those houses should eventually re-enter the housing market (exiting the rental market). But, SFH rentals are always a very long overhang because people who bought these homes a long time ago can afford to rent them out for years to come, so perhaps there is no short/mid-term market based solution.

I don't like "excess profit taxes" of any type under any (fair) circumstances. Unless collusion or other outright illegal activity is uncovered, owners are deserved of any profits they earn. Taxing those for social engineering reasons will only create a whole bunch of unexpected results, probably punishing groups who were never a problem in the first place. I don't think outright banning of rentals is legal. Unless the homeowner enters into a CC&R up front, and those CCRs are legal, a city/county cannot simply prevent legitimate economic activity within zoning rules. And, zoning rules cannot be discriminatory, as rental prohibitions or limitations would be (economic discrimination is still discrimination).

FormerApt,

Australia taxation law is different from the US.

US has mortgage deduction for up to 2 homes per couple, for high-income families in high-tax states like California, that is a big saver. Australia ATO (equivalent of our IRS) does NOT allow mortgage interest deduction for your main residence, however, mortgage interest deduction for your investment property is allowed.

Australia does not have fixed-interest mortgage. If you look back the entire 90s on its RBA (Reserve Bank of Australia) site, the cash rate (equivalent of our Fed rate) was hovering at around 10%+ for a long time throughout the 80s and early 90s. Unlike the US home buyers, Aussies couldn't take advantage of lower-rate cycle to lock in a 30-year fixed mortgage.

Also, Australia has a much smaller population and economy compared to us, so the influx of foreign capital and immigrant money from UK, Singapore, Japan, Hong Kong and Taiwan were able to make much bigger swings both ways compared to the US. They have seen more spectacular RE busts in their major cities.

So combining all these factors, it won't be a surprise to me that Oz RE investment in general didn't perform that well over the longer term.

Linda,

thanks for the link, 3000 sf historical home, hmm, I am afraid the maintenance of this home will bankrupt me...

A Spring Bump?

Don't be surprised if there is one. Anecdotally, activity is picking up. I think that as long as mortgage rates stay low and the BA job recovery stays in gear we're likely to hear a lot on this board about how certain neighborhoods are started to appreciate again. We'll probably even see multiple offers for "good" homes. What I'm seeing in southern Marin is about a 1:10 ratio of good homes to crap for the same price. The good homes are selling fast still, usually with 1-3 offers and small premiums (over asking). Sellers seem to be favoring strong financing and all-cash deals. Inventory is growing fast, but 9 of every 10 homes are overpriced "me-too" properties which aren't moving at all. But good homes are gone sometimes before the first scheduled open house. I don't expect this dynamic to change until either a good old fashioned recession hits and/or the prices of the 90% crap homes starts to come down in earnest.

(This is a bit depressing to me because it means listening to the standard Realtor(tm) speil isn't likely to go away anytime soon.)

Down in the South Bay, competitively priced homes in a good location is still selling with multiple offers above asking, but the general market is still terribly slow.

A friend of mine was trying to bid on a Monta Vista school district home in Cupertino foothill area priced at 1.1M with a 1/3 acre lot, she lost out to about 15 bids, all above asking, it was sold within a couple of days. Then there was another listing which I felt was priced below current market, for a 2700-sf home on an acre view lot in Los Gatos priced at 1.6M or so, it was also sold within days. When I browse through listings, I have a pretty good feeling of which ones are good quality listings at a competitive price, and they usually sell within a couple of weeks.

However, 85% of the homes are just sitting and relisting with marginal reductions of 30-50K, or coming in and out of escrow. A realtor told me that nowadays, nobody is willing to pay above 2M for neighborhoods other than Saratoga and Los Altos Hills in Santa Clara County.

But good homes priced below market are always selling in good or bad times, so it is not surprising to me. As long as there are more good homes selling *below market*, that in itself will establish no comps on the way down.

astrid wrote:
"I believe you have to work to get section 8, so its at least not full fledged welfare abuse."

When I managed property not one of my section 8 tenants worked (but a small number of them do). My Dad currently has a few section 8 tenants and none of them work at all (even they all look like they should be doing something)...

"I don’t feel anger towards welfare mothers, vast majority of them are there because the choices of others in government and their life experience have lead them there".

With very very few exceptions welfare mothers are on welfare because THEY (not others) made very very poor choices (I dated a SF assistant who got in to law to help women before she quit in disgust). I heard story after story of stupid women who thought that their drug dealing abusive boyfriends would "change and marry them if they just got pregnant...

Bap33,

Like, what if Bill Gates bought every home in Modesto. Then just rented them out even money. Meaning the sum total of all rents services the note on the X Millions used to purchase the town. After a while he buys every home in Fresno and rents them out for even money. There is nothing that can be done? No limits in place? Just asking folks.

I don't think there are any regulatory limits in place which would prevent this. Although, there may be some kind of old laws in place in old rust-belt cities which were put in place either during the Great Depression or perhaps even early during the era of Industrialization. I know that, for example in Michigan, certain laws were put in place limiting what "Company Towns" could get away with. These are big-society kind of questions that probably get handled in state supreme and Federal courts (and don't happen too often, I suspect).

More importantly, Bill would have a hard time moving into even a small area like Modesto and buying up all the housing stock because of simple micro economics. After he begins buying (since he can't buy all the stock in a single transaction), the supply will go down and prices will rise. He will very quickly experience a disequilibrium point (picture a sloped supply and demand "X" graph, but then there is a break, like a stair-step in one or both lines). Owners of remaining housing stock realize their assets are much more valuable than before, and prices vacillate wildly. Bill says "screw this", and then things suck for a while before it all settles back into equilibrium. If he just tries to use his irresistible wealth to buy everything at any price, then see the above paragraph. (I don't think this would happen because, imagine you are the owner of the last home in Modesto. You rationally charge Bill a price exactly equal to what you expect his maximum remaining wealth is. This is the beauty of market economics in action).