patrick.net

BTW - I should mention - rents in the Campbell / Cupertino area are *scary* low right now, and I fully expect them to bump *substantially*, for a least short while, once the housing market cools - if only to get in balence with the rest of the bay area. So I know using them is creating a more bleak picture than elsewhere (like Fremont, or, apparently Marin). But hey, it's where I live.

What does “complex political/cultural system” mean?

For instance, half of Hong Kong's population live in government housing. Most people do not own cars. There is no sales tax and no capital gain tax. The income tax is closer to 15% than 35%. These all contribute to a higher median home price to median income ratio.

What do you mean by making serious money? Does it mean making 500K in home appreciation or 500K in stock options? Salt Lake City does have a lot of high-tech opportunities and it is still growing.

If you ask people in Hong Kong or Tokyo they will say that their prices are higher than SFBA because they perceive more opportunity to make money there. Thinking that SFBA can be as expensive as Tokyo before it crashes is absurd.

Also, do you know what is the rent in Tokyo for the $1M apartment?

Face -

Tokyo is much the same as New York. But only if you compare Manhatten, as opposed to, say, the wilds of Queens.

The geography of both Tokyo and NYC are very different than here. It's important not to compare the premium places, but the median places, where most of the population actually dwells. (And I have no data on that for Tokyo - I'd be interested in hearing if you do).

It's also important to compare salaries, both at the high (three sigma) end, and the median. Excluding the crappier parts of uptown, Manhattanites make quite a bit more than the residents of, say, Campbell. Sadly, the salary figures I've seen only break out NYC incomes by Bourough, not neighborhood, so I don't have the hard data to back up that claim :-(

Jack -

As a currently dedicated Renter, I'm here to tell you that LOTS of cashflow positive rentals exist in the south bay. I've lived in a few.

Here's how to get one:

Step one: Ten years ago, purchase a home or condo.

:-)

It was also possible to get a positive cashflow rental going during the dot-com bubble, though if you tried that, you probably had to either cashout or refi to hold the property for the last three years ;-9

Prop 13 - every landlord's friend. One of the things that is *certainly* driving the current housing boom is that you'd have to be NUTS to sell a cashflow positive rental in California - Prop 13 is a HUGE windfall. Noone in their right mind would sell a home with property taxes in the low four digits when you can clear even a modicum of rent to cover costs. I'm suprised this isn't mentioned more often here. Since tax costs remain fixed, you can only count on the profit growing by leaps and bounds as the years go on, even with only marginal rent increases. Of course, if you start now in a negative position, good luck riding out the next seven to ten years until you get positive position.

Prop 13 is certainly a factor in whatever happens next to the housing market. I suspect it may be enough to make the bubble deflate more gently, but I'm truely unsure. And I don't think it's enough to stop it from deflating completely. Just more slowly.

(Note - beleif in the existence of the bubble doesn't mean I think it'll pop. A balloon with a slow leak is just as flat as one that pops.)

"IF rents go up by 10 per cent a year for several years, you probably wont really leave,it will be because it will be WORTH IT to renters to pay that much to live here."

Only if every comparable rental goes up 10% as well. This would require a complete rebirth of the Tech/VC/IPO industry. But if people realize that easy money can again be made in the stock market, won't they pull money out of the housing market?

People may be able to pay the premium for fixed rate but they may not be able to pay down the principal. IO loans are more of a problem than ARM loans.

"Things are not out of balance. This IS the balance."

I do not blame you. One camp believes that market is always right. The other camp believes that market is always wrong. I belong to the second camp.

Jack says: "Things are not out of balance. This IS the balance."

OK, we completely part company here. Balence implies a steady state, or, at a minimum, one that evolves slowly. Is that what you meant? And if so, *any* data to back it up?

Jack says: "IF rents go up by 10 per cent a year for several years, you probably wont really leave,it will be because it will be WORTH IT to renters to pay that much to live here."

For tech workers, probably (but check out that outsourcing fad for a different future.) But who the heck is gonna flip my burgers? Those poor guys can't barely make it now. In this group include *any* unskilled or poorly skilled labor. They can't all live in Merced, can they? (P.S. Merced's up 43% in the last 3 years too.)

At any rate, my point is that the market simply won't eat that in rents. Therefore they won't go up - people will relocate (it ain't THAT nice here). Most of us weren't born here anyway. Causing rents to fall, after a brief rise.

At least we agree that cashflow positive rentals are not possible to construct in today's market.

Pop quiz - do you personally know ANYONE who's moved here and bought a house as a part of the move? I don't. But I know alot of folks moving the other direction.

All the new house purchases I know of are 1) trading up, or 2) two income tech workers taking out ARMs and *shudder* IO/ARMs. (No speculators, I don't run in that crowd.)

We only have a limited supply of dual income tech workers. I suspect that we'll run low soon. (Sooner than October, I think.)

"Rents are around $5K-$6K for a $2M apartment.

Salaries there are pretty similar to salaries in the Bay Area, so if you think life’s hard here, just try to imagine what it’s like to make it there. "

The P/E ratio in Tokyo is still very high, so it will continue to drop for many more years. Families there do not have two SUVs. Most of them do not even own vehicles.

I never said that Bay Area is hard, but I refuse to buy when the P/E ratio is 30+.

Jack said: "My point was that positive cash flow rentals have not existed for a long time here. (Which could also be an argument against a steep correction–looking at housing as simply an investment in SF Bay Area is THE big mistake that everybody is making.) Hey! its just a thought!"

This is probably worth exploring:

OF COURSE a house isn't an investment. Only silly people think that. Sadly, most of the US is silly. What it actually is is a major long term capital expense with significant carrying costs, with a fairly decent chance of a few points of appreciation over inflation, over a long term (30+ year) period. There've only been three departure points from this long term trend: the 1950s, and now for the upside, and the 1930s for the downside.

The reason why we're currently in a period of significant risk is that almost *everyone* to purchase property in the last few years in this area has become an unwitting speculator. Work with me on this:

Why are all these people buying houses with ARM loans at the bottom of a interest rate cycle? Because they're planning on either selling their homes or refinancing within five to seven years. (>80% in bay area)

Why are all these people buying houses with IO loans, previously virtually unknown since their role in the Great Depression? They don't expect to hold the loans (or at least the mortgage) when the principle comes due. (>60% in bay area)

What is this, except speculation? They're speculating that 1) Houses will continue to appreciate and 2) that credit will continue to be readily available. And they're making a committment to flip within 5-7 years. Some as quick as 3, but I don't have any data on average length for IO Loans. I sure hope most people are smarter than that, but hey, they bought pets.com too.

If they're wrong on either count, then their "investment", leveraged well over 90%, on average, will become a guarenteed ticket to bankruptcy.

So - let's ask the question: How many forclosures do YOU think it will take to tank the market? This is not rhetorical. I think everyone has SOME number, even the biggest bulls. I'm not sure of my number, I'll have to think about it, but I suggest everyone try to come up with that number. And then watch for it.

All that it'll take is a flat market and moderately restricted credit. Won't even need interest rate hikes, thanks to the IOs. 10% down market, even with generous credit, will also do the trick, thanks to all the 100% loans.

Please, convince me I'm wrong. I want to be wrong. Really.

Reminder:

It does not take much turnover for prices to tank. Old-timers can stay in their houses. They do not care and they will not be affected.

"PeterP…can you explain what you mean by “extra volatility” in the equity markets that could cause havoc. What/where is the volatility."

October is close to the end of a fiscal years. There are a lot of year-end reporting for companies. Moreover, many funds close their books around that time. The reshuffling of positions can lead to increased volatility.

Most importantly, October is cursed. :)

I have to repeat:

Being able to refinance in 3-7 years is a very big assumption.

Being able to do so with a 100% financing, non-amortizing loan is an even bigger assumption.

"I think the ratio of price to the income and wealth of an area is a lot more important than the ratio of price to rent."

The standard deviation of both ratios are important. We are experiencing a high-sigma event.

Very smart, Netrugu.

Y2K is not a financial event and there is no reflexivity between market and participants. In short, its outcome is independent on expectation.

A bubble bust is *always* a self-fulfilling prophecy.

I mean that Netrugu is smart about posting an argument to protect ourselves from it.

1-2 price % declines are significant. What we have in SD and OC is a steep run-up thru the end of 2004 followed by flat or decreasing prices. If prices continue to be flat, as they have been since December, it won't be long until the yr/yr goes flat as well...just takes time to reflect in the numbers (lucky for the Realtors who can continue to misleaded people by quoting yr/yr statistics).

Prices in SD peaked in December 2004 in the 490's, they have been slightly down since then.

If you rent, you get the same "low crime, very diverse population (very little racism), good schools, good weather, significant job opportunities, excellent weather, etc"

What premium are you talking about?

We are not talking about the premium of buying here versus buying in Tulsa, OK. We are talking about the premium of buying versus renting in the same good old Bay Area. This is what P/E ratio is all about.

Jack, we are not talking about whether investing in BA RE for cashflow.

A desirable P/E for cashflow-based RE investment should be less than 10.

A P/E of 15-20 suggests that it is not a good investment unless there is high expectation of rental growth. Historically, Bay Area fits in this category. It is desirable, so it can justify some premium.

A P/E of 25 and above is speculative.

A P/E of 35 and above indicates a severe housing bubble. That and lower sales volume indicates a climax top. We are around here.

"Also, renting isn’t much of an option for people who aren’t willing to put up with the limitations of renting."

I never deny that there should be a premium of owning. I will accept a P/E ratio of up to 20. This ratio already implies a lot of premium.

"Highly desirable assets which are in short supply aren’t likely to crash."

Even with a soft-landing and appreciation drops to 5% a year, do you think that housing will still be a "desirable assets"? It is desirable only because of the high expected appreciation.

Face Reality, if you are saying that there is no bubble for 3M+ homes in Los Altos Hills, I may agree with you. Those homes are not closely tied directly to the credit market. They are more like rare collectibles.

I think homes above 2M have decreasing coupling with the housing bubble. However, their values can still be affected by wealth destruction caused by a recession, but this is outside the scope of our bubble discussions.

It seems to me that fear is a greater driver than greed, and many people are actually “playing defense”.

When it is the seller's turn to play defense, watch out.

Perhaps you are right about some who buy for appreciation, but you may also have simply underestimated how important it is for people to own what they live in.

More likely they overestimate how important it is to own. Or you might have misunderestimated me. :)

Obviously many people will pay a higher premium to own vs rent in the Bay Area than what you will accept as reasonable.

Exactly. A classic financial mania. P/E ratio for housing *always* mean revert.