patrick.net

I think this thread still has room to grow and there are still a few regulars who haven't yet posted their stories (where's TWIT, astrid & Fake P? Face Reality, where's your bio?). Nonetheless, I've started a new one:
Rats Deserting a Sinking Ship?

I already posted most of this in an earlier thread, but will recapitulate.

I am 40, getting married in a few months. My fiance and I bought a duplex in Upper Noe in March 2003 for $710k. By neighborhood comps it is probably worth $1.1 - 1.2 M right now. We have put about $50k into upgrades. I have been nervous about a real estate "bubble" since before I even bought it, but I don't think it will go the way most of the more bearish posters here believe. I think the downturn in RE will go the way the last three in California have gone and "rust not bust" with a brief period of negative nominal valuation changes and then a much longer, probably decade long at this point, period of flat nominal and negative real (including inflation) valuation changes.

In the long run, we intend to hold onto this place as rental property and live in a single family home in East Bay, probably Berkeley, Rockridge or Orinda, but we won't feel any pressure to move for at least five years or so. Right now, the tenants downstairs pay half the mortgage and half the property tax with their rent. With the tax breaks, we are paying less overall than we did before we moved in together, and we each were just renting out rooms in collective households. And our lifestyle is much better! The flip side is that we are landlords now and I spent many weekends caulking the bathroom and supervising construction crews that I would have spent sailing otherwise.

We both work in San Francisco, she as an investment advisor in low income tax credits for an insurance firm and me as an IT Manager. My job feels pretty secure, though globalization is probably pushing down wages, the company will not be leaving San Francisco. I am not so sure about hers though.

I found the site via google, after a long argument with friends about whether the real estate market in San Francisco was in a true bubble or not.

I am protecting myself against a possible downturn by moving all of my non-work stock into overseas markets, including my 401k. I am putting more and more into Japan and Germany, with the logic that since they have already had their real estate asset price deflation, they are less likely to be effected by a global downturn in real estate. Perhaps one of the economists posting can tell me what they think of that notion.

All right MP, as a fellow San Francisco landlord, tell me how you intend to raise your rent by 10% next year. Perhaps you had not realized this, but it is not as easy as that.

(where’s TWIT, astrid & Fake P? Face Reality, where’s your bio?).

Also, where is Gabby?

yes, Kurt that is me, ptiemann on epinions.com, the one and only ptiemann (Peter Tiemann)
Ah--thought so! My handle over there was "Webguy"

Peter P - The party has already spread back to equities. We’ve been an Equities BULL MARKET since the summer of 2003!! You must have noticed your 401k account growing over the years no?

My stocks have low beta and they have been doing consistently fine even before 2003. I have been trying to do some major rebalancing recently. Need to take more risks.

My point is: don’t believe the media. Renters will tell you oh, the place i’m renting could sell for XXX, but i only rent for XXX/2. It’s psychology, to make them feel better.

You are probably right about the price/rent ratio in prime locations. However, crappy places in subprime locations are getting really crappy rental yield. This is the price compression that we have been talking about for a while now.

I do believe that you are in a safer position once your house is valued at 1.5M or higher.

Believe it or not, the majority of homeowners and ‘investors’ are rational in the Bay Area. People do the math before spending hundreds of thousands of dollars.

I do not believe this. After all, most people are not spending hundreds of thousands of dollars. They are just making low but ballooning monthly payments.

Buyers in the 1.5M+ range are perhaps more savvy though. As a result, no major mania (as you have mentioned earlier regarding bidding war).

My point is: don’t believe the media. Renters will tell you oh, the place i’m renting could sell for XXX, but i only rent for XXX/2. It’s psychology, to make them feel better.
Well, hard data is useful, so here's some:
A friend is leasing a well-maintained 1 BR waterfront condo in Marin--that would currently sell for $550K. Overlooks water, a park, Mt. Tam--"prime" locale.
We live down the street, so we're pretty familiar with the market, as a lot is for sale now.
The monthly? $1400. I think the math's easy on that one.

Well, hard data is useful, so here’s some:
A friend is leasing a well-maintained 1 BR waterfront condo in Marin–that would currently sell for $550K. Overlooks water, a park, Mt. Tam–”prime” locale.
We live down the street, so we’re pretty familiar with the market, as a lot is for sale now.
The monthly? $1400. I think the math’s easy on that one.

Rental yield of 3.05%. Not good at all. It appears to me that renting is clearly cheaper at least for properties under 750K.

If I were you Peter P, I’d swing for the fences. You have your whole life to make money. Definitely take some risks before the wife and kids start cementing you down. Life’s too short to just stick in one career for example.

I do intend to swing for the fence, albeit using more liquid instruments. My wife is very supportive and is actually pushing me to take risks. My "kids" are litterbox-trained so they are not going to cement me down. :)

Life’s too short to just stick in one career for example.

I agree. This is the best advice you have given yet. Thanks.

I believe the best rental yields come from the 2bedroom, and sometimes 3bedroom condos.
Ok, here's a few more recent condo scenarios in Marin:
2 BR waterfront, approx 1200 sqft: $750K
3 BR waterfront, approx 1700 sqft: $890K
A friend rents a 2BR in same complex for $1700/mo.
Any guesses on the 3BR? I'm shooting for $2K.

We can agree to disagree on this subject.

See, we can actually agree on things. It would have been so much nicer if we had better understanding of our views earlier. :)

BTW, I do notice that prime condos in areas with single (or DINK) professionals can command better rental yield. For example, 1/2 br condos in Pacific Heights or 2 br condos in Palo Alto.

Pied-a-tiere

Peter P, On a current cash basis renting is certainly much cheaper than buying right now in many places. Historically, renting usually is cheaper in the more desired areas. Now that disparity is higher than usual. When prices decline the buyer has higher monthly expense and a decline in equity. There certainly have been better times to buy in the past and there will be better times again in the future.

However, in the long run the appreciation, even at the low end of the range, will more than offset the monthly cost difference. Further, the buyer locks in his monthly costs (mostly) and over time the rents will increase with the average inflation rate. Eventually the monthly cash cost of renting will exceed the cost of owning.

But consider this – my experience has been that my properties (over many years including two full downturns) have appreciated by more than the total of my cash cost of ownership. Even if I had let the renters live in my properties without ever paying a dime of rent I would have made money.

Of course, this is helped by the fact that I bought more property in the low years than in the high years. If you buy only in the peak years the long-term appreciation (by itself) would fall short of covering all costs. Properly structured, buying only at the peak years should generate an after-tax ROE of about 8% when appreciation and rent are considered. By comparison, I have averaged over 25% after-tax ROE on a long-term basis and in the 40 – 50% range in recent years.

Time horizons and timing make a big difference.

However, in the long run the appreciation, even at the low end of the range, will more than offset the monthly cost difference. Further, the buyer locks in his monthly costs (mostly) and over time the rents will increase with the average inflation rate. Eventually the monthly cash cost of renting will exceed the cost of owning.

It's different this time. Where is all the money coming from? And, who is making it? As OUR jobs are outsourced and SV is dead, show me the money! Not too many people can afford to live in the BA, anymore.

Zephyr, thanks for your analysis. I am really glad that you spend time to edcucate us. At the very least, I have learned a lot from this "bubble" already.

Don't worry, I am not going to rent for my whole life. :)

Chan, "It's different this time" So often this is said. Usually to justify the idea that prices will never drop. However, it is just as wrong when used to say the cycle will not recover and repeat.

I don’t know what’s worse, not buying something you could of, or your situation where u made money, but sold too soon.

None is really that bad. The past is the past. Let's focus on the future and attempt to make a killing!

Peter P, I have no reason to encourage anyone to buy, sell or even hold or wait. But my own opinion is that the time to wait has been here for a while (only about one year in some markets) and that prices in a few years will be lower in most of the cyclical markets. I am waiting for that now.

I expect the bottom to come between 2008 and 2009. Not all markets will peak at the same time, and they will hit bottom at different dates as well.

Chan, “It’s different this time” So often this is said. Usually to justify the idea that prices will never drop. However, it is just a

Who knows? If any of us could predict the future we would all be rich and wouldn't care too much about housing prices. ;-)

Chan,

Actually, it is a little different this time. In fact it is a little different every time. However, the fundamental forces continue every time.

The current problems are real. However, the situation today looks far better than the way the future looked in the 1970s and even the very early 1980s.

MP, if there is no obvious sign of a pending crash in October, Fake P will chase me down anyway and I will have to admit that my prediction is inaccurate.

...and never apologize to people they are giving advice to.

I bet he did not say "not investment advice" when he called for the downturn :)

MP,

I bought nothing after 1987 until 1998. During the early 1990s the property values continued down. I never buy while prices are declining. So I waited for the appreciation to be firmly established before buying. I would have bought earlier but the downturn was so severe that I wanted to be sure there would be no relapse.

The current problems are real. However, the situation today looks far better than the way the future looked in the 1970s and even the very early 1980s.

I don't agree with you. The amount of fraud committed during this credit bubble will dwarf the 1970's oil crisis and the 1980's S&L debacle.

This is the tip of the iceberg. Lot's of fraud ahead, homebuilders, mortgage companies, appraisers, and the borrowers just to name a few.

Plus, I was very focused on the stock market until 1998 when I sold everything with the dow around 9600..

Chan,

Perhaps what you predict will happen. But it has not happened yet. If it will happen, then this market must continue up for several more years for the problems to build to a comparable level as last time.

The real estate bust of the 1990s followed upon excesses in the 1980s, many of which we have not yet seen this time. Remember that the Savings and Loan Crisis of the 1980s started about four years before the real estate market peaked. We had many savings banks already going insolvent at least three years before the real estate market peaked. The RE Bubble was so bad in the 1980s that the Federal S&L Insurance Corp. was declared insolvent – TWO YEARS BEFORE the RE market peaked. And the bubble marched on.

After four years of financial collapses by banks, builders and property owners, the Federal Gov. created the Resolution Trust Corporation to engage in an orderly disposition of all the troubled assets. The last of the major bubble markets peaked in that same year (1989).

We have yet to see any of these severe symptoms in this cycle. Once we do it will take only a few years to get just as bad. Pray that it never happens.

Perhaps what you predict will happen. But it has not happened yet. If it will happen, then this market must continue up for several more years for the problems to build to a comparable level as last time.

Do you really believe that everyone has been honest through all of this run-up?

Look what has happened to Fannie Mae today...possible delisting in the near future. What is really going to tank housing is the fraud that was/has been committed.

So soon we forget what happened after the NASD crashed. Worldcom, Tyco, Enron, Adelphia, and many others.

What makes you think that the same thing won't happen, soon with RE related companies?

Chan,

Yes it can happen again. However, last time the companies, banks and others were visibly in financial trouble for several years before the market collapsed. To happen again we will need more time for the problems to grow.

I believe we will see a more normal decline start before those extreme excesses have a chance to become as prevalent as last time.

I believe we will see a lot of financially distressed property owners in the coming decline. The longer it takes before the decline starts the worse it will be.

Chan, you said “Do you really believe that everyone has been honest through all of this run-up?”

No, I do not. However, it was much worse last time. Show me the long list of lenders who have gone bankrupt from rampant loan fraud. Show me the bankrupt homebuilders… etc.

Chan you said: “So soon we forget what happened after the NASD crashed. Worldcom, Tyco, Enron, Adelphia, and many others. What makes you think that the same thing won’t happen, soon with RE related companies?”
What makes you think that it will?

These companies are cases of fraud committed by the key officers of the corporations. How does this relate to the housing cycle?

NASD crash was a tech stock crash. More specifically it was the logical ending for investors who bought companies that had little or no business or revenues and many were just shams to steal money from over-exuberant, foolish investors. While real estate attracts these people as well, it is a real asset, with real utility and revenue potential.

No, I do not. However, it was much worse last time. Show me the long list of lenders who have gone bankrupt from rampant loan fraud. Show me the bankrupt homebuilders… etc.

Worse from whose perspective? It is just starting to unwind. What's different this time is a lot of individuals will go BK and lose their homes, vis-à-vis; major lending institutions and BIG RE companies...That’s the difference.

I don't remember too many people that were financially hurt in the 70's and 80's. THIS time greed is more widespread, and in the end, the "invisible hand" will cleanse the market and the little guy is the one who will be really hurt.

These companies are cases of fraud committed by the key officers of the corporations. How does this relate to the housing cycle?

NASD crash was a tech stock crash. More specifically it was the logical ending for investors who bought companies that had little or no business or revenues and many were just shams to steal money from over-exuberant, foolish investors. While real estate attracts these people as well, it is a real asset, with real utility and revenue potential.

And...

Holy Christ! You don't think that the same thing is happening in the RE industry.? Just read the news, Fannie Mae, Freddy Mack, Countrywide, Citibank...

Chan, It might be madness but I don’t think it’s fishy… it’s a cyclical peak. It happens after a while. Eventually we will have cyclical bottom…

Good luck with your shorting. I will look forward to hearing from you on your results.

Chan, there is a big difference between accuracy of accounting for derivatives, and sophisticated embezzling.

MP, I believe that the 1980s were worse. Which is not to say that all is well now.

The real estate bust of the 1990s followed upon excesses in the 1980s, many of which we have not yet seen this time. Remember that the Savings and Loan Crisis of the 1980s started about four years before the real estate market peaked. We had many savings banks already going insolvent at least three years before the real estate market peaked. The RE Bubble was so bad in the 1980s that the Federal S&L Insurance Corp. was declared insolvent – TWO YEARS BEFORE the RE market peaked. And the bubble marched on.

After four years of financial collapses by banks, builders and property owners, the Federal Gov. created the Resolution Trust Corporation to engage in an orderly disposition of all the troubled assets. The last of the major bubble markets peaked in that same year (1989).

Zephyr, I'm not so sure that things will necessarily play out exactly the same way this time around. I do see the prospect of institutional bankruptcies and financial collapses, especially for holders of large amounts of sub-prime NAAVLP paper, but it I believe --like Chan-- that the banks and S&Ls have learned a very important lesson this time around: privatize profits, but share ("public-ize"?) risk.

What's different to me this time is how many lenders don't even hold much (if any) of the mortgage paper they're generating. Not when they can easily sell it to the GSEs or some private outfit to repackage and re-sell as MBSs. I realize that not all banks operate like this and not all of them are huge into the NAAVLP game, but the ones that do are pretty much running the show right now. When the sh*t really hits the fan 2-3 years from now (when that $2.4 Trillion of IOs adjust to fully amortizing loans - in a higher interest-rate environment to boot), it's not going to be pretty for individual and institutional hoders of residential MBS paper.... IMO

The banks and S&Ls may not fail en masse, but recent buyers and investors sure will.