patrick.net

They’re pissed at the neighbors now, for adversely affecting the comps. But in the future, they’ll be pissed at us, for making “unreasonably low” offers!

You mean "reasonably low" 50% off or more! Unreasonably low would be 90-95% off.

OO Says:

"Driving report from Gilroy and Morgan Hill, it is OUT OF CONTROL.
...I’ve never seen such a building craze in the Bay Area since I moved here 16 years ago, maybe I have not lived here long enough."

1968-'74 was the last South San Jose building craze. I was a baby, moved into our house off Snell Ave., by the Foothills.

My high school, Santa Teresa High, was built in 1974.

So, yeah, all that Morgan Hill explosion harkens back to the old days. But, damn. They're gonna kill a lot of Garlic to make those ugly-ass McMansions.

When will the insanity end?

DS,

I fear the transportation infrastructure and the coming high gas prices will soon make the Gilroy area rather undesireable. Affordable housing you're thinking about is based on a static comprehension of a recent phenomena. If the real price of BA houses retrench back 15 years, very few people who want houses will have trouble getting them. I'd advise the affordable housing people to wait this one out to save themselves from paying inflated prices for housing stock, land, and building costs.

It's sticky, soft landing now. I increasingly expect it to get stickier and softer, especially with the behavior of interest rates and bond spreads. The current environment will allow lenders to invent a new breed of "creative mortgage products" that will help to prolong the overextended debtors' reign. Namely, they'll be able to market low-payment products to those escaping ARM resets. In fact, there is plenty of evidence that this is already happening.

Homedebtors will believe that they can wait out any correction in prices so long as they can make payments. They'll psychologically justify this (mental accounting) with rising rents and general inflation. In fact, there will be some who do manage to hold on through the correction and end up 15 years later ahead of both those who sell on the way down and those who buy near the bottom.

Michael,

I do give Utah the edge in beauty and possibly the weather. It's too bad the wages there are low and the prices have been pushed up by ex-Californians. Slickrock is a heck of a lot more fun to hike than soft sand.

Randy,

I don't think it'll stay sticky and soft for long. There's a lot of people out there already stretched to the limit and on the brink of foreclosure. Once they're crushed down by their burdens, the prices will fall some what. Some of those properties will be bought by those waiting on the sidelines, thus reducing the pool of buyers even more. Then the next wave of defaults happen, rinse and repeat.

Stickiness can only come if buyers can be found and most owners have the means to survive. I think the last ten years have drastically cut down the buyer side while many owners will be forced to sell or foreclosed upon.

Astrid,

As I've argued here a lot, I think that is a bit of wishful thinking, even if I am also wishing it. I find that in general people tend to overestimate the likely rate of foreclosures. Even if we assume that foreclosure rates will be double or even triple the rates of past corrections, we're still not talking about a very high number. That means a rise from a .07% today to .21%, not even one quarter of a percent.

The thing that keeps RE prices stable is the time-dimension. Not everyone in homes bought their home recently. Not everyone of those used ARMs. Not all long-time owners HELOC'd or refi'd ARMS. Not all HELOCers took out all their equity, or even half their equity.

Even if we assume that the range of "owner positions" is normally distributed, we're talking about a pretty slow, sticky price movement. In reality, I suspect the distribution is skewed conservatively, so the more rapid price movement may well be front-loaded, not rear-loaded.

I think this is what we're seeing now. Prices falling quickly in different categories/neighborhoods. But "quickly" doesn't mean 80%, or 50% or even 30% as we hope. It means maybe 25% or less, depending on locality. What I expect is slow losses YoY for a few years here on out. Most of the correction will take place as real-prices fall due to inflation, especially as wages inflate which they are definitely doing now as yesterday's data further solidified.

Randy,

That may be true in desireable core areas, where demand could stabilize the selling price at relatively high levels. But in most other areas, new houses have been built, high proportions of the current owners are stretched, and sellers will not find ready buyers.

As to the proportion of price decline, we're less than a year in. The price drops are only exposing the most overexposed FB. Most people are still holding on to the belief that this is a temporary setback. We haven't reached the psychological or the economic tipping points.

House prices in much of the country has doubled to tripled in the last 5 years, with no accompanying wage increases and with big increases in food, energy, education, and health costs. Houses will be squeezed, definitely in real dollars and likely in nominal dollars. I think enough people will be squeezed at the margins (and be the stones from which you can't squeeze more money from) that they will impact prices.

I think the current bust is likely to dwarf what happened in NYC and CA and DC in the early 90s. I'm not sure it's a good thing and I'm not antsy to buy, but I think the big price drops and the ensuing pain is pretty much inevitable.

I don't think so. The areas with the fastest rate of price increases are the built out or NIMBY obstructed areas. It's just a scheme to pay off baby boomers. The voters get some money and feel wealthy for a couple years, and who cares if the grandkids are screwed? They can't vote yet.

Mike/a.k.a Sage,

Thank you! I've advocated that for years and it just makes sense. That way we at least have some assurance that homeowners are exactly that AND have "some skin in the game"! I realize I can get to sounding like a broken record but this "flipper" it seems to me was very aware of the "24 Month Clock". Yes Mr. Sage 7 years sounds most reasonable (with exceptions for transfers, med. reasons and death by debt)!

The thing that keeps RE prices stable is the time-dimension. Not everyone in homes bought their home recently. Not everyone of those used ARMs. Not all long-time owners HELOC’d or refi’d ARMS. Not all HELOCers took out all their equity, or even half their equity.

Also, those with ARM resetting next year bought (or last refinanced) a few years ago when prices were a lot lower. They should be able to refinance and stay in the game for a while.

Those who bought last year will not face ARM reset for a few years.

It is going to be sticky. At least in the beginning.

Psychology will bring down the bubble. The _expectation_ of ARM reset will be a trigger. The actual ARM reset may be a non-event.

Unlike the stock-market or currency markets, real estate affects pretty much everyone. Some very interesting social dramas are going to unfold in the next few years. Scares me a little bit.

what exactly do you mean sriram and what social gramas do u expect
thanks

I'm not so sure about the "re-set" being a non-issue at all! We've already seen a rash of Ameriquest and Di-tech commercials imploring FB's to "get out from under" the ARM they sold them like uh...... two years ago? Something like 78% of CA's went ARM last year? Moody's and S+P, Fitches are chomping at the bit to downgrade the 80/20 paper and Wall St. is sweating bullets. An article from Bankrate was pretty clear that over HALF of mortgages in America today are UNDER two years old. We can pooh pooh the "re-set" and it's impacts all we want but it seems to me plenty of firms are quite concerned.

SQT,

Thanks for the heads up! But it seems the author offers no explanation for his hiatus? Well, whatever! Just good to have 'em back!

SQT,

That's great news! I emailed the author to ask him exactly what happened --I agree it's very curious he offered no explanation. You have to wonder if it's even the same guy.

As to the sticky/soft landing, I agree it's likely to play out slowly over several years (as RE bubbles tend to do). But that doesn't mean prices won't come down --in real terms-- by a lot, until they are closer to historic ratios vs. supporting rents/incomes. The only question for me is how much of the correction will be in the form of nominal price drops vs. non-RE price & income inflation.

RE: option-ARM rate resets, you don't need a huge number to make a significant impact on the market. Market RE prices are after all, set at the margins, right? With an average turn-over of only 5-6% of all homes in a given year, it really doesn't take too much of a spike in foreclosures, short sales & bailing specuvestors to make an impact on the supply-side. Add to that plummeting demand due to specuvestors going elsewhere (or getting out of the game altogether).

Wasn't it Peter P who used to say there was no need for a specific one-time "trigger", such as interest rates hitting a tipping point, a bad recession, or foreclosures hitting a critical-mass level? All you really need is the cumulative, gradual impact of some of these things to change mass psychology. Once people are disabused of the notion that residential RE "always goes up", stop seeing their houses as investments, and back to seeing them as a sunk cost & a roof over their head, seller & buyer psychology will change very quickly. As Peter P used to say, the feedback loop works in both directions.

If prices (however you prefer to measure them) haven't corrected significantly in real inflation-adjusted terms (say 30-50%) by no later than 2011, then I will have to reconsider my whole outlook. Until then, I see plenty of sales and inventory evidence (& price in some areas) that the correction --though in its infancy-- is already under way.

HARM,

If prices (however you prefer to measure them) haven’t corrected significantly in real inflation-adjusted terms (say 30-50%) by no later than 2011

The only problem applying that planning horizon is that, if you expect significant inflation as you imply, then an asset drop of 30% still might be enough to overcome the present value of the alternate use of funds. In particular, if you can afford a fixed payment on even a 30% overpriced modest asset--ie a home--then you come out materially ahead aver 5 years of inflation even with that real-price drop (implying an even bigger nominal drop).

The real culprit here isn't the cap-gains tax exemptions everyone likes to beat up on, but which I contend only marginally affect behaviors (like that of 2-year specuvestors). The real evil is mortgage interest deductibility. When you add that iteratively into a fixed rate amortization, it seriously leverages against inflation and offset a good portion of asset depreciation. It's basically the government subsidizing your inflation losses with tax deductions.

Of course when I mention this line of reasoning it pisses people here off. But I can prove it mathematically, and have made those calculations freely available and open to criticism on my blog. I would be happy to be proven wrong as it would help confirm my personal choice to rent in the interim. But I do so knowing that I am risking potential inflation losses over a term of 5 or more years.

Hard or soft landing in the next 5 years will depend on whether Fed will tighten or relax lending standard. Interest rate doesn't really matter if one is allowed to borrow 120%, or even 150%, interest-only, or even partial interest-only. We have yet to test the limit of the lending standard.

Of course this game will come to an end. But I don't see the resolve of the Fed to really tighten money, it is doing exactly the opposite. I have been seeing banks handing out even more toxic loans as we speak. So the party will go on longer than people think. Fed is showing with its action that it is very wary about popping the housing bubble. If anything, it wants a flattened housing market.

That is why I am very bullish on gold and commodities. Stagflation, and rampant stagflation, may I add, is here to stay.

Randy H,

Not being a finance type (perhaps astrid or DinOR can weigh in here), I'm flying a little blind here. However, assuming I'm reading you correctly, by "present value of the alternate use of funds", you mean the opportunity costs of investing the money (used to buy a house) elsewhere. If this is correct, then I can't say I completely agree with you here.

I just don't see how, if everything else rises in price 30-50% in 5 years while my house value stays flat or even dips a bit, this puts me ahead --even taking the mtg. interest deduction into account. After all, it's a federal income tax deduction --not a credit. It also does not apply to state income tax, sales tax, special assessments (Mello-Roos, etc.). The most I can ever get back is whatever my federal tax rate is (28%, 33%, etc.) x my taxable income --that's all. I don't a get a dollar for dollar credit for 100% of my mtg. interest. Obviously, this benefit is greater the larger your income (and tax bracket), so wealthy high-income households stand to benefit the most. It's moderately regressive (and unfair) towards low-income people in this regard. Even factoring in the MID, most people can still rent for half or less than half the monthly cost of PITI + HOA/maintenance - tax deduction.

If I were to invest this money into relatively conservative investments (MM, CD, T-Bill, etc.), which I'm already doing, I can still come out ahead of the typical Mr. Homedebtor. It's not that hard to get 5% or better today on short-term federally insured CDs, and rates are only likely to go up from here, thanks to Fed hikes, expected rate hikes from BOJ/ECB, etc.

Another one of your assumptions isn't even realistic for CA or other severly bubble-impacted regions: "if you can afford a fixed payment on even a 30% overpriced modest asset". How many CA buyers have opted for amortizing fixed-rate mortgages in the past 2 years? 5 years? Easily less than half. If people had been using traditional amortizing mortgage products vs. NAAVLPs all along, then we probably wouldn't even be having this discussion.

Randy H Says:

> I use the 90s as a specific case of sticky prices.
> Prices were in fact very sticky then on the way
> down,

In 1992 the price of new spec. homes were dropping $100K a month in Hillsborough and Atherton before they went REO (my cousin a developer went BK) and San Diego Apartments that sold for $65K a unit in 1990 were not selling for 30K in 1992 (I gave a couple buildings back to my partners), it that “sticky on the way down”…

> and it was a soft landing, at least by economic definition.

The Bay Area never had even a 10% annual decline for homes under $500K (90%+ of the Bay Area homes 15 years ago) but in S. Cal it was UGLY…

> All I’m saying (again) is that all previous corrections
> analyzed ex-post have been downward price-sticky.
> I don’t believe in new paradigms proclaiming but it’s
> different this time.

Reasons it “is different this time”

1. Last time interest rates fell from 1990 to 1994 (This time they are on the way up)
2. Last time most people made at least a 20% down payment (This time almost no one made a 20% down payment or if they did they pulled it out with a HELOC).
3. Last time huge numbers of long time owners were not refinancing to increase leverage since they were happy with their low interest loan (This time with rates falling as the bubble got bigger most people increased their leverage).
4. Last time most people had fixed rate loans (This time most people have adjustable).
5. Last time we didn’t have an internet (This time a company can move an entire division out of CA and with e-mail and video conferencing no one will notice the difference).
6. Last time almost every loan was amortizing (This time most loans are IO).
7. Last time China was a backward communist country (This time everyone that manufactures something in California is trying to increase profits buy using inexpensive Chinese labor).
8. Last time India was a poor country with cows walking past starving people (This time is a source if hard working engineers).
9. Last time everyone working in Retail in CA had a fairly safe job (This time with internet shopping and big box categories killers we will probably have half the people in retail looking for a new job soon….

Honestly, Randy, I think you and Peter P are suffering from BBF (Bubble Battle Fatigue) ;-). Sure, it's very difficult and frustrating to watch this insanity play out so long from the sidelines, while almost everyone around you is telling you you're crazy (or stupid) for not getting in before you're priced out forever, etc. We've had whole threads about this before --being pressured and taunted by co-workers, impatient spouses, etc.

It's very hard, but I really think it would help to keep a cool head, relax and maybe even step away from the blogs once in a while (hope Patrick's not reading this :-) ). I know that the only thing worse than being a FB in the last couple of years would be to become an 11th-hour capitulating bear who loses his cool and jumps in too soon. I refuse to catch a falling knife and end up the greatest fool of all: a hypocrite and the guy who has no one else to blame because he actually knew better.

LILLL said:
Lefantome
Thanks for the story. It was a great pick me up.

Ditto from me.

FAB,

interest rate can head down again from here if things get ugly. From 5.25% to 0%, we still have an elbow room of 5.25%. Japan went on ZIRP for over a decade, we could do the same, too.

I am not saying that this bubble won't pop, but it may still take longer than people think.

HARM,

if, theoretically, you believe that everything else will go up 30-50% while the housing value remains the same, it will make sense to take out the maximum loan you can and pay back later in cheap money. The question is where should you park your money when you get the loan. Putting it in a house and getting the mortgage deduction back may NOT be a bad idea, if you have not owned your primary residence yet (since you are going to pay rent anyway, and we assume rent will go up 30-50% too).

Here are two big assumptions this claim is based on: housing value will be the same (instead of heading down), regardless of inflation, and rent will be going up keeping pace with general inflation.

Reasons it “is different this time”

FAB, these are good reasons to think the crash will be much worse than last time. Do you happen to have a links to back up the mortgage stats above? I've found it difficult to locate hard data on anything pre-Internet.

Here are two big assumptions this claim is based on: housing value will be the same (instead of heading down), regardless of inflation, and rent will be going up keeping pace with general inflation.

Precisely. And neither of these assumptions is coming true so far, which makes Randy's "you're better off buying now" scenario even less viable. We're seeing rents in most areas flat to falling (a few prime BA locations excluded), and housing prices clearly on their way down already in AZ, San Diego, Sacramento, FL, etc.

The newest catch phrase of relator's; Inventory! Inventory! Inventory!

I know that the only thing worse than being a FB in the last couple of years would be to become an 11th-hour capitulating bear who loses his cool and jumps in too soon. I refuse to catch a falling knife and end up the greatest fool of all: a hypocrite and the guy who has no one else to blame because he actually knew better.

Exactly.

Which renting poster on this board succumbs to this flawed logic first and disappears soon, slinking off to the neighbourhood or condo association as their new community to replace the cameraderie of this board.

Who will be the one?

HARM,

Fair enough criticisms; but in your spirit of care to back it up, please provide me with calculations that prove your perspective. I have provided mine. For one, please enlighten me as to exactly what you intend to invest your alternative use of funds into that will hold or gain versus inflation without undertaking significantly more short-term risk than a real asset. If your answer is that you'll buy an interest in commercial property and is instead that you'll buy bonds or equities, then that ain't gonna fly. All you've done from a financial perspective then is trade lower sigma for higher sigma.

And please don't assume I have any type of "bubble fatigue". I'm a numbers guy. If you can provide reasonable numbers to the contrary, then I'm all ears.

As to FAB's "data", I have provided links to my hard data, as compiled by HSBC, annotated in hundreds of pages in a PDF, and downloadable as analyses in Excel. I'd like to see FAB's data aside from anecdotals. I'm sure the good folks at HSBC would too.

Which renting poster on this board succumbs to this flawed logic first and disappears soon, slinking off to the neighbourhood or condo association as their new community to replace the cameraderie of this board.

Who will be the one?

I personally just committed to renting for another year, so I'm not arguing anything from conclusion. You guys do realize that everyone has a different discount rate, right? That means that the optimal point for each person to buy in is different. Everyone has different salaries, different upside income upside potential, different wealth profiles, and different time horizons. Someone who intends to buy and hold for long enough will do fine as long as they can afford their payments on a fixed loan with 20%+ down...yes, even if they buy now. This has always been true. The only difference is that if they wait a year or 5 they might get something much nicer for the same $.

Randy, as far as "care to back it up" goes, like I said, I'm not a numbers/finance guy. Even if I made a best effort, I doubt I could come up with anything sophisticated enough to impress someone like you, who makes his living doing this stuff every day, all day long. But there are other professional number-crunchers out there who have made the effort, such as SoCalMtgGuy. And his numbers and conclusions broadly support my position (at least where the CA market is concerned).

...the optimal point for each person to buy in is different. Everyone has different salaries, different upside income upside potential, different wealth profiles, and different time horizons.

This I can buy, yes, absolutely.

Someone who intends to buy and hold for long enough will do fine as long as they can afford their payments on a fixed loan with 20%+ down…yes, even if they buy now. This has always been true.

Also true. However, you've just described a scenario that hardly even exists in CA anymore. 20% down? Anything down? Fixed-rate whatchamahoozie? What's that??? You must be speakin' martian or something.

The only difference is that if they wait a year or 5 they might get something much nicer for the same $.

Or get the same house for less in constant USDs. Either way's a win-win for me. :-)

Or get the same house for less in constant USDs. Either way’s a win-win for me.

You will have to buy when nobody wants to buy. The psychology of "not catching falling knives" will be overwhelming. Are you sure you can manage that?

As to FAB’s “data”, I have provided links to my hard data, as compiled by HSBC, annotated in hundreds of pages in a PDF, and downloadable as analyses in Excel. I’d like to see FAB’s data aside from anecdotals. I’m sure the good folks at HSBC would too

Randy, do you actually have reliable data on what the composition of loans (and down payments) were during the last bubble (mid-late 1980s)? I'm not trying to be "cute" here, I'd really like to know as a point of comparison. Everyone who worked in RE at the time seems to "know" that lending standards were very lax then, too. But this doesn't tell me anything quantitatively. I'd like to know what % were neg-ams/option-ARMs, interest-only, fixed, etc. And what % was the average down payment?

New restaurant alert: "Madison & Fifth" on University Ave in Palo Alto is pretty good. Try it out! It has some NY-style Italian food. Price is quite reasonable.

BTW, Downtown Palo Alto and Mountain View are really thriving. That may cushion the soft landing for certain types of properties.

Yesterday when I was surfing my section of East San Jose in Yahoo Real Estate I saw an MLS listed house where it said in the description of the property that it was in foreclosure and must sell this weekend. That's the first time I've heard of such a thing in that section for the past ten or so years.

During my Saturday errands I planned to drive past the house. It is in the enrollment area that is highly coveted by well heeled immigrants for "Evergreen Valley High School". On the way to see the "evergreen" house that is facing foreclosure, I saw eleven of those "open house" real estate signboards at the intersection of Quimby and White, which is kind of at the northern fringe of "Evergreen", about 300 meters from the foreclosure property. Two of those 11 signboards did not show the name of realtor companies, but instead, something else. One of them called itself "lender" and the other one called itself something like a "mortgage and loan trust". Neither of those two sign boards was for the foreclosure property that we drove by, a vacant house that's about 38 years old with an asking price of something like 669K.

You will have to buy when nobody wants to buy. The psychology of “not catching falling knives” will be overwhelming. Are you sure you can manage that?

Hey, I'm not saying it will be easy --far from it. We will have to organize local chapters of the Patrick.net Buyer Resistance Support Groups. Motto: "Friends don't let friends buy houses while prices are still falling".

Surfer-X will be my local PBRSG brother. I will carry his number around with me at all times. Whenever I see a cool turnkey bungalow in a good neighborhood and get the urge to "buy now!", I will call him up, and he will come over and smack the s*it out of me until it passes.

It can work, trust me... :mrgreen:

Wait a minute, did you mean the psychology of NOT wanting to buy will be overwhelming at the bottom of the market? Hmm... I hadn't considered that. I guess as long as I find a place I can really afford in a nice community where I'm happy, I really won't care what other people think. That's what I hope happens, anyway.

Bubble Battle Fatige
Another one for the dictionary, no?

Yes, consider it done.

HARM,

I don't know what the loan composition was in the 80s or 90s downturns. I think it's safe to say it was a lot less IO and NA loans. Were there even NA loans in the 80s? There were a good number of ARMs in the 90s, because rates were falling.

I don't make any claims about whether this correction will be more or less sticky than previous rounds. I simply contend it will be sticky. It already is sticky.

The reason I rail against you sometimes here is that you're overemphasizing timing and ignoring utility. This is actually the same thinking that got the specuvestors into trouble. A little good, common sense timing is fine. But I recommend leaving ultra-precise timing of any market to geniuses and fools.

Utility is a huge factor in home owning. In my case, renting is tremendously undesirable. All the normal reasons for someone of my age with a young child plus lack of handicapped accomodations for my mother. That means that economically, I will derive more utility from owning a home than someone who is in a different situation, like a single 25 year old with no children or elderly mother living with him/her. That means that I will place a higher value on any given home, and I will be willing to pay more for it than someone who is playing the purely technical game of "don't catch a falling knife".

I am dubious of technical investing. I'm a value investor.

I could find no proofs, models or formulae on that link you provided. If they exist please call them out. I am eager to see how he calculates returns in an inflationary model, overcomes iterative tax benefit and fixed rate advantages, and still proves that real assets are suboptimal.

Randy H,

Take a deep breath, and step outside of yourself for a minute. I like numbers too, but not as much as you. Rely on all the information you have gathered through the years of your life, and see the big picture.

Using a computer model to predict the exact point of a hurricane making landfall 5 days out, is about as accurate as predicting where the economy is headed on D-Day. The exact point if landfall can change within a matter of hours, as was the case with hurricane Charley. All the numerical information crunched by a super computers, could not predict how things would eventually turn out. This is what separates us humans from the numbers. We are not like a race horse, running down a track with blinders on.

I take into account anecdotal evidence and psychology of the market, which numbers cannot crunch. Things like the EAU, Russia, and China wanting to increase their gold reserves from 2% to 10%, buying on the dips. Other things like historical patterns of how previous housing bubbles have played out. National and personal debt, each about 10 trillion dollars. And don't forget political instability and the price of oil.

Although, computer models cannot accurately predict where landfall will be, you can at least see the general direction that a hurricane is headed, and plan accordingly.

Bubble Battle Fatigue (BBF): Term coined by yours truly to characterize the cumulative psychological damage caused by constantly doing battle with housing perma-bulls, trolls and unrepentent specuvestors. May result in sporadic grouchiness, ennui, and the tendency to mumble aloud about "cap rates", "rent vs. buy" & "ain't feedin' no damn squirrels" at inappropriate moments. If left untreated, extreme cases may result in total bear capitulation, where the subject assumes the identity of the trolls he's fighting and may even begin to recklessly speculate in RE.

Randy, hopefully this link should provide at least some of what you are looking for. But neither SoCalMtgGuy or myself have ever bashed traditional financing --quite the contrary. If everyone used FRMs, 20% down, provided proof of income, etc. then there would be no bubble.

Point taken on considering utility along with timing. I have never claimed the power of perfect prescience ;-), and while I have a rough idea of when a bottom *might* happen --just based on previous bubbles-- the prudent thing to do is keep an eye on all the relevant data and consider your particular needs. This we can agree upon.