patrick.net

What will happen to the homes of people who are foreclosed on? The same thing that happens to the homes of people who die. Someone else buys it. And death is more prevalent than foreclosure.

Allah, A brief study of economic history would show you that deflation is far worse than inflation. Even if you do not understand the theory, you should be able to see the difference in the results.

What will happen to the homes of people who are foreclosed on? The same thing that happens to the homes of people who die. Someone else buys it.

Someone else does buy it, but usually for a much cheaper price.

Allah, A brief study of economic history would show you that deflation is far worse than inflation.

You cannot always use history as a guide....during the great depression, things were alot different than they are today. I am not an economist, but I do know that it would take higher income to support high inflation and the companies in this great country of ours will not pay the price for american workers. Sure....deflation is not good for companies, but do you think inflation is? If people cannot afford to support themselves, they will have to find another job and/or move to a community that has cheaper living expenses. Also, people will cut back on spending and that can't be too good for companies either.

Thirty years ago I conducted a study of real estate prices using some pretty good data spanning the 50 years from 1920 through 1970. It was actual same home type data by year, by neighborhood, for about 40 distinct neighborhoods in a major SMA. This home price data was very proprietary to its source, but they allowed me to use a derivative of the data (indexed values, not the raw prices).

...The purpose of the study was to evaluate the market realities for the benefit of improving residential investment strategy. After finishing the study I decided that I did not want to share what I had learned with anyone. Selfish, for sure - but I saw a competitive advantage that would be worth more to me than any recognition that could come from publishing the results.

Zephyr,

As far as the GDP being a better/broader measure of inflation, you may or may not be correct, although some believe it overrelies on substitution and thereby understates the impact of real price hikes on the consumer.

I certainly understand not wanting to reveal valuable proprietary research you're currently using. But without knowing what it reveals, it's hard to debate you over it's merits relative to Shiller's methods & data.

How about this: if you were to re-plot Shiller's RE price graph using the GDP deflator as an index, and substituting your own price data, what would be the approximate result?

Zephyr writes:

“Deflation is great for the consumer until he loses his job and has no money to take advantage of the lower prices.”

Deflation, to the extent that it is a corrective process, will temporarily bring higher unemployment rates as factors shift from mal-investments to more efficient allocation of resources (e.g. who needs all those Real estate agents!). The new jobs created will be more permanent because they are not the result of some inflation-induced bubble.

“While deflation makes everything cheaper in nominal terms, the real costs do not decline by the mere strengthening of the currency.”

Real costs do not decline by the mere strengthening of the currency, but because of the more efficient allocation of resources (i.e. more efficient production) - something that under a price targeting, inflationist economy has historically been proved impossible to achieve (repeatedly).

“…deflation creates an environment where investors are better off holding their cash idle”

I think I sufficiently covered this in my prior post. Let us just agree to disagree, then :-).

“…deflation reduces the benefit of investing, and eliminates the imperative to keep the money working”

Huh? You are assuming that there are no good investments in a deflationary period? That is not historically supported, and seems counter-intuitive. An economy that is good for both consumers and businesses, after all, has to be a good place to invest.

"But it strikes me that even the most stupid sheeple will look at the fact that that shiny new car or toy ( like the bike ) keeps getting cheaper then it’s best to wait"

It depends on individual circumstances, but if this were a general rule then I would never own a computer, iPod, Palm pilot, digital camera, TV, bike, or one of a dozen other toys that become continuously cheaper over time.

Necessity is only one factor. I think you grossly underestimate the desire to consume now as opposed to later. We all want to enjoy the fruits of our labors at some point. It is ridiculous to think that in a deflationary environment, everyone will take their money to the grave with them ;-).

The value of looking at price data such as the Shiller graph is to show how the real price has changed over time. It would be better to look at the total cost of ownership rather than the price. However, that is not as easily portrayed. Working with price data we can take the analysis to a more refined level than mere price. Mere price ignores changes in the average house. How much house do you get for your money?

Over the last 50 years the average home has increased in size dramatically. This size growth is an important factor in considering housing price changes over time. In addition, homes built or remodeled today include a much higher level of luxury finishes and features. It is hard to calculate the value of these upgrades with confidence. However, we can calculate the cost per square foot to see how housing costs have changed over time on an apples to apples basis relative to size.

I have done a rough calculation of the inflation-adjusted median home price per square foot. I used the U.S.A. median prices, median home sizes and the GDP deflator for the last 40 years. I have stated the values as an index where 1965 equals 100%. Here is the result:

1965 100%
1970 135%
1975 118%
1980 134%
1985 131%
1990 157%
1995 127%
2000 152%
2005 197%

Housing prices per square foot have roughly doubled. It is interesting to note that inflation-adjusted household incomes have also roughly doubled since 1965. Interest rates were rising or high during the 1970s and 1980s suppressing price appreciation, and the declining and more favorable interest rate environment of the last 20 years has accelerated housing prices. Interest rates today are comparable to what they were in 1965. The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years. Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years. Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

Housing is not more affordable...........the only reason it seems that way is because of the looseness in credit standards and the crazy types of mortgages that are available. If we didn't have these two elements, it would be no more affordable than it was back then....and there would not be a bubble.

the percentage of households that own the home they live in is now at an all-time high.

...another thing,.......the percentage of ownership statistic is totally flawed. Someone who took out a 0% down, IO ARM cannot reasonably be called a homeowner........and I know when this crash plays out, the percentage of homeowners(as they like to call it) will drop lower than it was before the boom due to cash out refi's and spending on investment properties.

R. Patrick, You are spot on with your comment that deflation would cause some deferral of purchases. They would not fully stop. That is not possible, but it is a well established fact that consumers react to expectations about future prices. When prices are expected to rise significantly consumers rush to purchase if they can. This is in fact one of the symptoms and a contributing cause of bubbles. They (we) also tend to wait on some purchases when we expect prices to fall. Many on this board are in fact advocating that very behavior regarding home purchases.

It is certainly true that not all purchases can be deferred or accelerated. But for those that can be consumers do respond to expectations of future price changes.

You are right that even the most stupid sheeple will see the benefit of this strategy and act on it to some extent.

Allah, You say that easy money is the reason for people being able to buy. OK, I am only saying that it is more affordable, not why. You are correct in observing that easy money is a factor in making housing more affordable. Take away the easy money and the affordability declines.

As for financing, whether you have no debt or 100% debt you do own the house. You may have only a small stake in the house but it’s yours. This does raise questions about risk factors and distribution of risk.

As for financing, whether you have no debt or 100% debt you do own the house. You may have only a small stake in the house but it’s yours.

That stake may be below zero....in which case the house owns you.

The value of looking at price data such as the Shiller graph is to show how the real price has changed over time. It would be better to look at the total cost of ownership rather than the price. However, that is not as easily portrayed. Working with price data we can take the analysis to a more refined level than mere price. Mere price ignores changes in the average house. How much house do you get for your money?

...Housing prices per square foot have roughly doubled. It is interesting to note that inflation-adjusted household incomes have also roughly doubled since 1965.

Hmmm... I smell a 'hedonic' adjustment coming.

Over the last 50 years the average home has increased in size dramatically. This size growth is an important factor in considering housing price changes over time. In addition, homes built or remodeled today include a much higher level of luxury finishes and features. It is hard to calculate the value of these upgrades with confidence. However, we can calculate the cost per square foot to see how housing costs have changed over time on an apples to apples basis relative to size.

Not so sure about that "much higher level luxury finishes and features" being the primary reason for driving up prices, though you have a point about homes being about 50% larger on average than they were 40 years ago.

Even so, here's the problem with this logic:

1. I don't see how/where you're arriving at the conclusion that HH incomes have gone up at roughly the same rate as housing prices, especially in the coastal states. Every reliable measure of HH incomes and prices says otherwise, even the BLS (who have reasons to want to show income growth). If switching from the CPI to GDP deflator is alone responsible for this result, then this convinces me that the GDP deflator is an even WORSE method of measuring inflation. Clearly, incomes are lagging behind RE prices, or affordability rates (even with exotic financing available) would not be so low, nor would record numbers of households devoting record high %s of incomes to service mortgage debt.

2. Newer houses being built are significantly larger than they used to be, yes. This still doesn't explain why resale prices on older existing homes (with less square footage) have also gone up far faster that rents, inflation and HH incomes in recent years.

3. People may be buying bigger houses than before, and they may or may not have more "features" (whatever that means), but such hedonic "quality improvements" don't in themselves explain why prices have risen so high so quickly. Today, my computer has tons more "features", more RAM, CPU, storage capacity, speed, etc. than it used to 5 years ago, but it hasn't doubled or tripled in price. Housing, like practically all consumer commodities, gradually improves over time, but that alone doesn't lead to higher prices.

The net effect of the additional considerations is that housing is more affordable today than it has been during most of the last 40 years.

Right. Except that even CAR/NAR admit housing affordability is actually at its LOWEST level in 18 years.

Not surprisingly the percentage of households that own the home they live in is now at an all-time high.

With median home equity per household (a better measure of "homeownership" than how many people have taken out an NAAVLP special) at historic lows of around 55%, this conclusion is highly questionable, if not flat out wrong. Let's rephrase it for better accuracy:

Not surprisingly the percentage of households that owe record levels of mortgage debt is now at an all-time high.

Frank, The key to evaluating the impact of deflation is the magnitude of the deflation. Mild deflation (under 1%) will work fine, but anything much higher leads to a deflationary contraction, under-investment and rising unemployment. Those who keep their incomes will benefit as prices fall faster than incomes. However, in the aggregate, real incomes will decline if deflation is more than mild.

Falling incomes lead to falling sales, and further unemployment… A death spiral.

Extreme inflation can also cause severe problems. However deflation of 5% annually is more destructive than inflation of 10% annually.

In other news, a recent AOL survey concluded that only 30% of participants think we’re in a bubble.

Well that only proves my theory that at least 70% of AOL users are ignorant.

It's funny how they say the ownership rate is about 70%

HARM, You disagree with the notion that higher luxury features are the primary reason for higher prices. I do too. And I did not say they were. I did NOT include them in my calculations. I only noted them because they are a real (and perhaps material) consideration left out of my calculations. There are no hedonic adjustments in my data.

As for the average household income, compare the prices per square foot to whatever income measure you like. You will get substantially the same result if you do so correctly. We can debate the precision of the income and inflation calculations, but that will only yield minor adjustments.

You suggest that inflation has been higher than I used, and that inflation-incomes have grown less. OK. Higher inflation factors will make the old years look more expensive per square foot, but will be offset by higher inflation-adjusted incomes back then. So the relationship will barely change. It doesn’t really matter what inflation index you use as long as you apply the same index to the numerator and the denominator (prices and iIncomes).

Allah, You said "Well that only proves my theory that at least 70% of AOL users are ignorant."

At 70% AOL users compare favorably to 95% among the general public.

HARM, Size of home is not a hedonic measure. It is a quantity of the good, like two gallons instead of one gallon. Do you really think that in the same housing development you can buy a 3,000 square foot home for the same price as a 1,500 square foot home of the same quality and features under normal conditions? I know from your prior posts that you are smarter than that.

Home prices in California have gone up by much more than the national average. Incomes in CA have not.

Like all assets, some appreciate more than others. Compare Toyota stock to GM stock…

In 1970 the median price for a single family home in CA was about the same as the national median price. Today the CA median price is more than double the national median price.

Allah, You say that easy money is the reason for people being able to buy. OK, I am only saying that it is more affordable, not why. You are correct in observing that easy money is a factor in making housing more affordable. Take away the easy money and the affordability declines.

BTW...just because you can get a mortgage for an obscene amount of money to purchase a house doesn't make buying more affordable. People have taken out loans with a 1% teaser rate without understanding either that it will eventually cost more than they can afford or that it will be hard for them to refinance to a fixed rate or sell when it does. If housing was truely affordable, I would be able to buy with a traditional mortgage,.....but it is not. When the majority of mortgages fail and the rates are higher, the idea of easy money will be history and only those who can truely afford to buy will be able to again...thus bringing prices back to earth.

Here's a good article to read despite the bullshit in the other half of it.
http://tinyurl.com/8dvmr

HARM, Size of home is not a hedonic measure. It is a quantity of the good, like two gallons instead of one gallon. Do you really think that in the same housing development you can buy a 3,000 square foot home for the same price as a 1,500 square foot home of the same quality and features under normal conditions? I know from your prior posts that you are smarter than that.

Zephyr,

We're not debating the price of 1500 sft homes compared to 3000 sft homes, we're debating why the average price of ALL homes has gone up so fast compared to CPI, rents, incomes, etc. You're arguing that we should change the metric from "price per house" to "price per square foot", because houses today are bigger than they used to be (true).

I'm arguing that "price per square foot" is a very poor way to compare RE prices over time for a number of reasons:

--Regardless of average size today, you cannot buy 1/2 of a house, you buy the whole house (well, technically you can, but that's a topic for another thread). 1/2 of a house may still be "affordable" in CA, but try taking out a mortgage for that.

--You are applying "price per square foot" to the structure not the LAND, which is by far the biggest cost component in any RE purchase, especially in high-cost coastal states. The cost of the structure itself is is a much lower % (someone actually posted a link with this data a while back --have to look for it). This gives you a conveniently lower figure, but says nothing about the average selling price of the whole house --the only metric that really matters.

Tell me the average plot size of a house has gone up 50% and you might have something.

--If you want to calculate the true "price per square foot" of a house today, look at the replacement construction costs, and you'll see that it's roughly the same as it was 40 years ago, when adjusted for inflation (however you want to calculate that). Even though houses built today are 50% larger on average, this does not mean prices for LAND + STRUCTURE should go up 50%. It means just the structure part should go up 50%, which is itself only a small fraction of the total RE cost.

In California
If land = 80% RE price
If structure = 20% RE price

Then a 50% larger house at roughly same inflation-adjusted replacement cost per sft = land(.8) + structure (.2 * 1.5) = .8 + .3 = 1.1

We could reasonably expect prices to have gained some 10% in value due to higher construction costs associated with larger average home size. This alone does not explain the recent run-up in prices relative to practically everything else.

Anyway, you know what I’ll be doing over Thanksgiving. And if you thought working, wrong answer. I’ll be watching the Dallas Cowboys play football.

Probably most of the other realtors will be doing the same thing.......... doesn't it suck for you realtors when the boom comes to an end?

Home prices in California have gone up by much more than the national average. Incomes in CA have not.

How about rent in California versus the national average?

Compare Toyota stock to GM stock…

Of course one is profitable and one is not.

“The key to evaluating the impact of deflation is the magnitude of the deflation. Mild deflation (under 1%) will work fine”. - Zephyr

Zephyr, I’m glad you’ve given up the “deflation is deadly” theory – that, at least, is a step in the right direction! :-)

You know one crucial difference between inflation and deflation is that inflation can escalate up to an infinite supply of money at the behest of the Fed, whereas the money supply can only deflate as far as the free market wills it to. Think about that for a while.

Also, was it you that said deflation means that no one will incur debt? That’s far fetched, isn’t it? Deflation just means that incurring debt is costlier than saving, and this is as it should be. Just look at the mess our economy is in now with regards to savings and debt and you’ll understand why this is desirable.

There is a bubble in Texas. It is just smaller in scale.

I do have friends who are investing in Texas. They said that because Texas is growing rapidly, real estate will appreciate.

I totally agree that Texas is growing and will continue to do well. However, the growth comes from sensible pro-growth policies, which practically rule out extraordinary appreciation in the future.

Some Californians just do not get it.

Like all assets, some appreciate more than others. Compare Toyota stock to GM stock…

If the massive run-up in RE prices along both coasts were fully offset by equal-magnitude price declines in the rest of the country and could be explained by a massive population shift to the coasts, then you might have a point. But there are no price declines happening in middle America, just smaller increases (yet still above rents/inflation/incomes). And if anything the population is migrating out of high-cost areas into lower cost regions.

massive population shift to the coasts,

The fact that the inventories are so high disproves this theory. If there is such a large population shift to the coasts, then why won't they buy these houses? Like the realtors have been saying "there are so many properties to choose from."

I read a report that says that short interest has been exceptionally high from mid-October to mid-November. So far that has appeared to be a positive catalyst for the markets.

Psychology drives the markets. News drive psychology.

Sometimes, market reactions can be counter-intuitive in the short run, right? ;)

Newsfreak, You said "I wonder why in a country so awash with cash, some people cannot afford a house."

There is lots of cash, but some do not have enough for a house (even with loose lenders), while others have enough for several houses.

Peter P, Yes, it sure seems that way to me too -- markets (people) often react in ways that are at least somewhat counter intuitive. They are particularly prone to overreact -- to overestimate the significance of bad (or good) news. This tendency is the basis of that old cliché “buy on bad news, sell on good news.”

I guess we should have bought Fannie Mae on the bad news. It’s up $8 to $50 now. On the other hand Toll Brothers has not recovered (yet?).

PeterP, You said: “I totally agree that Texas is growing and will continue to do well. However, the growth comes from sensible pro-growth policies, which practically rule out extraordinary appreciation in the future.”
You are so right. Many people are not aware of how significant the growth policies are to home prices. Builders build in response to their perception of demand. There is a significant lag from the time of deciding to build, to the time the homes are ready for the buyers to move in. The actual construction only takes a matter of months. The big delay is the time it takes to get approval of the project. Two years is common, but in some cases it can take a decade. Places where these delays are longer have more volatile price cycles because of the timing mismatch between supply and demand.

Allah, The population shifts are part of the demand side. Supply is also a very important consideration. Even with strong demand there are times when we have oversupply.

Peter P, The GM vs. TM comparison was an extreme case to illustrate the point of differing valuations to nominally similar assets. The fact that one is actually losing money rather than merely making less money is a matter of degree. Even among companies with similar profitability we often see very different valuations.

As for CA rents vs the nation, their relative movement over time is not as important as the rent level relative to the price level in each area. CA rents are far too low compared to the current cyclically high prices. The two shall converge.

…and rents tend to move slowly. So the majority of the convergence must come from price declines.

"I wonder why in a country so awash with cash, some people cannot afford a house"

Infusing cash into the economy as our fed does does not make the economy wealthier.

Allah, The population shifts are part of the demand side. Supply is also a very important consideration. Even with strong demand there are times when we have oversupply.

Zephyr,

There were many speculators who bought houses,...these speculators were buying not for themselves, but because they can make bucks on flipping them....some of them don't even live anywhere near the house, some haven't even seen the house!...but now that the market is slowing, they are trying to get rid of them...........thus the artificial demand they created is now subsiding. Not only are the speculators running scared, but there are many who are starting to realize that they shouldn't buy now.....this lowers demand even more. Is there still alot of demand? Maybe, but there sure is a whole lot more supply than demand...and we all know what that means.

What caused such incredible demand in the first place? Did people all of a sudden say "I'm gonna move to the coasts, I like it there"? No. The cheap money that was thrown at RE caused many renters to buy as evidenced by the increased rental vacancies and prices......this sudden event caused RE prices to artificially increase in magnitude.....and because of this, speculators saw opportunity. People don't buy 2 or 3 houses unless they feel there is money to be made......take away that psycology and what do you get? decreased demand....so as far as the demand side of the equation goes, it is a whole lot less than it was when RE was booming.....and as prices slide it will lessen it furthur.