patrick.net

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.

"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."

Lol. Not on this world.

You mean my monthly payment has increased?! - duh

http://www.denverpost.com/business/ci_3247039

HARM, My analysis was of the national median prices not CA. Obviously the math will be different when the land values are higher (or lower). While land is the majority of the price in the more expensive places like CA, land is not the majority of the price in most places. I used the middle ground of the national aggregate market. Markets have variation, and over the last 35 years CA has risen to be at the high end (as I forecast that it would 30 years ago).

I think we agree that observed differences in price and price per square foot are mostly caused by differences in land value. The index that I posted is not intended to address the variance around the country. It is an illustration of the change over time for the national price level – which I also believe is primarily caused by land values rising.

Whether we look at home prices or price per square foot we do see a wide range across various locales. This is mostly driven by differences in land value. When land values are higher there is a tendancy to build larger structures, including condo high rises and office buildings (Manhattan is a classic example of this). This is the textbook example of the “highest and best use” concept. Of course, over time the highest and best use can shift. On a small scale you see people tearing down small houses on highly valued lots to build something bigger.

BTW, you can buy half a house. But, the half a house argument is a red herring.

Frank,

That article is good until you get to the biased bullshit in the second half :

Industry experts have mixed feelings about whether the boom is beginning to ease.

"I think that price appreciation will for the most part remain pretty solid for another three, four quarters," economist Celia Chen of Economy.com said. "By the end of the next year into early 2007, we'll see substantial slowing in house prices."

Kind of sounds like the misinformation minister. :lol:

On inflation vs. deflation:

Our capitalist economic system seems to work best when there is mild inflation. As Zephyr has pointed out, even mild deflation can lead to counterproductive behaviour among the participants (the whole vicious circle thing).

I have no idea of economic theory, but could it be that the *ultimate* long-term driver behind that required inflation is population growth?

A few examples in support of that thought:
- Japan's population is slowly decreasing these days, and they have experienced mild deflation for some time now (not only in real estate).
- Same in Europe. Stable or decreasing population, economic growth not so good, inflation very very low.
- in the U.S., people move to the coasts because that's where the jobs are, and thus are inflating the value of the only good that doesn't have the same price across the nation (and happens to be difficult to make in this area) - real estate. Take the bubble out of the equation, and real estate prices would still be relatively higher there because of the population growth pressure. If at some point in the future the coastal areas would actually experience outflow of people, the relatively high valuation would deflate, back towards a new equilibrium.
- as for the U.S. as a whole, if the immigration levels are keeping up (and Greenspan has urged lawmakers to facilitate that a few years ago), there's going to be continued growth coupled with some inflation.

If you spin that thought further, then the reason why western societies have been so prosperous over the last couple of hundred years is continuous population growth, which creates economic growth, which creates inflation, which makes the system work well.

Ultimately, that would make the whole capitalist system a humongous pyramid scheme :-)

I read somewhere (don't remember where though) that in the not too distant future, the society that can attract the most young and educated people from all over the world will be the most successful. What's needed is a good education system for their kids, good jobs and a decent standard of living.
I think the U.S. as a whole still has a good shot at that. Hope we don't screw it up with all that greed and stupidity.

I read somewhere (don’t remember where though) that in the not too distant future, the society that can attract the most young and educated people from all over the world will be the most successful. What’s needed is a good education system for their kids, good jobs and a decent standard of living.

.....and it's no wonder the younger generation is starting to move away from the coasts (at least the northeast), because they can no longer afford to live along the coasts (at least at this point in time).

Allah, Speculators definitely affect the rising market as you describe. They are really temporary extra demand that shifts to temporary extra supply later. This distorts the market and accentuates the price increases in the late stages of the cycle rise. These speculators are basically momentum investors who buy on the expectation of continued appreciation momentum. Eventually the momentum ends and their shift to selling adds to the supply for sale while their absence as buyers diminishes the demand. The inevitable result is a market turn. Without these speculators the market cycle would be smoother.

The smart money plays a different strategy. At the bottom of the cycle there are speculators who buy at the market low points to hold or sell later. These speculators actually act as a stabilizing influence on the market, adding demand in the low periods and selling their supply when other buyers are plentiful. They, of course, have not been buying for some time now.

The smart money plays a different strategy. At the bottom of the cycle there are speculators who buy at the market low points to hold or sell later. These speculators actually act as a stabilizing influence on the market, adding demand in the low periods and selling their supply when other buyers are plentiful. They, of course, have not been buying for some time now.

The true speculators don't buy until they see the rise of the next cycle..... or at least until the rental prices are inline (p/e ratio)....noone knows where the bottom is and no smart investor will try to guess (cath falling knives). I feel there will be a tremendous drop being that where I live, according to realtor.com, the cheapest house is over $300k, and we are talking major piece of shit! I would be very amazed if prices didn't fall at the very least 50%.....In fact, if they offered to cut their price 50% right now, I still wouldn't buy..........it is just not worth it! The money you would have to put in to it to make it worth living in would be ridiculous. If salaries increase at least 50%, it might work, but we all know that's never gonna happen!

Girgl, I share your view on the importance of education and the determinants of success for a society. The U. S. remains in the lead on economic strength, but greed and stupidity (especially stupidity) can damage it. Our tax policies and the strength of our currency are making foreign locations more cost effective places to operate.

Allah, Over the long run real incomes do grow, but 50% will take several decades at least.

From a financial perspective it is better to not buy if prices are falling. I have been an investor for about 30 years. That is one of my rules – never buy while prices are falling. Wait for the bottom. Of course, it is not easy to know when the bottom has arrived. Ditto for the top.

There are good methods for confirming once the point has passed. Many people have prematurely called this housing decline. However, I believe that it has actually started in most places.

A year ago I was convinced that the housing market was not yet at the peak. By March of this year I decided that the summer of 2005 would be the most likely time for the peak -- with a modest probability of continuation until 2006.

As prices rise wages rise so people can still buy the same things over time, it just appear in the short term like things are getting more expensive.

Wages have been rising historically, but not anymore....wages are shrinking, mainly due to outsourcing......and this will only get worse in the years to come....Companies figure they can maximize profits by having the work done overseas for pennies instead of dollars.

. For consumers the key will be the speed at which inflation hits and whether they can adjust their income to keep up.

Seems to me inflation is self regulating in the age we are in........things get more expensive, consumer gets paid less........consumer spends less......companies lose profits.....companies layoff workers............consumers spend even less.......you can see what this leads to.........and the fact that most americans are leveraged to the hilt with debt and have zero savings, this vicious cycle will only cause more defaults on debt. You cannot compare any other time in history to today because there are way too many differences!

Allah, Over the long run real incomes do grow, but 50% will take several decades at least.

Exactly! ...and that is why house prices will fall tremendously!

Allah, We are in a time that is different in many ways. Collectively, we have more debt than ever, more income than ever, and more wealth than ever. It is to be expect, of course, that more borrowing will come with more defaults, unless the rate of defaults declines.

The wage pressures cause by global competition are definitely limiting incomes for those whose jobs can be performed in far away cheaper places. Ultimately the currency exchange rates should cause this cost advantage to diminish. However, the USD is the main reserve currency of the world, and this makes the dollar less sensitive to such trade pressures. So the pressure will continue.

Interestingly, while wages for the bottom half of earners has been under pressure, those whose jobs are not very exposed to lower cost foreign competition have enjoyed strong real wage increases in recent years.

We have a situation where the averages or median income statistic does not tell the whole story. The median is not moving much, but half of the people are enjoying gains while the other half are losing ground.

While the underlying fundamentals of the market move slowly, the market prices can (and often do) move quickly as peoples’ expectations about the changing environment fluctuate. Psychology is always an important market factor. It tends to accentuate market cycles, as people move in a herd mentality. Even without speculators and flippers we would see clear cycles in housing prices. This would happen even if interest rates and incomes were stable over time. Of course, the cycles would be milder if these factors were all more stable.