patrick.net

Red Whine,

I am not sure if I follow your anology of stock prices. It has always been the case that P/E ratios of different companies to be different. And by a wide margin. Hence some are called expensive stocks, while some not. The stock price is based on expectations of future. But then, even the P/E/G ratios are not same for all companies. That's due to risk premiums associated with different businesses.

That has nothing to do with any "New Paradigm". In fact that's the old paradigm.

In RE, the analogy is location. Different locations command different sqft rates. It has always been the case, and it will always be the case.

In a secular bull / bear market, most stocks would go up / down, but there will always be exceptions. And not all stocks would move by the same %. I expect the same in RE. Not all markets will fall the same.

The new paradigm would be, the % of income people are willing to spend on mortgage. That's the ownership premium we as a society will pay to buy a home. Can that change ? Who knows.

Randy H said:

Your calculation is wrong. It is NOT LINEAR. The “gap” closes faster than that because of the iterative nature of the interest tax shield, the time-value nature of the alternative investments, etc. This is basic finance stuff, yet I’m being cast as some kind of obscufator for pointing it out.

Of course you shouldn’t use a NAAVLP. But, for those who can afford a traditional 15 to 30-year fixed and have a 20+% downpayment, the gap takes around 7 years to close, not 20. This is because of the way the “curve slopes”.

Ok, let's assume I buy this (I don't, but for the sake of argument, let's just say I do). So, let's assume it takes only 7 years, not 20, to close the rent-vs.-buy gap. And that it can be accomplished solely through wage & non-RE inflation. Again, this would be OK with me.

While underwater FBs are struggling with the dual whammies of rate resets + amortization payment resets, taking the bus to work and eating Ramen by candlelight, I get to continue to rent an equivalent unit at a steep discount, sleep soundly and invest my savings in T-bills, S&P or Euro stocks, or anything else that pays a premium at or slightly above true inflation. And at the end of that 7 years, I get the full benefit of inflated wages and depreciated housing by having a much lower real cost basis than the previous owner PLUS my savings/investments.

How is this hurting me? Sounds like a pretty good deal in my book.

@LILLL,
(HARM blows kiss)

I would think that it depends on how you measure “nice days”, because I cannot imagine Chicago has as many nice days as Portland. How did you measure?

To me, a nice day is a dry, overcast day.

Homma’s Brown Rice Sushi is very tasty, by the way. They have to fly stuff in from Florida they told me

Where is this sushi place? :)

HARM Says:

> I’m convinced CA median prices will never return to the
> 3X HH income ratio common in other states. It’s not
> beyond the realm of possibility, however, for it to fall
> to 5-6X HH incomes (it’s currently about 12X).

When I do research on the income to housing multiple I do it at census.gov on the census tract level (a census tract is smaller than a zip code). It is important to remember that census data for the income of real rich people is almost as bad as it is for real poor people, but it is dead on for middle class areas like Burlingame, Mill Valley and Danville…

To BA Or Not To BA Says:

> I am not sure if I follow your anology of stock prices.
> It has always been the case that P/E ratios of different
> companies to be different.

There will always be companies (like those with a lot of growth potential or in BK) or homes (like those designed by Frank Lloyd Wright or those next to a crack house) that sell at multiples higher or lower than average, but most homes like most stocks will trade within one standard deviation of the mean…

Face Reality,

I am the one who keeps talking about Cupertino. I use it as one of my gauges on how things are going. I consider it to be the real core of South Bay bubble. It attracts middle class, upper middle class and affluent parents alike. It has one of the lowest inventories, and highest price/sqft. Hence my gauge.

Yes, the market is "normal" in Cupertino. We agree there. But it's the direction that I am interested in more. No bidding wars, room for negotiation, and inventory slowly but sure creeping up. Has it crashed ? Hell, no. Will it "crash" ? Depends on what one means by crash. My prediction, it will be one of the last one to crash, and be the softest landing possible.

Other area like, Evergreen, Morgan Hill, Dublin will fall "harder". I don't know what you mean by prices holding steady. They are already coming down in those areas. I have posted numerous times about the inventory, price reductions, relistings and specific instances price reductions.

This is just the beginning. It's slow. And these things always take longer than you expect, even if you think it will take longer than you expect.

I do not think the prices will crash by an obscene number, and will revert back to 1998 or whatever. But I do expect prices to revert back to 2003 prices. Maybe Cupertino will avoid that.

Even if I am wrong, the worst case scenario seems to be prices remaining steady. I am happy to rent for one more year, save more down payment, and buy the house at the same price next year. I sleep very well these days.

Robert,
You have to admit that the word " trailer" has a certain negative stigma attached to it. People associate "trailer" with " trailer trash" and lord knows Californians have a frenzied paranois af anything remotely resembling bastions of conservatism- classical trailer trash stereotypes included. I can gurantee that even if population density were not the problem, residents would still not want to have a trailer park next door. The knee-jerk reaction is one of disgust.
The stereotype of trailer trash is so heavily outdated. There are many people I know back home who now live in one, and you'd be hard pressed in some cases to tell the diffrence between the manufactored home and the real deal.

Jon,
the middle class in California are already done. Sorry to say that they're leaving in hordes.

FYI: The yield curve is now flat-to-slightly negative on the 6mos./10yr. spread:
http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

Based on his recent comments, sounds like ole' Heli-Ben is prepping the markets for another qtr. point hike (or 2, or 3...).

Returning to Bay Area,
I think all one has to do is look at your last post to realize why some people are wringing their hands. Why in the hell should you have to wait 10 YEARS in order to put a down payment on what will likely be a smallish, 1950's house? Am I wrong or is there something amazingly out of whack with that equation?
By the time you're 40, you should be well on your way to not only having your fianances and housing situtation figured out, but you should also have a majority of your retirement saved up. Otherwise, you'll be one of those guys who's suddenly 55 years old, invested most of their money in a freakin' house, and thinking of retirement, but can't because you blew it all on a house. That's what is happening now- people who waited until they were already well on their way to retirement to do what most people in this country do at the age of 25; buy a house, and suddenly realize they have zilch saved up for what really matters, which is what are you going to do at the age of 60? work 10 more years?
Maybe I'm old fashioned, but if I realize that I'm going to have to wait for yet another 10 years just to buy something in an area that will likely have deteriorated even further , then I hardly see the point in buying anything at all. If you're dead-set on practicality and wage-saving, then you'd probably be better off just to rent, grow old, and go to the retirement home. Otherwise, other states beckon and offer more than what CA could/will offer. We want this thing to crash sooner than later for very obvious reasons.

FRIFY,

No worries. I don't consider myself "monied", because to do so would be inconsistent with my Midwestern roots and I'd be forced to hate myself. The truth is that my wife and I both worked hard to crawl out of very modest beginnings. Every bit of what we have we earned, except for what we got out of home equity; that was just luck. I have no illusions that I in anyway did anything to earn my home equity winnings other than sleeping there for a few years during a lucky time.

Peter P Said:
Randy is our leader. Follow the Leader…

Even on those rare occasions where I disagree with him, I always respect Randy H's intelligent and carefully argued analyses. Randy will probably forget more about economics and financial markets than most of us will ever learn. If I had to make a short list of people I'd go to for professional investment advice, his name would probably be at the top of that list.

And yet, still I do not think anyone can predict the future with 100% accuracy. Not even Buffett. Only time will tell how the crash/correction will play out (or how we were both wrong and how we've truly achieved a New Paradigm where debt = wealth).

So how is DEBTPRESSION not different than stagflation? If people have to stop consuming because of overwhelming debt, wouldn't that contribute to a slowdown in the economy? Are you guys also saying that the Fed will shield the US economy from a lot of inflation?

Returning to BA,

Well it certainly wasn't scientific by any means! I think that's the reason I put "nice" in parenthesis. Having lived in both places about equal amounts of time I felt somewhat qualified to render an "off the cuff" opinion. To me if you have to wear a coat (not a jacket) and KNOW it will rain? Probably not a real "nice" day. Well it seems the days of our "indian summers" are over and last year the very weekend after Labor Day? Yeah, raining. Chicago by contrast has seen many days in the 70's and 80's right up to and through October. Right now we're into June and it is STILL overcast and raining in Portland! I hate to say it but I have come to take summers for granted. I mean at what point can you plan an outdoor event in Oregon without the threat of rain? May? No. June? No. July? Maybe. August? O.K. September? Maybe. Se what I mean? Is the BA in for a dose? Who knows?

Yeeaah…I though we unanimously elected Randy our ceasar!

What will Randy-style caesar salad have? Ikura?

Randy,
What you said earlier about:
"I don’t consider myself “monied”, because to do so would be inconsistent with my Midwestern roots and I’d be forced to hate myself."
Is sort of the way southerners think too. Anyone that drives a bimmer, mercedes, or looks/is rich is eyed with immediate suspicion. I kind of hate this kind of implanted stereotyping I was bred in because even now, If I see a bimmer drive by, my instant reaction is: "Look at the asshole."
If you're rich in the south, the best way to be about is to act as gentleman and be extremly humble. I even feel somewhat wary of mentioning what I do when I visit. We're supposed to be "gawds" children after all..

HARM,

How is this hurting me? Sounds like a pretty good deal in my book.

It's not, it's helping you. This is not where we disagree.

I'm just pointing out the non-linearity of the system that causes accelerating "gap closure". Every dollar a house drops = more than 1$ in benefit for a future buyer. Every dollar that income goes up = more than 1$ benefit for a future buyer. Every dollar that rent increases = more than 1$ benefit for a future buyer. That means a little of each goes farther than common sense would otherwise tell you.

The crazy thing is that, even given all that, prices are still way too high to be justifiable, and MUST revert to the mean. We just disagree about what MEAN means ;)

WW2,

Well said. I still remember when I got my first job after graduating college in Chicago. When my mom found out what my salary was -- which wasn't really all that much to boast about looking back in retrospect -- her immediate reaction was "you make sure you keep your mouth shut about that and don't go showing off all your money; I don't want people to think I raised you to be like 'those people'".

By the way, that big whopping richy rich salary she was referring to would be exactly $30,519 per year in TODAY's dollars.

eeaah…I though we unanimously elected Randy our ceasar!

What will Randy-style caesar salad have? Ikura?

Ugh.

After 1 month in office you'd all be arguing about who got the privilege of being my Brutus, and more importantly, what kind of gourmet knife you'd prefer to use.

Using the measure of 3x annual salary for housing affordability, you would need to make $196k per year in order to afford this gem:

http://www.mlslistings.com/common/properties/propertyDetail.asp?open=0&page=1&mls_number=615647&type=property&name=

It's just barely out of our price range. But maybe if we keep saving and get that raise this year...

By the way, that big whopping richy rich salary she was referring to would be exactly $30,519 per year in TODAY’s dollars.

That's part of the craziness of the BA. You guys bust on Haha, but I know engineers who make more than his claimed salary (consulting). While we lesser mortals all scramble like mad to figure out this housing game, the truth is if you can hang on out here, many expenses (cars, TVs, computers) and savings (401K contributions, educational accounts) are simply not nearly as significant as they are if you're working elsewhere. If you don't fall into the keeping-up-with-the-jones BA crowd, you can bank serious coin here. You'll be monied (and perceived an a$$hole perhaps) if you take that elsewhere after struggling here.

Part of the Fed's problem is they have one lever for the whole nation. The coast bubblezones need a major tightening but the red states could probably do better with a looser policy.

BEGIN PARROTING ECONOMIST ARTICLE
Europe's been having the same problem with the Euro and their Rabbits (Ireland) and Tortoises (Germany).
END PARROTING ECONOMIST ARTICLE

Using the measure of 3x annual salary for housing affordability, you would need to make $196k per year in order to afford this gem:

I think pre-tax PITI being 28% gross or less is a better measure of affordability.

"I think pre-tax PITI being 28% gross or less is a better measure of affordability."

The dream keeps slipping further and further away...

FRIFY,
Truth be known, Salaries of Graphic designers at least in Austin, Nashville, and Atlanta are about 90% of what they are here, yet the cost of living in each of those areas are around 3 times cheaper. You could compare the BA to another country. 100k here= around 40k elsewhere. I did the math. Whether viewed with typical economic facts or compex equations, the econimics of the BA are SEVERELY out of whack. I think if more people in CA realized that they could just as easily work for 75-80% of their wages yet live better lives somwhere else, the RE here wouldn't be as severe.

A $588,000 home, purchased with 20% down ($117,600) on a salary of $196,000 per year would yield:

19% average PITI-to-AGI
1.30 average holding cost (assuming 5 years)-to-rent ratio

Monthly loan payment would be $3,227, and the present value of the average (amortized over the holding period) total PITI would be $3,254, or not much more than the total P+I.

This is a prime example of the non-linearity of the system due to how the tax-shield iterates and eats away at the rent delta investment.

If you are willing to spend up to 28% AGI on PITI, then you could afford this home with either:

a) $133,243 per year AGI or,
b) $156,502 per year AGI and $0 downpayment (ignoring loan implications and the fact you can't get a 0 down 30-year-fixed traditional loan).

The problem isn't YOUR affordability, it is the guy you think you're going to sell it to next.

He'll have to buy it from you for $1,351,849 or 129.91% appreciation over 5 years (18.12% per year). This puts that poor sap, if he has exactly your income inflated in year 5, at a 61% PITI-to-AGI, with a downpayment of $172,748, and a mortgage payment of $9,403 per month (but a PITI advantage if he can take full interest deduction, at a realized $8,810 per month holding cost).

I think this is a perfect illustration of the real problem. Many people CAN afford at these prices, but they're basing that on a game of never ending musical chairs.

If we want to complain about tax policy causing this problem, it's not the $500K cap gains exemption as much as it is the qualifying home mortgage interest deduction. When the numbers are big, that deduction makes a big impact on the present value holding cost of ownership; when the numbers are smaller, it makes a lot less impact (and not $ for $).

Interesting Randy, thank you.

He’ll have to buy it from you for $1,351,849 or 129.91% appreciation over 5 years (18.12% per year).

Huh?

A $588,000 home, purchased with 20% down ($117,600) on a salary of $196,000 per year would yield:

Ummm... sorry to break up the bull-fest here, but precisely how many recent borrowers actually put 20% down, or had anywhere close to $117,600 in savings? Or for that matter, earned a HH income of $196,000 --or even the more "conservative" $133,243? Now, perhaps there were many cabdrivers/grocery clerks/police dispatchers, etc. who CLAIMED to make this much in or to qualify for their liar neg-am loans, but those who actually did (Ha Ha, please fight the urge to contribute) ?

Flawed assumptions = flawed conclusions.

Oh, and btw, this scenario of course assumes steady employment and no other significant debt.

@FormerAptBroker Says:

Okay. Intel was a poor example. So use Sirius or Google as your "totally speculative new 'n exiciting tech stock" example. My point was not to look at any one stock, but simply to say that the public got used to paying larger premiums than in past history, and even after the tech bubble popped, some of that willingness to pay more for investments managed to stay with us. Then, I suggested that the same might be true for housing.

@To BA Or Not To BA Says:

"It has always been the case that P/E ratios of different companies to be different. And by a wide margin."

I'm talking about the extremes. I'm talking about paying fifty or a hundred times foward earnings, or buying a stock that sounds exciting but will take 10 more years to become profitable (satellite radio comes to mind). Sure, banking stocks frequently command a 9:1 P/E, and another sector might lean more towards 15:1, and yet another might command a higher premium than that. Of course you are correct, but you're missing my point that the wild speculative premiums being paid in the late 1990s reached a crazy new height, and a little of that exists today. How else do you explain the Google phenomenon?

Hence some are called expensive stocks, while some not. The stock price is based on expectations of future. But then, even the P/E/G ratios are not same for all companies. That’s due to risk premiums associated with different businesses.

"The new paradigm would be, the % of income people are willing to spend on mortgage. That’s the ownership premium we as a society will pay to buy a home. Can that change ? Who knows."

You just agreed with me, but used a different metric. I used a gross income to home price multiplier, you used "percent of income". In either case, they've accepted paying more, and things fail to revert to the mean once falling from the height of the bubble.

Whichever metric you choose to demonstrate that people have become comfortable with more expensive housing than ever before in history, I didn't post to bicker over minutia (I'd get married if that's what I was after). I'm only suggesting that WILLINGNESS TO PAY A PERMANENTLY HIGHER AMOUNT of one's money for housing might, unfortunately, be here to stay. And it might not. But it's certainly not rediculous to speculate that this is one of the scenarios that could play out.

willywhopper2 Says:

"By the time you’re 40, you should be well on your way to not only having your fianances and housing situtation figured out, but you should also have a majority of your retirement saved up."

Willy if what you say is true, I'm totally screwed. I'll be 40 next month.
I don' have a career. I do have an MBA from a State school in AZ and college debt.

I figure I'll retire 62-65. That gives me about 20-25 years to get it together.

If what you say is true, I'm finished. If everyone at 25 should have their house and be set, then this country is finished. I'm not sure where you get your figures from, but they don't take into account how many times people jump jobs and can't hang onto a career over 5 years since shit is constantly in flux.

If you're right, screw it. I'm finished. At 40 most of my retirement saved? To me that sounds INSANE. I don't know too many people in that situation except my Army buddy whose just finished his 20. We joined at 19, he stayed in and I got out.

Anyone have any words of encouragement for me, or should I just throw in the towel?

God, I feel screwed.

@Michael Holliday,

You're not alone:
Forbes: "Counting Their Nest Eggs before They Hatch: Pre- and Post-Retirees Bank on Assets They Don't Have"
http://tinyurl.com/gdy5b

Also:
Will More of Us Work Forever? The 2006 Retirement Confidence Survey
http://tinyurl.com/gcxw6

Modest savings: More than half of workers saving for retirement report total savings and investments (not including the value of their primary residence or any defined benefit plans) of less than $50,000 (52 percent). However, the large majority of workers who have not put money aside for retirement have little in savings at all: Three-quarters of these workers say their assets total less than $10,000 (75 percent).

HARM,

Flawed assumptions = flawed conclusions

The assumptions are not flawed. If you have less income or less down, then you just compute off of those numbers instead. I'm getting riled up now. Where, precisely, is the error in the computation?

I was going off of the $196K salary and $588K home that were presented in the initial comment. I didn't say anything about these figures being reasonable. I know people who make $196k or more. I know people who make a lot less. That doesn't flaw this specific calculation.

In all fairness, I think I am the extreme case here. I just happened to have a grandad who hammered it in my head all the freakin' time that I HAD to get some mutual funds, CD's, and savings plans underway. This was at the age of 13. I had no clue what he was talking about, but he made it sound like spending money at all was a mortal sin. So we shopped at Dollar General Store, bought grocery store cheerios( which tasted like cardboard) and drove absolute crappy trucks that were sometimes "repainted" with Sears house paint. It wasn't that he couldn't afford the stuff. he just didn't want to.
So I moved out here with that attitude, that you have to save every damned pneey, ask if you really, really needed it, and whether you'll be doing yourself a favor VS socking it away. My grandad died at the old age of 98. He was stingy all his life and it didn't really get hime anything he wanted.
There is a fine line between being too extreme with your money. I think I'm on the other side and more like a scrooge. My wife has repeatedly gotten me to loosen up a bit even though she too is pretty cheap. It feels good to be able to get something you needed, or just plain out want. Makes it feel like your hard work went to something. That's why the housing thing bugs me so much. If I- the stingy bastard that I am- cannot save enough no matter how miserably miserly I am- cannot afford some dump of a place here in Cali, then what the hell is the matter? that's why I come gere to look for the unanswerable answer, which is what's gonna happen?
I also realize that it takes way the hell longer to get established here. So perhaps my above comments aren't appropiate, so I appologize for that. ANyhow, it's adios amigos for me for today! have a good one!

Peter P,

That is the amount the home would have to appreciate by per year to sell for a financial break-even.

HARM,

I can't guess at one's debt load. It is up to them to back out their debt pre-existing debt burden from their affordability. No one should buy a home if they have even $1 of credit card debt they are forced to carry over a payment period. That's because you can earn a HUGE GUARUNTEED RISKLESS RETURN simply by paying off your credit cards. But remember, not all debt is equal. CC debt is revolving, high interest, variable and not interest deductible.

If someone has 20 years of 2.5% fixed, consolidated student loans, then they should NOT pay off that debt unless they have no other debts, interest rates are very low, the market sucks, and they own their home outright.

I was going off of the $196K salary and $588K home that were presented in the initial comment. I didn’t say anything about these figures being reasonable. I know people who make $196k or more. I know people who make a lot less. That doesn’t flaw this specific calculation.

$196K can support a PITI of almost 4600 a month using the 28% guideline.

RE: downpayment.

Recent hikes in prime rate are going to make HELOC/piggyback loans very expensive. This may reduce considerable demand in the starter homes market.

That is the amount the home would have to appreciate by per year to sell for a financial break-even.

I might have missed something. Can you list the assumptions regarding required return?

I’m getting riled up now.

Huh?

S.F. County Median household income (dollars) 2004 estimate: $60,031
Source: http://www.bayareacensus.ca.gov/counties/SanFranciscoCounty.htm

WW2,

Austin is on my escape destination list for sure (see a few posts back), but I think I'd make less than 90% of my current salary there and be forced into a less interesting job at a much bigger company. Gas will not be $1.20 down there, however nor will Haggen-das be $1.

I bike to work 2/week and took the kids and dog to the beach this last weekend. Went camping at big basin in April and we're headed to the northern coast this weekend. Its often a rat race, but apparently not bad enough to stop me from posting today. BTW - The Learning Company lectures are great for a long commute (which I fortunately no longer have).

Big picture side - We're all renting time on this planet and ultimately have to lose the house and the car. The last thing you'll lose before oblivion and/or nirvana is your memories. Pooh-pooh the area all you want, but if you're into beauty and great weather, this place is hard to beat and we've had a terrific time here. I'll take the renters-stigma with the redwoods until the wife pushes us to make a decision and then its on to the next adventure which will hopefully be right down the street.