patrick.net

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.

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

Assumes the buyer is a "mirror image" of you when you bought it X years prior. That is, they make your AGI, adjusted for inflation. They pay your mortgage rate, appreciating at nominal rate growth (a conservative estimate because mortgage rates lag nominal rate hikes). They put down the same % as you did.

That's for their affordability.

The calculation of what you need to sell for to break even financially in present-value terms is directly solved for from the present value of all cash flows, and has nothing to do with the "next buyer". I'm just trying to show how screwed he is, unless you believe salaries will undergo the same appreciation home prices did over the past X years.

This is the problem, as the numbers go up, they start going up faster and faster. But as they come down, they come down faster and faster too. Thus, the whole closing-gap debate.

Huh?

S.F. County Median household income (dollars) 2004 estimate: $60,031
Source:

lunarpark didn't say $60,031. (s)he said $196,000. I don't have an Excel function for "=WhatYouReallyMeantToPutInWhenYouSaid(196000)".

Michael,

What WWII is describing is the ideal scenario. A friend of mine from college did it. He graduated from college at 22 and got a job with the Defense Communications Service (he's an electircal engineer.) The job didn't pay much, but it enabled him to buy a new construction townhouse in Tyson's Corner, VA that same year. He took in roomates to help cover the mortgage. That was 13 years ago; by now, the townhouse is almost paid off. He also contributes fully to whatever the federal employees' version of the 401(k) is called, and lived well beneath his means for years, drove a used car, brown bagged his lunch, commuted via the Metro, etc., etc. This allowed Ed to build up a substantial nest egg very early on.

I planned to follow his example when I got out of graduate school. It seemed to be working out great for Ed, so I figured that I'd do it too.

Unfortunatley for me, my first job after graduate school after graduating at age 25 was as a temp for $12.00/hour. My first real job paid just enough to cover my student loans ($1,200/month) and a studio apartment ($500/month) in a seedy side of town.

The firm didn't even have a 401(k) until my second year there, and when they finally adopted one it was for something called a SIMPLE-IRA. But once I was finally able to climb aboard the the 401(k) bandwagon I always contributed the max. Unfortunatley this was in 2000, and by that time the huge runup in the S&P was already over, so I've never seen any real appreciation. I haven't lost any money either, but there have been no dramatic gains. I recently changed jobs, and I don't become eligible to contribute to my new employer's 401(k) until I've been here for a year, so my contributions will be put on hold.

I've always earned good money, but it's never been enough to buy a house in a bubble market. At present, there is no freaking way that I can buy one, not even in Compton. A house in a neighborhood where the murder rate is not a concern is totally out of the question, and one in a neighborhood with good schools is impossible.

So for me at least, there really haven't been many opportunities to build real wealth. I am 34 now, and would like to say that my mortgage will be paid off early in just 9 years , but unfortunatley, I cannot.

I haven't really made any stupid mistakes, I ran up my credit cards once while unemployed, but it didn't really make any material differnece in my situation, the interest charges didn't amount to more than a few thousand dollars, we're not talking about a downpayment on an SFH here.

I knew what the ideal course of action was, but just wasn't in a position to take advantage of it.

There are a lot of us in this boat, I wouldn't concern yourself too much. The economic conditions that people our age are dealing with don't permit too many people to follow the ideal course.

One thing I do know is that most people are far worse off than I am. I wasn't able to start contributing to the 401(k) right away, but once I did it started to add up fast. And having no consumer debt helps a lot, if a buying opportunity ever does come along I will be in a position to take advantage of it. My non-retirement savings are nothing special, but they would be enough for a down payment if the housing market were more sane.

If things don't improve here, I will move to a place where housing is cheap.

So I wouldn't worry yourself about it, times have changed.

Randy,

Ok, I misunderstood where you were going with this. You're using your Bubblizer to calculate the BE point at today's prices --even assuming lunarpark's unusually high income --and coming to the conclusion income inflation alone is not likely to bail out FBs.

Didn't mean to rile you up --sorry.

HARM,

LOL, it's all good. I was just trying to show how the numbers don't always come out 1-for-1, and using Lunarpark's example.

There are plenty of FBs, and I'll be in full schendfreude watching them engage in Torschlusspanik.

*schadenfreude

Randy, I am following you... except that the required return of 18%/year seems a bit high intuitively.

If I am to buy a house today, I will be extremely happy to recover the inflation-adjusted original purchase price in 7 years.

Great inpute. Whew! I thought my goose was cooked.

Although not totally financially successful (yet) I did manage to accomplish some things in life that I wanted to and make me fill more fulfilled: BS and MBA degrees (state school guy), two military intelligence schools and doing a talk show & playing drums. Money isn't anything, but I'd sure like to make a few $$ and retire in my early 60s.

I might go back to the Bay Area and become a cop and retire after 15-20 & take the pension then maybe do something else...real estate?

Thanks for the input.

But remember, fortunes change for the better and worse all the time.

People plan then comes the job loss, the health issue, the heart attack, the lottery win, the new big job. It goes both ways.

Run the race but don't kill your neighbor. Prepare for the afterlife. Love your neighbor...

Thanks John!

Who cares. The fools who are looking down at you cant even say they own anything in life. nothing. they own nothing. if they were to liquidate everything they owned and put it towards the debt, they would still be deep underwater.

This is very likely true in many cases, but the trick to happiness is to avoid comparing yourself to the other guy. John's right that many who appear to have it made are drowning in debt, but there's plenty who truly have it made financially. So what? Everyone's going to the great equalizer in the end. Enjoy who you are, your friends and family and what you can become. Get some sunshine and some exercise and you'll feel better immediately

- Your friendly 36-year old renting fool

HARM,

Thanks for the link to the Forbes article. Actually I've been saying that stuff for a number of years now. One of the many "sins" that I witnessed first hand was people looking at their 401K balances, thinking to themselves "hey this isn't bad" then creating an unworkable scenario at work, getting laid off/fired/quit FULLY intending to "rollover" the IRA and either plundering it "to pay off some bills and get debt free" or slowly "bleeding" the acount to where they would finally say there's just X amount of $'s left in it anyway, why don't you just send me the money and close the account. Yes I realize that is one long sentence but it is intentional. I've seen people fritter away huge sums of money (and rack up some ugly tax bills) in what feels like a single breath! Oh and all the while they're telling their new friends they "retired early".

Well yeah, for awhile! Now they have a 1,2 or 3 year hole in their resume and their not getting any younger. What makes it better is I've seen a lot of guys that were "playing contractor" doing "improvements" and additions so they can sell their house for major bucks! (That way the Mrs. can "retire too!) Oh and of course they're hittin' up the ol' House ATM ta' boot! After you've heard the "rollover pitch" a few times you feel like just telling them to save their breath and give you an address to cut the check to!

John’s right that many who appear to have it made are drowning in debt, but there’s plenty who truly have it made financially.

You rarely find out who the posers are who isn’t.

Still, the winners of the google lottery will be sitting pretty. $5 Million is hard to completely squander even if you're a total idiot. 5% return on that is $250K/year. I'd buy a $1M place with a 30yr fixed in a second with that kind of nest egg.