patrick.net

I do wonder how you guys felt about the market one year ago? two years ago?

One year ago: the housing bubble will burst in 3-5 years
Two years ago: housing is expensive but not crazy

...if someone has to bail out, they can still sell at a profit because of the recent run up in prices.

Jack, that's an interesting observation! This option may be more viable for those who bought 2-3 years ago, but might recent buyers have far less of a hedge? How much of a loss will people be willing to take? This could get really dicey if RE drops, and "homeowners" get seriously upside-down.

People are typically more loss averse.

This is actually quite well studied. On average, people experience losses at twice the percieved magnitude to gains of equal objective amounts. This can be, and is well understood and manipulated by many companies and institutions.

This is actually quite well studied. On average, people experience losses at twice the percieved magnitude to gains of equal objective amounts. This can be, and is well understood and manipulated by many companies and institutions.

Yes, fear is about twice as powerful as greed. We should manipulate this fact to the fullest extent as well.

By the way, Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing by Hersh Shefrin is a pretty good read.

"Could someone discuss today’s surprising 2% rise in home re-sales today for August"

Sales are a lagging indicator. I'll wager 2 large against any takers that this same number will be lower in September, October, November, and December.

I'll further wager another large that 8 of the top 10 markets including 2 or 3 in Cali, Nova, and NY, all crash out at least 10% by end of spring 06.

If prices roll back to two years ago level, would you buy at that level?

The decision is path dependent. It is not about a particular price level. If it drops back to that level with momentum, it may not be prudent to catch the proverbial falling knife. But if it levels off at that level with improving fundamental, the decision may be different.

What about in real terms (so 7% nominal appreciation, say)?

In a stagflationary environment, it is very difficult to measure asset prices in real terms especially because the benchmarks will not be representative.

What if mortgage interest rate goes up to 7 or 8%?

It depends if it is stable at 8% or going up with momentum. It is better to buy in a falling interest rate environment. Absolute level is less relevant.

Or do things just keep deteriorating in a slow downward arc once FEAR and GREED are surpassed? It all makes sense now. Your weird posts I mean….

Huh?

If prices roll back to two years ago level, would you buy at that level? What about in real terms (so 7% nominal appreciation, say)? What if mortgage interest rate goes up to 7 or 8%?

H.Z, you bring up an interesting angle: how buyer sentiment plays into any possible boom/bust scenario. We can devise all sorts of intricate forecast models, but I think it's hard to predict how much investors drove up the market, and once it tips, how risk-averse future homebuyers will be. Combine stories of investor sell-off, raising rates, recession, owners upside-down, and future buyers may really get spooked at buying any house that drops further. Add to that, the number of people who bought hastily and thus took themselves off the future RE market; those people won't be back anytime soon.

How long will people wait for it to bottom out? Will people see a "false bottom" and buy prematurely (especially investors)? Or--due to fewer (and more cautious) buyers in a weakend economy--push the bottom longer and deeper? My gut reaction now is we won't see bottom for 5 years. Given that previous (and milder) booms/busts, such as Vancouver or LA, where prices dropped nominally by 30-40%, how do we interpret that towards the current boom? This one is so big that I almost feel silly to predict even rough numbers.

I was never worried about CA housing until 2004. Here is why.

I witnessed the RE pop in Tokyo and HK up close and personal. The biggest differences in pre-2004 and post-2204 CA housing are
1) gush of amateur investors toying with IO loans, and
2) lots of flips

In both Tokyo and HK's case, the last phase were distinctively marked by LOTS of AMATEUR investors who thought they could buy and sell just like the seasoned ones, and lots of short flips.

There are 2 major characteristics about amateur investors. They buy brand new developments for renting out or flipping, and they buy negative cashflow properties. Seasoned RE investors seldom buy new developments because the margin and expected appreciation is already built in the price. Seasoned investors typically buy a beat-up property, put in some cosmetic touch-up, and rent it out for POSITIVE cashflow. When the market is full of amateurs, that means the demand for new developments becomes unjustifiably high, which will create a lot of inventory (BAD for RE investors), and the fact that they are willing to pay for negative cashflow properties means they are bidding the price up too much. Both are very bad for serious RE investors to make any profit, hence the smart money (aka, the seasoned RE investors) will hasten out, the market pricing becomes unbearable for owner occupiers, and the slide begins.

Flips are fine, except that short flips within weeks are just not economically sustainable. While there are always some wonderful arbitrage opportunities around, if lots of flips are happening, that means either the market is overheated, or investors are building up very unrealistic expectations. When their expectations are not met, the slide begins.

Back in 2002/2003, I argued for no CA bubble. Because most people I saw were buying for occupancy. Unless they lose their jobs, they will continue to make their mortgage payment, so price will be sticky even on the way down. However, when the amateur investors jumped in, the picture is different. They don't have much resources lined up, their "investment" properties are generating negative cashflow, so when the uptick halts, they will dump their properties at whatever price they can get, illiminating the price stickiness on the way down. Of course, when they are weeded out, then the slide will level off.

My worry is, there are already too many amateur investors out there.

Just to stir it up a bit more–the last decline in the early 90’s happened in a falling rate environment…

You are right. It really depends on the nature of the boom and bust.

My worry is, there are already too many amateur investors out there.

I prefer to call them by their other name, chumps.

After digesting all of this information, you will be able to trust your gut-even without tons of analysis-

Yes, after the dust settles, and investor mania is gone, and people can feel calm and rational about a home purchase, that may be the beginning. I think many people sense a "top" now...and someday a "bottom" might be just as obvious.

I think when things go back to the historical averages, price to income, price to rental value etc, I'll buy. Ca has always been expensive, I think the national average is 2.8X income, but Ca is more like 3.2-3.4X

What typically happens post bust is like this (based on Tokyo and HK experience).

Two years post crash, all amateur investors are wiped out, the market sees a 20-30% drop. The housing price seems to be settling down a bit (false bottom). Many owner/occupiers start to jump in. However, the aftershock of the housing bust is just starting to be felt through all sectors of the economy. Jobs are cut, some owner/occupiers who got in at the top start to breakdown, bringing the price to a further slide. However, this slide will be slow and painful, it is heading down 5-10% a year, may be even slower, but the downward trend is obvious. At that point, even future buyers with enough resources may start to think that buying is a BAD idea, not because he cannot afford it, but because it is simply a bad investment vehicle. Once the society as a whole is caught in this pessimism, it will take a long while to recover. When do you start to see the bottom? When RE is a forgotten subject and the media stops questioning if RE will ever recover. This will take a decade.

HK is a less of a comparable because it is too small. Tokyo/Japan is a better example to look at in this scenario. 13 year after the crash, prime areas of Tokyo eventually showed breath of life, the land price and housing price started climbing sometime last year, and the trend is continuing into 2005.

I’d much rather buy with a high interest rate than a high price

Plus, your property taxes will be lower.

I agree with you H.Z. That is why I don't see a big loss of nominal value of homes, measured in USD. But it will also be hard to imagine that given the amount of bizillion USDs already in the market, we won't see a further drastic erosion of USD if Fed decides to inflate away the debt, a likely course.

I will be very upset if my paycheck cannot afford my favorite travel destinations in Europe, or Japan.

I prefer to call them by their other name, chumps.

I remember... Cunning Hard-eyed Ultra-savvy Market Professionals

Out of all the countries in the world, US is unique in the position (and very tempted) to inflate its debt away.

The world does not have to use USD as the reserve currency forever. The currency paradigm changed not long ago and it can change again.

H.Z.,

All English-speaking countries are seeing exactly the same thing as CA right now.

My brother works in Sydney, I think it is a good comparable to BA, good weather, hot jobs, beautiful landscape... Take Sydney's lower north shore for example, it is sort of equivalent to Marin, prime real estate with amazing harbor views. The median price for homes in that environ without a view is selling around 1M (you won't find a shoebox for less than 800K), AUD of course, but you are talking about a country with 45% marginal tax rate. Sydney's high earning couples typically make less than 200K a year, and there is not even tax relief on mortgage interest! I just cannot fathom how anyone can get started in Sydney. But what the Aussie government did well was they raised the interest rate way earlier than us, so the property market cooled down quite a bit, still not enough for the average Joes to live a decent life.

New Zealand is no better. All the homes seem cheap by US standard, but if you compare the price to local pay, the ratio is entirely out of whack. NZ, Oz all suffer more than us because of what I call a spill-over effect. People in UK and US, feeling priced out of their markets, turn their sights to international properties. Where can we pathetic English-speaking people go? NZ, Oz. So we went there pushing up their realty price using our income-to-home-value ratio, dropping cash like there is no tomorrow. There are lots of UK investors in Oz buying up investment properties sights unseen.

One of the factors we do have to take into consideration is, desirable areas (defined by weather, geography, job opportunities) around the world will see a surge in price that will stick. This is another effect of globalization, money flows more freely to wherever is desirable. So people expecting CA properties to become dirt cheap again so that they can get in may never see that happen. In the short term, properties in desirable areas are over-bought. But in the long run, I can see two kinds of world, the nice parts of the world, regardless of which country they are in, and the unattractive parts of the world. Such a pricing difference between these two parts will solidify, it is just a matter of how much pricing difference is justified.

Such a pricing difference between these two parts will solidify, it is just a matter of how much pricing difference is justified.

How does that explain the the very low cap rates (high P/E ratio)?

Peter P,

I think the high P/E has something to do with wealth distribution. I am uncomfortable to admit that we seem to be heading towards more concentrated wealth distribution. The rich gets richer and the middle class gets poorer. In a few very desirable spots of the world (aka London, Sydney, Auckland, BA, NYC, etc.), while some of the pricing is based on collective stupidity, some of the pricing finds support in the riches around the world who can more conveniently buy and sell and hold properties in another country. These "riches" include many nouveau riches from developing nations like China, where wealth is notoriously concentrated in the hands of a few.

Also, new immigrants are more likely to bid up prices than the long-time residents (watch out ya old dogs). Today's new legal immigrants to these English speaking countries are more likely to be highly educated, competitive talents who did well in their home countries armed with more cash and resources than average old-timers. New immigrants have no idea what these properties should go for, and they just assume the current price is the norm. As long as they can find a job to support the mortgage payment, they are fine.

So, the globalization of both capital and skilled labor, coupled with AG's money creation policy in the last few years, have contributed to the global asset appreciation.

OwnOcp, how many non-resident RE investors do you personally know?

Given the current situation of RE in California, ie, rents so far out of whack with prices, why would anyone outside of the US buy a single family home in CA for an investment? Or why would they buy it as a vacation home? Surely the money you are dumping down the toliet each month could more effectively be used to just rent a hotel or buy a time share for your annual visits. Sorry, but I'm just not buying the rich foreign investor proping up Ca RE.

I think the high P/E has something to do with wealth distribution.

But P/E ratio is a pure function of opportunity cost and expected appreciation. Unless you believe that extraordinary appreciation is sustainable, the ratio will revert to historical norm.

Sorry, but I’m just not buying the rich foreign investor proping up Ca RE.

MIRAGE!

I don't know of any in BA. I have friends who hold 2+ properties here as investors but they all live here.

But I do know of plenty non-resident RE investors in WA, OR, Sacramento, NV, all BA residents who felt that they are priced out of BA and need to grab on any RE anywhere so that they don't miss the boat.

But I do know of plenty non-resident RE investors in WA, OR, Sacramento, NV, all BA residents who felt that they are priced out of BA and need to grab on any RE anywhere so that they don’t miss the boat.

Titanic is sailing to New York. Last Call. Do not miss the boat.

I am not arguing for high P/E here. We are the center of the bubble. What I am arguing for is, we, the all-mighty-godfather-of-all-bubbles, priced out of BA and go around creating bubble elsewhere.

BA is certainly not relying on foreign investors, most of the world's VC money sits here. But the BA residents ARE foreign investors in neighboring states or even down under bidding up properties passing our bubbles overseas.

OwnOcp, are they non-residents or foreigners? I just don't see some schmuck from the UK or where ever coming here with their suitcase of money to buy overpriced CA RE. P/E way to out of whack. Things will revert to the historical norm. This is all bullshit, I repeat this is all bullshit. Homes in Ca will become what they've always been, a place to live.

Owneroccupier, if foreign wealth was the main cause of the boom, then we would see higher appreciation in exclusive and desirable locations. However, the markets for 2M+ houses in many areas are pretty much dead in the water. Yet fixer-upper $hitboxes in transitional neighborhoods had the most appreciation.

How would you explain this?

Surfer-X,

The BA residents I know are mostly first-generation immigrants, just like myself, from all over the world. Some of them come with a suitcase of money, and some of them come empty-handed to realize their CA dream.

I always admit that there is a bubble, and a norm needs to be restored when the bubble pops. But the norm that we are restoring to will be quite a bit higher than CA is always used to. This is the case because we are sitting on a rather nice piece of realestate here. I have traveled around the world and have to say, this is about as nice as it gets. So there will be more and more people with means coming here to reside. If you are well-off, you can live anywhere in the world, and I am convinced that many rich people will choose to live here.

This is painful for long-time Norcal residents, I am aware of that. But as I argued before, when money and skilled labor are allowed to move around, they tend to seek the best place our globe has to offer. Unfortunately there are not as many nice spots as Norcal.

Owneroccupier and Randy,
You guys have traveled around a lot. How do you feel the U.S. and CA in particular, property prices compare to desirable places in other countries?

Owneroccupier covered English speaking countries accurately and quite nicely, in my own opinion and experience. I can't really speak to Asia with a ton of knowledge (and I've never really considered buying there).

Mainland Europe is a harder question. There are some restrictions to how you can buy there as a foreign owner, but it is possible and somewhat common in places like France and less so Germany. The problem with most EU countries is that they have a much more narrow RE market, a lot less use of debt financing, and a general "rentor culture". There are parts of Germany (particularly in the Eastern states like Thueringen) where home ownership is being actively encouraged by the state governments, but there is very little new development and a lot of landlords only very slowly selling off "homes" (homes are often not single-family properties).

If my family ever decided to vacate CA permanently and move to Europe, then I'd have to very carefully consider if it would be worth it to buy at all given I could rent with a lot of protections. And oh yea, there are capital restrictions to moving your assets in whole out of the US. It is generally not possible to take your .5M (or whatever) and just jump ship. You can invest in a 2nd home/vacation property, etc. in Europe, but you can't just leave and take all your money. If you have enough money, you can try to cycle it out through creative investments and a few "businesses", but it's a tough game with high transaction costs.

So I'm not sure that free-flowing, globalized capital will effect RE all that much except in the form of local, fragmented inflation, real interest rates, and PPP.

The problem is how do you calculate the earning part for a desirable property that can not be comparably rented.

Most condos are pretty much apartments with less amenities and less management. They are almost comparable. Moreover, owning is more risky, so there should be a risk premium.

Also to be comparable to owning you have to have a long term lease with guaranteed limit on rent increases.

This is correct.

If anyone can convince me that Bay Area rent will be 50% higher in 5 years, I will call my RE agent immediately.

I have traveled around the world and have to say, this is about as nice as it gets.

Vancouver is much nicer if you can bring a job with you.

And oh yea, there are capital restrictions to moving your assets in whole out of the US. It is generally not possible to take your .5M (or whatever) and just jump ship.

I am not aware of this. Randy, can you explain?

OwnOcp, sorry man, while I agree that Coastal Ca is it, buying into the "new paradigm" bullshit just isn't going to happen. Hard to argue with over 100 years of historical data. What you are suggesting is akin to the crap spewed on us during the dot.bomb, "ITS A NEW PARADIGM", no it's not, it's the same old one, transfer of wealth. Easy Al has to run the printing presses non-stop, what to do with the cash? Make RE loans. This aside, Ca will go back to it's historical average, roughly 3.2-4X income. Yes Ca is nice, but if for example you are from Buffalo NY, fuck man, you can live anywhere, and given enough pain, you'll move away, trust me. Besides, the immigrant bs might explain high prices where there are jobs, but how does it explain the ass raping were taking down here in SLO county? No jobs unless you count picking grapes and that 3/hr isn't going to cut it.

If you are well-off, you can live anywhere in the world, and I am convinced that many rich people will choose to live here.

Hmmm, I don't think that suitcase of money buys you citizenship exactly. You can't live whereever you want, yes you can visit, but immigration is a whole different animal.

all BA residents who felt that they are priced out of BA and need to grab on any RE anywhere so that they don’t miss the boat.

I plan to miss any boat sailing out of "Cape Fear;" you never know who may be piloting it.

Hmmm, I don’t think that suitcase of money buys you citizenship exactly. You can’t live whereever you want, yes you can visit, but immigration is a whole different animal.

Quite true. I have a good friend who is an immigration lawyer. He told me that many researchers and rich businessmen have trouble getting greencards.

Apparently, the US welcomes illegal immigrants more than people who can make major positive impacts.