Businessweek Archives

Past Housing Bubbles


? Sell your house on Wall Street |

Main

| Fannie Mae Sees Mortgage Risks ?

July 12, 2005

Past Housing Bubbles

Amey Stone

It has been six weeks since I wrote a story that discussed the experience of homeowners who experienced a real estate meltdown in their local markets in the past (See, "Getting Crushed in a Housing Collapse," May 31, 2005.

It proved to be a very popular topic with readers and I'm still getting feedback.

Surprisingly, many of the emails have been challenging the same point in the story, which comes very near the end. I wrote, "Two things have to happen to pop a real estate bubble: Interest rates have to rise and jobs have to disappear."

The following email from Kent Beuchert, which I just received on Sunday, is the latest example. Below is his note, (posted here in its entirety with his permission):

I read your article, "Getting Crushed in a Housing Collapse," and agreed with most of your claims. However, when you state that only two things can cause the bubble to bust (recession or sharply higher mortgage rates), I have to respectfully disagree. While either of those two events may cause the fastest bursting of the bubble, there are plenty of others.

The bubble exists because of speculators. Pent up demand and lack of supply is not the cause, otherwise the rental market wouldn't be so depressed. Current supply is in fact outstripping population growth. The excessive demand is produced by speculators. Since this doesn't satisfy the demands of housing anyone, the demand is totally artificial, thus creating totally artificial prices.

Eventually, there will be a physical lack of "Greater fools." There is, after all, a limit to the number of new real buyers. At that point prices will stabilize or possibly drop a little. That in turn will spook investors, who will dump their properties because they can't carry them or rent them. This will cause downward spiraling prices, causing prospective buyers to hold off, waiting for prices to stop dropping, and away we may go into a collapse.

Interest only mortgages will be walked away from and the collapse may accelerate. It will be far worse than previous price drops because the run up has been so much greater, the stability of the owners so much less, and the degree of speculation so much greater. Looking at past bubble busts doesn't provide an analogous situation. We're in a different game this time.

It's a pessimistic case, but worth considering. Thanks for writing, Kent!

02:28 PM

Housing Prices

TrackBack URL for this entry:

http://blogs.businessweek.com/mt/mt-tb.cgi/

It's a new paradigm, and everybody who doesn't buy, now, will be priced out forever. Anybody who does buy will be rewarded with a lifetime of riches, as their property will continue its 30% yearly price increase.

Renters, and anybody born in a future generation, will not be able to afford a $10,000,000 starter home in 15 years. They will live in tent cities, and Hondas.

This asset bubble is different than all of the others - it will never slow down, or pop. The gains are permanent.

Posted by: seattlecoder at July 13, 2005 09:19 AM

I agree with Kent, the housing bubble does not require both the rising of interest rates and the disappearance of jobs in order to burst. In most of the "frothy" markets, the occurence or one of these two would be more than adequate.

Also, Kent's scenario of the unwinding due to speculation is right on spot. Virtually every bubble in human economic history was driven by speculators getting overly optimistic, new speculators entering often too late, and using the riskiest of means to get it.

Think about the NASDAQ let stock bubble that we experienced in the late 90s. As it built steam, more and more people were becoming investors. Don't have money? No problem, that's what a home equity loan, or margin loan is for. In some cases, even credit cards. Look at margin debt levels in early 2000. Investors were financing thier speculation in the riskiest of ways possible, just like real estate today.

Also, in virtually every speculative bubble, it is the lack of "greater fool," as Kent describes, that eventually begins the unwinding. We have seen ample stories of the same home being sold two, three, even four times within a short period of time. Each time for an outrageously higher price. See Chris Palmeri's "More Flipping Tales" on this site. Are there really fundamental reasons for this type of activity and rising prices? Or is this the "greater fool" at its best?

In today's real estate market, the fact that roughly 35% of real estate in 2004 was sold to investors or as second homes is widely publicized. However, talk to many new homeowners. Ask them how they financed their purchase, why they bought now, and how long they plan to stay in this house?

Frequently, you will find that the house was financed with little or no down payment, interest only, and Adjustable rates. They bought now because they were fearful that they would not be able to afford a year from now (as it is a foregone conclusion that prices will continue to rise at this breakneck pace). And they plan to stay 3-5 years, take the equity that they are sure to build up and trade up to the house that they REALLY want.

I don't see Kent's view as pessimistic at all. This is how bubbles deflate.

Posted by: Eric at July 13, 2005 04:05 PM

The decline of house market does not necessarily need any trigger (eg. interetst rate or job...). The market can fall by its own weight.

Aha

Posted by: aha at July 13, 2005 08:09 PM

I also agree with Kent's posting. It has been proven time and time again (stock market booms and busts, gold booms and busts, etc.) that whenever any asset class is bought and sold without any regard to it's underlying value and prices spike or plummet unexpectedly, that the market is fueled by hope. Hope is how people lose a lot of money.

OK...let's do some math. Let's say a family of two brings home $100,000 a year for two. After taxes (at Married 0 0), a 6% 401(k) contribution, and insurances that's around $55,000 a year for two. Conventional wisdom says at a median, 33% of GMI can go to debt payment - $2800. They have monthly debt (car payments, credit cards) of $700. So, maximum net nortgage payment would be $1800. Conventional 30 year loan at 5.5% - $392,000 most expensive house.

This is going by "10 Steps to Home Ownership". Written in 1996 it sounds outdated now. Sounds like a lot of money but it doesn't get you a lot around Baltimore/Washington any more.

It seems to me the new frenzy is feeding off of the equity of established homeowners and pricing out the middle class. Plus, first-time homeowners will eventually be scared off. Established homeowners need rist-time buyers somewhere in the chain to upgrade homes. Speculators and investors are the "hope" part of this cycle and when it dries up it will be messy.

Even my dentist is flipping real estate...come on.

Just my $.02.

Colin

Posted by: Colin at July 14, 2005 01:17 AM

I had to re-read the first comment posted as I'm *pretty sure* it's a joke. Usually I would be 100% certain but unfortunately I've seen people who actually believe this to be true. And they are betting their families future on this being a true outcome.

I'd change the part about living in Hondas though and make it living in Hummers, with the price of oil they could be the new apartment of the future for the dispossesed housing poor:)

Posted by: gabby at July 14, 2005 01:40 AM

It is mind boggling to imagine a response that a house will be $10M in 15 years.

Even though there is incredible speculation we as american seems to be always self-centered in our thoughts.

How can a house be $10M when no one has a job. A guy working in McDonald's, Wendys, Burger King or target?

Remember your house doesn't give you money simply because you own it.

A house appreciate in value when the economy and the United States are doing well. Both is not the case currently.

Consider a very nice house in China. That beautiful 3/2 in Los Gatos will cost 100k in China. And that engineering worker there will earn a modest salary at 20-30k.

Approximately 2-3 less than an average american engineer would make.

Consider the case.... On the latest travel to China, the amount of bilingual Chinese people who are ENGLISH fluent is 50%. Consider that for a minute and why your house is more connected to that Chinese guy who is making your next iPOD for dirt cheap prices.

Just think for a while out of your own centre of universe and why the US is headed to become the next Europe with high unemployment.

Posted by: concerned_citizen at July 14, 2005 01:51 AM

New paradigm ? Sounds eerily familiar and I'm not speaking about the Internet land grab of 2000, which could also apply here or any mania for that matter (even the Cabbage Patch Kids craze). I'm looking back to 1980 when gold and precious metals were reaching all time highs. People began to horde gold at $900 an troy ounce. People were becoming frantic saying that gold would never be under $1000 dollars... ever...by 2000 it will be unattainable. That the US monetary system was going to collapse and hard assets were the only guarantee for the future. But in 1980 it looked quite possible, inflation and oil prices were at an all time highs. It did look like they were right but like all parabolic markets they eventually unwind under there own weight. I still know people who have gold that they paid $800 dollars ounce believing it will go back up but 25 years is along time for losing money .I wonder how they felt when it hit $250? in 2000. Some people will say ...gold is a commodity and cannot be compared with housing because people need a place to live. Well that's true but housing has now turn more into a commodity then ever before because of the rampant speculation. People are hording houses and flipping them like stocks in 2000 or just like the scrap metals dealers did 1980 on a daily basis. Markets can commoditize anything in a short period of time, tulip riots in Holland in 1600's . Why isn't rents going up and vacancies going down?

What happens when Grandma and Grandpa, who invested in three vacation homes because their fix income doesn't look as attractive as the 30% appreciation in those homes the last couple years or when their grandson, who has brought five homes at top dollar using a negative amortization loan, (basically buying on margin)...because everyone knows that real estate always goes up and now with limited supply maybe 30-40% year over year.

People should step back and take a long hard look before they play the greater fool because housing historically appreciates 5% year over year since WW II. Sometimes more, sometimes less. The last five years in some locals close to 200% but why? For one the Fed had cut the FED Funds Rate “ overnight rates” to 1% to restart capital spending after the dot com crash where some investors lost 75% of their stock profolio and bankruptcies were threating to throw the economy into a shallow depression. Most large investors were spooked to invest in equities so they started to put more of their money into hard assets, ie: real estate. Lower interest rates made it possible for the small investor to buy in. Especially when real estate had always been perceived as a safe investment. It pretty much snowballed from there. Banks and mortgage companies found the fees lucrative from refi and new mortgages products especially when Fannie Mae and Freddie Mac were the underwriters for these products.(don't let anyone fool you these GSE are perceived in many peoples minds as GBS which the taxpayers are on the line for).So these institutions started to heavily market these products to the general public (TV ads). Enter the hedge funds, who live for “alpha”(highest return) these are hair trigger operation who follow “hot money” with even “hotter money”. They came in and are playing both sides of the coin, first they been buying up housing projects and condos by doing so raising these asset prices (limiting supply) then investing heavily in construction companies and homebuilders so it a win win situation as long as the greater fool steps in and buys, which they have. But before you call me an conspiracy theorist, first of all this is not a large conspiracy or anything like it. It's pretty much the same game that was played out in 2000. It's called running with the story and more the story pans out or in this case a self fulfilled prophecy the more insane it becomes because of greed. The big loser eventually will be the small players and your local neighborhood because these people who are profiting now do not care for the repercussions of what is happening. They're in it for the fast buck. It happen in 2002 in tech... The aftermath it's pretty. I saw it first hand.

It's funny that people never talk about the real estate crash in Texas in the mid 1980's after the oil crash...yes real estate goes down...yes any asset class can crash...yes there are pumpers out there with a vested interest in fees that are generated. Which in the end this all about... FEES, just like your broker and for the homebuilders their stock price, which inside selling is pretty heavy. I kinda laugh when people live on every word that's coming out of NAR or homebuilders quarterlies. Didn't it dawn on people that maybe they have an interest in painting a rosy picture. Short are people's memories. I can still remember Bernie Eberts and Ken Lay talking about the incredible futures of their companies and seeing many people running out to buy the stock. Except that was just worthless paper, now we are talking about people's homes and neighborhoods. Any way where I live the North Shore of Long Island it looks like everyone selling but little buyers. Houses have been sitting for months and in one very trendy neighbor signs are posted as reduced. A top?

Posted by: C H at July 14, 2005 02:27 AM

I totally agree with Kent, Eric and Aha. I worked

in Silicon Valley from 1996 to 2002 and

experienced the last great bubble first hand. I

am now living in San Diego, one of the most

bubble-ish house market in US. I can tell you

there is a lot of similarity in people's attitude

to house nowadays and their attitude to stock

in 2000. These so-called investors who bought

stock with negative earning or P/E of 500 were

betting on stock price going even higher. Nowadays

people are buying condo or house with a monthly

owning cost to rent ratio much higher than one

(in San Diego this ratio is about 2.5).

The comment by "seattlecoder" is outright ridiculous. It sounds awfully similar to what

all those so-called stock analysts said in 2000:

"We are now in the New Economy. P/E ratio can

no longer be viewed in a traditional way. We raise

our price target of this stock (ticker symbol: ABC) to $600 by next July, so at $400 now it is

a steal. You have to pay a lot now, because you

will make a lot next year....."

Does it sound familiar?

Posted by: Xtalprotector at July 14, 2005 05:03 AM

I read some posts above. It’s laughable to read that “since WW2 real estate appreciate 5%” so it must continue in this pace, otherwise it’s “bubble”. It’s laughable to read about Texas down market because of anomaly oil drop below $10. Why don’t recall that Indians sold Manhattan for $25, so it must be “bubble” there.

Indeed, it’s new paradigm. It’s 21 century now, you know. Oil will be higher and higher, population will be larger and larger, and beside US has the greatest population growth among developed countries. People demanding larger and better houses and some of them demanding 2nd and 3rd house. It’s named “lifestyle change”. What about supply? Many old houses need to be bulldozer. Shift in government bureaucracy make it harder and harder to get building approval. This make land much more expensive. This makes construction prices skyrocket.

As for “comparison” to stock market, well, it’s easy in Wall Street, just print billions new shares, analysts upgrade to $600 and sell them, or just announce split 3:1 every 6 months. But you can’t split your house into tri-plex, not even duplex. You even can’t build new house on you own land because multiple government agencies, neighbors, anti-growth group make sure to sue you as soon as you stick shovel into ground. You’re basically on mercy of the government, and with these government regulations (sometimes absurd) we’re getting to the point that only 10-20% of population would afford to buy house(s) the rest would be their tenants. I don’t understand why it’s so surprise many people, for instance in communist countries 100% population are tenants and nobody complain. There is only one relationship with stock market collapse – indeed investors don’t trust it anymore and shifted money to real asset.

Reading “housing bubble” economist theories since February 1999 (yes, that’s right, have copy), I expect real estate prices to continue to increase, especially in desirable areas. It’s because economist theories normally have nothing to do with real life (in this case they employ wrong assumption, criteria, and don’t even consider the right ones); don’t forget that all communist foundators were economists, and we all know what happened.

Posted by: yuri at July 14, 2005 12:23 PM

By the time the dumb money starts flowing in, it's time to get out -- and the dumb money has been flowing now for some time. A house on my street in Columbus, Ohio - 1700 s.f., 1932ish, nothing fancy - sold for $175,000 in 2003. last week it just fetched $352,000. Meanwhile, the house that I rent, which is nicer, rents for $1,250 a month. I don't cut the lawn and have no maintenance or taxes, and i could probably do even better if i moved. By my calculation, the other house owner is paying $2,100 plus maintenance and a couple hundred a month in taxes (if the auditor doesn't catch up to that sale price anytime soon). What a great investment if they ever were forced to rent it out! You, too, could be losing 50 percent a month for being so savvy.

Posted by: Billy B. at July 14, 2005 02:14 PM

I agree with Yuri and NO ONE ELSE - MERLIN

Posted by: Merlin at July 14, 2005 03:13 PM

Here's another point towards the argument that maybe we're creating a society where a large part of the population will be permanently priced out of owning a house.

Germany had rampant inflation in 1923. At some point in time in the fall of 1923, a piece of bread cost millions of marks.

The only people not having their savings wiped out were the ones who owned "hard assets", mostly real estate.

In the following years (1924 - 1930), a huge real estate boom set in, bigger than what we have here today. Real estate prices rose 700%, pushing the price of a house in the cities out of reach of ordinary people (I'm still trying to find hard data on this).

Of course, this caused much social distress, and combined with a economic depression (perhaps correctly perceived to be caused by "speculators" and the easy money in the 20s), Hitler came to power with a platform of right-wing national values plus socialist redistribution from rich to poor.

This is, of course, oversimplified and not backed up by hard data. But something to think about.

The interesting thing is that real estate prices stayed relatively high in Germany, even after the war, and affordability never went back up.

Germans were willing to make huge sacrifices to own a house, and even then only a smallish percentage could.

Germany now has one of the lowest percentage of homeownership in Western economies, and until a few years, housing prices there were about 2-3 times as high relative to income as in other neighboring European countries like France.

Also interesting is that, while all of Europe enjoyed a lot of housing price appreciation in the last 10 years, in Germany prices went down(!) in real terms. This is probably because now that the housing market for EU citizens is really all of Europe, imbalances get levelled.

Posted by: Chris at July 14, 2005 03:34 PM

Every generation believes they are living in a new paradigm. Sometimes a generation gets two or three shots at a new paradigm. There is an asset class for which rapid appreciation leads the masses to believe that it is justified, inherent and never ending. They come up with reasons loosely related to economics, sociology, and maybe politics as to why this time is different.

Tulip bulbs in the 1600s, British stocks in the 1700s, the Florida real estate bubble in the 1920s, the stock market crash of 1929, Gold in 1980, Dot-com bust of 2000.... They begin a little bit different. As they grow they become a self fulfilling prophesy. The very nature of a pyramid scheme begins to arise. And then, the next "greater fool" doesn't appear. Prices flatten, those overly leveraged begin to panic, and sell. This causes prices to decline. Now, those who thought they were comfortably leveraged are getting nervous. And the whole process begins to unwind.

No industry can consistently and continually grow at a rate that far surpasses the overall rate of growth of the economy. It's literally not possible. Let me give you an example using a corporation. Say XYZ corp. is a very large company and it comprises 5% of the GDP of its home country, RealLand. Assume that XYZ corp. grows at an impressive rate of 20% annually for the next 30 years. This is similar to the growth rate that real estate has experienced in the hot markets during the last few years. Now assume the RealLand's GDP grows at a comfortable rate of 5% annually over that same time period.

In 24 years XYZ would amount to 107% of the GDP of RealLand. It would be bigger than the GDP of the country!!! The same goes for gold, oil, stocks, tulips, and yes, Real Estate.

I don't doubt that you read housing bubble economic theories in 1999 (although the author would have been a rare, lone voice). Bubbles all throughout time have lasted longer and gone to greater extremes than even the most informed economist believes it will. Remember, Greenspan's infamous "irrational exuberance" speech was given in December 1996.

How long will this one last?

Posted by: Eric at July 14, 2005 07:22 PM

Yuri's comments are some of the most uneducated and financially unsound comments I have read. He has no understanding of the financial soundness of the immigrants or their offspring which make up the mass of population growth in the U.S. One of the hottest markets in the nation, San Diego, had a net OUTFLOW of population last year (state to state, i.e. people with money). Population (another measure) there did go up, but is mainly attributable to immigrant (legal and illegal) births and inflow from Mexico. These are not the demographics that can afford houses. The current affordability of homes for the median wage earner is about 14% in San Diego. Real soon there will be no one able to buy an entry level home (500k) which will ripple through the entire San Diego market and cause downward pressure in prices. A few other comments made by Yuri also make no sense..."Oil will be higher..." How do you relate that to high housing prices? If anything that will contribute to downward pressure on home prices as homeowners will have less money to spend on housing. Also merely stating that population will continue to grow has no bearing on upward prices of housing, if anything, the U.S. will become a 2nd world nation as the population masses without good paying jobs flood our great country. Houses are CHEAP in Tijuana... and Yuri, the population there is enormous and it's just across the border from San Diego.

This is a classic Bubble! I trust the current stock market regulations and oversight much more than the complete lack of oversight in the Real Estate market. If you follow the news closely the Feds are busting rings of unethical realtors, mortgage brokers, and appraiser across the country. Sounds similar to stock brokers at the end of that bubble. There will be a lot of people in the real estate industry being sued or going to jail once this bubble bursts. I reviewed some paperwork on my refi's the other day. There is NO logical reason why my house appraised at 450K in September of 2003 and then appraised at 690K the next June when I sold. This same exact house sold for 320K new in 1992. I bought from the original owner who sold it to me in 1999 for 282K. Consider that. The trick to this whole bubble thing is that it is impossible to time.

I would bet that Yuri is a "new" realtor or real estate speculator to make his moronic comments. Just remember that the money that many people will end up losing isn't really lost...it is just transferred into the pockets of the people that got out earlier. As many people that loose when the bubble collapses, just as many people will have raped them making easy profits when the bubble was forming. The Billons of market cap "lost" in the stock market crash enriched certain people. The cash wasn't burned or lost at sea, it simply changed accounts from those that suffered to those that made out.

Posted by: tommy D. at July 14, 2005 09:10 PM

What new could be added to what has been said already?

Real Estate prices started going up in March-April of 1997.

Yes, I belong to "bablelogist" because I witnessed fall in Real Estate in the 80-s and 90-s.

I am using just common sense (at least I prefer to think so).

1. We live in San Francisco. 2. Our household income is above 100k but quite far away from 150k.

3. Our rent for a 2000 sq foot house is $2000 a month. 4. It would cost someone else about $2500 to rent it today (down from the peek of $3500)

4. If I buy a townhouse for 450k and take a conventional 360k mortgage at 7% - my monthly payments (including association fee) would be $2500 a month.

5. I count nether interest deductions nor property tax - one will pay for another one.

6. Why would I pay a cent above the mentioned $450k ?

It DOES NOT make any f***n sense. I would rather rent and save money every month than to pay a ridiculous price for WHAT?

I consider my family income - average for the area, so I do expect Real Estate prices to go down 40%-60% in the near future because an average family

simply cannot afford such prices. What about college grads who are happy to get $12-15 an hour now days?

Further more I would like to remind you that for anyone who wanted to buy a piece of Real Estate in San Francisco during 92-96,

there were hordes of sellers chasing buyers and ready to make ANY concessions just to get rid of a property.

Posted by: Lupus Est at July 15, 2005 12:29 AM

I tend to use common sense in today's US real estate market. I've been thinking of a real estate bubble since late 2002.

I was born in Hong Kong and now I live in one of the bubbly region - New England. I remember back in 1997, when Hong Kong was ready to be handed back to China, people there were celebrating/speculating by pushing both stock and realty market through the roof. Since then, many "villages", "estates", or "communities" have never seen even 1/3 of the price reached at the peak in 1997. Do keep in mind that Hong Kong is one of the most populous cities in the world (very limited land), and its realty price has gone down 6 straight years (up to the point when SARS was exploited in 2003.) I know government policy has a lot to do with supply of land, or how policies could change realty price directly or indirectly (ie Japan since 1991.)

Turn the picture to present. I've seen many parcels of wet/marsh land being converted to condo's or townhouses in my area, and I think there will be lots of supply in the next 1-2 years. Also, I just don't see how people could afford some of these crappy houses with a ridiculous price. Bidding war is not uncommon in here as well, though not as severe as coastal Florida, or coastal California.

One other phenomenon I see is, every person I talk to would mention real estate related subject. Most of them does NOT believe there's a housing bubble, and those who are still renting think housing is a good investment and would think about owning a home in the near future. That sure sounds like what happened in 1999/2000.

Posted by: c_fud at July 15, 2005 11:56 AM

Hey Yuri, famous last words. "It'll be different this time". We're in a credit bubble folks. Don't mistake it or call it by any other name. Excess liquidity is the underlying driver of this phenomenon. I fully expect a slowdown from here on out with stagnant to declining prices for a few years.

Posted by: Rich at July 15, 2005 02:17 PM

Yuri and seattlecoder sound like some of the home builder economists. They are looking increasingly desperate to justify the current market increases.

Oil price is slightly relevant in this discussion. It does appear we are in a long period of oil price hikes which could in turn pop the housing bubble as people have less money to spend on houses since they are spending so much money for gas in a SUV. There might be a mass migration out of the suburbs closer to workplaces as well. This could cause outer-city rot, as some suburban areas (Atlanta, Dallas, etc) are so far from the core city that $3.50/gallon gas would have major macro-economic implications on commuting affordability. I have little faith the American people would trade in SUV's in a large numbers; the same people who think housing prices will rise 20-30% per year cannot be counted on to use sound judgement in regards to vehicle costs vs. quality of life.

Posted by: Wes at July 15, 2005 05:10 PM

I am intrigued by the posting of Billy B, and Lupus.

Billy, which part of Columbus are you in ? I am also living in Columbus OH, northern side, but I never recall Columbus enjoy such high home price appreciation at all, seems like we are being left out of this round of real estate bubble.

Lupus, why you would not pay more than $450K for the townhouse, besides the affordability issue ? My thinking is that, as long as you are renting, you are helping your landlord to build his/her wealth!

See, let's make a hypothetical assumption. Say the house you are living in cost $450K, your landlord loan $360K, and assuming it costs the landlord $3K a month to maintain. So, the landlord is losing $500/month. Sound like you get a deal ? At first thought, YES. But from a longer term perspective, you are paying $2500/month to help the landlord to build his wealth by paying the house. The landlord just need to pay $500 to own a house of $450K, plus downpayment of $90K.

Yes, I think the house price will come down. But, when you decide to buy a few years later, how much money you would have paid the landlord to build his wealth ? Will that be enough to make up the price dropped? More importantly, the opportunity loss in pleasure in owning your own home for years.

This is an economic question that has troubled me for a while. Any landlord or real estate expert has an answer ? Based on this logic, then everyone who can afford should have bought a house. Am I missing something ?

Posted by: Warrior at July 16, 2005 12:54 AM

Warrior,

What are you missing? - nothing except the opportunity costs of that money. Simply put, as the property owner what else can that $90K plus $500 a month go towards that would put me further ahead in the end?

In your hypothetical, the owner has plunked down $90K at the beginning plus $500 and has a $450,000 asset at the end of 30 years.

But wait - if he puts $90K plus $500 a month towards stock investments that earn an average of 6% per year, he has a value of $518,400 at the end of 30 years. Plus no headaches associated with renters, better ability to diversify a portfolio, more liquid assets, etc.

Posted by: trotfox at July 18, 2005 03:15 PM

Warrior:

"how much money you would have paid the landlord to build his wealth"

I do not care about my landlord's wealth. I do not care how much taxes I pay.

I am willing to pay 50% of my total earning If I could earn cool million a year.

I care mostly about how much I can earn and save.

What I said only is:

1. I've been paying $2000 rent a month;

2. I am willing to pay $2500 mortgage a month (7% interest), not counting for tax deductions, real estate tax, insurance, etc.

3. I am willing to put down $90,000 + 10,000 escrow fee + 30,000 repairs = $130,000;

4. $130,000 + $5,000 (extra payments a year) pay me today 4.8% (state tax exempt) - $6,500 (see http://www.publicdebt.treas.gov/sav/sav.htm)

5. The house must be no more than $450,000 to satisfy those conditions.

6. A similar house costs today $730,000.

7. It makes no economic since for me to buy the $730,000 house.

8. It must come down about 40% so I'll consider buying it.

9. I believe, my family is just an average family, with an average income.

Posted by: Lupus Est at July 18, 2005 04:10 PM

the music is playing, everybody's partying! some are playing "hot potato." the prizes are great for the ones who win the game then, everyone starts to play.

the music stops! who gets stuck with the last potato? is it you?

Posted by: leedo at July 22, 2005 08:32 PM

Warrior;

I live in Clintonville. the prices there have gone nuts. everybody has doubled their money in five years, if not done better. (and nobody has any closets).

You make a valid point, but you're changing the subject. true, at the end of 30 years, you own the rental house, and that's good, because finally you'd be making some money. but, normally, an investor wants to "make money" the entire time.

however, people on average only own their houses for seven years, which is why mortgages track the 10-year note.

The danger is, people are completely ignoring the rental market, and risk a huge correction. Either rents will rise - and they could, although it seems unlikely given the new supply of units being added - or prices will fall.

when a business buys a downtown office tower, what determines the value a building sells for? when the county auditor appraises such towers for taxation, what's the factor they look at?

It is how much money the property does in fact return on the investment. the cash-flow should be positive, or you would have a negative P/E ratio. In fact, you would have no "earnings" that could be booked to that investment, only losses. What bank would finance such an office deal based on this business model? Why don't all the downtown businesses buy their space? As you say, they'd be better off - until their stockholders revolted.

I don't know of many businesses that survive very long losing 50 percent a month. In the business world, that's known as a bad investment.

But if you survive to the end of 30 years, after taking this massive loss, you will own the bad business, thanks to your customers. And when you sell it, what will it be worth? By then, I assume, its worth will be back to something based on how much money it could potentially generate, and the historic norms for property price inflation.

Billy B.

Posted by: billy b at July 25, 2005 02:30 PM

Simply put, anyone who deny's that most "hot" real estate markets are not in a "bubble" is the "Greater Fool". Do the math and look at the overwelming facts presented on this page.

I am a licensed realtor in Florida, specializing in businesses. I am a business broker. I also am a real estate investor. I bought my first house at 19 (I am now 54) and I have bought and sold over 250 houses since, as well as 10 or so commercial buildings. I flipped 53 houses in 2003 and have bought nothing since Dec of 2003.

I have lived through several bubbles and if you think real estate cannot devalue you are a dumb ass.

I cannot add anything to what has been said here, except that I winessed most of it (No, I am not old enough to have seen the "tulip" thing)

My advise is, if you live in a house and everyone wants to buy it from you at some outrageous price, sell it and buy it back 1 to 2 years from now when it's value plummets. Thats good business. Incidentlly, rents are and will continue to plummet, making it an even smarter decision on your part.

Anyone who deny's the existence of the bubble, is usually someone who will loose his shirt when it pops.

Ahh....the Greater Fool now, unknowingly aids the demon "bubble" in it's dastardly deeds by denying it's existance....

Posted by: Mike M at July 30, 2005 12:17 PM

Lots of serious thought on this forum.

Living up the coast from Los Angeles, bought in 1994 post-earthquake when foreclosed, just inside my reach to buy. No regrets, just some bills to pay and insurance ripoffs to contend with.

Panoramic view of mountains and pacific ocean from a fixer on the hillside with a local mudslide this January 10th. For me, there is no better place on this planet where I can live, work, and commute to LA easily for business meetings.

Local property values are insane, maybe someday sell out and move to.....where ?

Its not paradise, but you can see it from here.

Bill

Posted by: isenberg6 at July 31, 2005 07:12 PM

Amey Stone considers Kent Beuchert's case pessimistic. Yet don't we in fact have two cases right now--namely, Britain and Australia--in which house prices have levelled off and in some areas dropped, as a result of exactly the dynamics that Kent has outlined? In these countries, there was a high level of speculation keeping demand artificially high. There was overbuilding in response to this artificial demand. Meanwhile, affordability was falling despite low interest rates and renting was becoming a bargain. Of course the actual trigger of the cooling off was interest rate hikes in both countries. But the hikes were not major by historical standards, and were soon ended. And the economies in both countries have been experiencing solid growth and high employment. As the Economist magazine wrote recently:

"It does not require a trigger, such as a big rise in interest rates or unemployment, for house prices to decline. British home prices started to fall in the summer of 2004 after the Bank of England raised rates by a modest one and a quarter percentage points. Since 2002, the Reserve Bank of Australia has raised rates by exactly the same amount and unemployment is at a 30-year low, yet home prices have fallen. ("In Come the Waves, June 16th, 2005).

So these countries have positive fundamentals of the sort that real estate industry economists always point to as ensuring that house prices can't decline, namely, fairly low interest rates and solid economic growth. And yet there is marked cooling. The likely explanation is, just as Kent argues, that speculators have been exiting the market at the first sign of price leveling and that this process is beginning to feed on itself. Just as the trend produced the trend on the way up, the trend will start producing the trend on the way down, this feedback loop being the defining feature of speculative bubbles. So far in Britain, investors are not dumping homes, they are just ceasing to buy additional ones. Yet now that house prices have levelled, the "wealth effect" is already going into reverse: consumers are borrowing less and spending less in both countries. And already there are signs that this loss of consumer confidence is becoming an important driver of the economy in its own right, especially in Britain, creating the spectre of a vicious circle, namely, a housing decline causing an economic slowdown, which causes job loss and further housing decline. None of this was caused by any major shift in the fundamentals. As many people have argued, it was caused by loose monetary policy and too much global liquidity with nowhere profitable to go after the stock market collapse, except real estate. And that created a classic asset price bubble, that is already collapsing under its own weight in two countries with sound fundamentals. Can we be far behind?

Posted by: John Dixon at July 31, 2005 11:23 PM

John Dixon raises a relevant point. This original discussion was the result of Amey's contention that "two things have to happen to pop a real estate bubble: Interest rates have to rise and jobs have to disappear."

Kent's e-mail to Amey was a well written, well reasoned piece on how the R/E bubble may pop without either of those events. Amey considered his views pessimistic.

We somehow fell into a discussion with others over whether a real estate bubble can or does exist. If she is still reading this, I would be very interested in hearing Amey's reaction and response.

Posted by: Eric at August 1, 2005 08:51 PM

Just a brief comment. Before any more people start criticizing seattlecoder, I'd suggest considering the possibility that he is being ironic.

Posted by: John Dixon at August 2, 2005 08:45 AM

Hi all (and Eric),

Eric asked me to respond and I have to admit I find many of the posts here very thought-provoking. I'm going to cull some of the insights that strike me as the most original and post a new item on Monday.

As for my views, I think there is a bubble in many areas and I think something has to happen to make it pop (or deflate). But I realize now that more than just job losses or higher rates could cause such a decline.

Posted by: Amey at August 5, 2005 01:08 PM

Well, the only question I have for the "blind optimists" is why are there so many exotic means of financing a mortgage.

Interest only, ARMS, 40 year mortgages.

True, these have existed in the past, they have only become so popular because, the average consumer cannot afford the traditional way of paying for a house.

I need someone to tell me of an asset class in history that continued to appreciate rapidly when everyone knows there is money to be made in it.

The real investors have quit this game about a year ago, what we have now are a bunch of wanna be investors who are lost at sea.

The most recent article I saw recently was a "minister" of the gospel, who only came to the United States 2 years ago, preaching the value of home ownership to his congregation ; "why rent when you can buy".....I guess that say it all

Posted by: DK at August 6, 2005 07:56 AM

My wife and I bought a 4BR/2.5BA SFR in Riverview, FL (just outside Tampa) a year ago for about $200K. Now it's worth around $300K and counting. Rents on similar houses are averaging about 1/2 of PITI payments on those same houses at today's prices. Folks, this is a big, red DANGER sign. We're getting out NOW...we're gonna lock in our $100K tax-free profit (bird in the hand), pay off our cars and credit cards, put a big chunk of $$$ in the bank, be debt-free, and rent for the next couple of years until this whole insane mess is over...

Posted by: Dr. Freeze at August 9, 2005 11:43 PM

Consider this:

It's estimated that 20% of new mortgages are interest only ARMs. These new owners are betting on the market to provide the equity on their investments, i.e. property value increasing b/c of demand.

So, once the market starts to flatten, (and it will) this 20% of the buyers has no reason to buy. Most of these are stretch buyers any


Burger King's Young Buns
LIMITED-TIME OFFER SUBSCRIBE NOW

(enter your email)
(enter up to 5 email addresses, separated by commas)

Max 250 characters

 
blog comments powered by Disqus