San Diego Housing Bubble News and Analysis

John Talbott. Among economists, he's the biggest housing bear. More than Shiller? That's why I upped my 30% drop forecast to 50%, after reading his book Sell Now.

It only dawned on me this week how significant it is that some 40% of the housing purchased in the last 24 months was purchased as investments and 2nd homes.

That's a lot of houses / condos being purchased by people who have no intention of living in them as their primary residence.

Many of these housing units are currently sitting vacant. This is important because some real estate analysts assume that when a housing unit is sold, the seller will HAVE to either buy or rent another unit.

What happens to these houses / condos when the market softens?

I believe most of them (maybe 70% ?)will end up on the market for sale. A lot of these sales are likely to be motivated by fear and desperation.

The housing units that don't sell will go back to the bank or become rentals.

Banks don't like to own residential real estate so they will be dumping housing onto the market at motivated prices. These units are likely to be purchased by investors for resale or rental.

It will take some time (12-24 months?), but I believe the local rental market will have a glut of new units being offered. Rents should drop as landlords compete to attract tenants.

But the really significant point that I hadn't realized until this week is this: if 40% of the housing purchased in the last 2 years was purchased by investors/2nd-home-buyers, when those people STOP buying, 40% of the DEMAND FOR HOUSING GOES AWAY.

That means the motivated sales of housing units is occurring in a market where demand has dropped by 40%!

Good point!

The above, combined with the fact that young families cannot fit themselves into a one-bedroom "entry-level" priced condo ($400+ in a good district in San Diego) means you have the non-investment entry-level buyer sitting out too.

Then all the people like powayseller who could afford a home now, but have done their homework and see the writing on the wall - they are sitting out too. The percentage decline in demand grows and grows.....

That is what I'm doing. I feel a little like a buzzard, waiting for the carrion to materialize. We sold our house, have our war chest ready and are watching the market closely.

I can't reconcile these numbers. If 40% of homes were purchased by investors, why are sales down only 30%? Shouldn't they be down 40% for the investors, plus another 20% for the entry level buyer who is squeezed out?

The builders have filled this market with excess capacity. In the US, the ratio of new units/new households, which vacillated between 1.0 and 2.0 between 1980 and 2000, stands at 2.6! That means they are building 2.6 housing units for every new household. Clearly a glut of inventory. Meanwhile, we still have a shortage of housing for low-income workers.

I don't think all investors have quit buying. There are still some housing bulls out there. My very rich neighbor just bought a 1.2M townhouse on the water and is trying to rent it for $3,400 a month. He will buy another one if he thinks it is a good deal. I fully expect him to do what many others did in the stock market in 2000 - buy all the way down.

You forgot to add back in the ignoramus current-buyer factor... +30%. Then your numbers will reconcile perfectly!!!

Off to garden and play with my six year old before the thundestorms roll through.

John Talbot published his first book over 3 years ago telling us to sell our homes because the great crash was eminent.

http://www.amazon.com/gp/product/0071422...

I guess if you publish a market crash book every 3 years, hopefully you'll be right one of them!!

Ahh, but he wasn't a smart man three years ago. He is now though. :)

Talbot's book is ok, but some of the conclusions he draws have no basis in facts. I think his view is a bit extreme. I just cannot envision the world wide calamity he calls for happening. We have a tough time ahead to be sure, but I do not see the banking system evaporating. If we get a 50% drop, literally no regular people will even have jobs. The world as we know it would never be the same.

Even 30% is going to be incredibly ugly.

As Thornberg said, you can recognize a bubble, but you cannot accurately predict how long it will go on. His analogy is, "Don't ask me what that crazy man is going to do. If I knew, he wouldn't be crazy".

Other economists have said you can recognize an asset bubble, but you cannot predict its collapse.

What Talbott did is make the points for why there is an asset bubble, and how it will deflate. Those points are still valid today, and he made them at a time when everyone thought RE would only go up. He was the visionary.

His timing was off a bit, as was Thornberg. The UCLA group predicted the bubble would end in 2003. I will write more about the UCLA group in the next day.

"Sophisticated investor" alert!

(Referring to RightSide's post.)

The Bankers Assoc. said that 30.5% of recent loan applications are for ARMs. What is the current percentage in SD? There are still areas of the country that will experience price increases and people won't get hurt with an ARM because they will be able to sell.

His timing may have been a bit off, but the price differentials were massively off! I bought a house in 2003 and sold last summer, in Seattle. Even with Seattle prices, I made a lot of money. I ignored the acedemics because they weren't the ones controlling prices, people were.

The problem with acedemics, and some economists, is that they pay too much attention to the fundamentals. Yes, fundamentals are important and they will bite you, and bite you hard. But people are important too.

In 2003 the prices were going up, and the vast majority of people (not economists or acedemics) were expecting the price to go up more. So they bought, and so did I. In mid-2005 onwards, the prices were going up still, but the expecatations had changed because people were changing their opinion - they were starting to believe that prices could no longer go up. I remember a study that said the the occurrence of the word "bubble" as it related to real-estate in the major press peaked in June of 2005. If enough people (the market movers) believe that prices have peaked, prices have peaked.

I believe, and I'm not alone, that it is the expectation of future gains that drives substantial price increases. It wasn't interest rates, although that helped, and it wasn't the lack of land. Fundamentals be damned, well at least until all the negative-amortization loans reset... ;)

There are areas in Florida where there are 30 to 50 percent decreases in number of sales.

Does anybody know if there is a correlation between an increase in the number of sales to an increase in price? If there is a quantifiable correlation, would you be able to extrapolate what a decrease in the number of sales would do to prices? You would have to assume that interest rates and other variables remained the same....

Your neighbor is a great example that being rich and being intelligent are mutually exclusive. How can he only charge $3400 in rent for a 1.2M property, it simply does not add up. Doing some quick math, if he bought the property with a mortgage the monthly payments would be almost $6000 per month. If he bought the house with cash, and we assume the market stays flat, the income in real terms is basically zero. But of course anyone that doesn't live in a cave must realize real estate is not going to be flat, but is on its way down.

This guy is a moron.

I didn't read the book, does Talbot say that "no regular people will have jobs" following a 50% drop, or is that your comment?

I can't see any reason why a 50% drop in San Diego prices would cause a calamity. That would basically return real estate to 2001 levels, which were already overpriced. The only people who should really be hurt are those who bought in the last 2-3 years, flippers, and a lot of real estate and construction people will be out of work. I don't see that as a calamity and don't see how it will hurt too many people outside of real estate related industries.

And for those that are ruined financially, maybe they will move out of San Diego and there will be less competition for jobs and houses for the rest of us (and less traffic). Not sure that this is a bad thing.

I agree, he is a moron. The property taxes here are 1.2% and the assoc. fee is something like $350 a month. He has made a ton speculating here in the last few years and is convinced that nothing matters except appreciation.

He was smart 3 years ago. As I said before, (impatience showing?), you cannot predict when irrational exuberance corrects. Excesses go on for much longer than anyone thinks possible. That doesn't mean the person who saw the excess was wrong.

This reminds me of the alcoholic uncle. You know he's an alcoholic, everyone does, but he is in denial. He loses his job, his wife, gets a DUI. You keep thinking he hit bottom, and he will quit drinking. But to him, it's not bad enough. Then one day, something happens, he has a revelation, and comes to his senses. Markets are like that too. Just because he kept drinking after the wife left him doesn't mean that you were wrong to call him an alcoholic.

I agree. Prices dropping 50% will bring them back to where they would be if this crazy appreciation had not happened.

Chris, I'm interested, which of Talbott's ideas do you dispute? I dispute his assertion that inflation has been burned out of the economy.

As far as the fallout, what he says is entirely possible. The entire MBS market is at risk, because of stupidity of the managers at Fannie Mae. In my opinion, they should be in jail! The whole liquidity game was a dangerous experiment. It will end in a mess. A big global recession, unless they come up with another asset bubble to prolong having to balance the global economy.

If it is indeed the case that he was predicting an imminent crash 3 years ago (according the previous post, at least) then we was NOT a smart man three years ago.

My comment was tongue in cheek and the implication is that someone is smart when they agree with you, and a fool when they don't.

In addition, I was not debating with you regarding the end of the bubble and if it is possible to predict the end - I happen to agree with you. I was, however, making a comment in reply to a post that stated that the author predicting an *imminent* crash 3 years ago.

Dead and poway

Do you really think that 10 Trillion dollars can get taken out of the US economy, and not have widespread unemployment? That is the equivalent of the DOW going negative. The total Cap of NYSE is less than 10 Trillion. So, it is hard for me to believe that we could have the equivalent of that much of a wipeout, and not have record high unemployment. Here in OC, close to 50% of the new jobs since 2000 are in RE. A huge RE depression, would leave most of these people out of work.

Do you think there is another industry or industries, that would be strong enough in the midst of a national depression, to absorb that many job seekers? There is a domino effect in our economy, things do not stand alone. Layoffs at 7/11 and Burger King, accountants at Big 8 firms, and attorneys(not a displeasing thought) would also lose jobs. Tons of small businesses would go under.

We are completely built on one asset class right now. If it implodes, the effect is alot bigger than what you are talking about.

I just think you are not being realistic. Make no mistake, a 30% drop will create the largest recession we have ever had. Even that is going to be an awful time for us here economically. I do think that could happen. I just model all of my views on history. A 50% drop is a "it will be different this time," view. It is that because we have never had anywhere near that previously. There are always ways of justifying why it is different this time. However, history has shown us that most of the time, it is in fact not different.

I look at that argument the same way I look at the bulls argument, for more upside appreciation. Just my opinion, I could be wrong. Maybe I am too optimistic.

Poway, mostly I agree with his comments, but the conspiracy theory aspect to it is not based on facts. Asset bubbles are caused by the most basic human emotions such as greed. I do not think you can isolate one symptom like that and blame it. If everyone were conservative, and prudent, these huge peaks and valleys in prices would not occur.

However, I like it though, because I make a living off those peaks and valleys in trading.

Are you saying a 30% drop in only a few markets will cause the recession?

PD

Yes if it occurs in the markets with the largest asset value like here (LA, OC, SD), San Fran, NYC, Boston, Dc etc..You are talking about a massive amount of erosion of net worth. Far more, in fact no comparison to what the stock selloff eroded. Housing makes up a far higher % of personal net worth than stocks nationally.

If just SD dropped 50 and nothing else moved, then no problem nationally. I do not see how that could happen in isolation like that. I just want folks to take the emotion out of this.

We all agree a drop is imminent, but I do sense a general almost rooting for it tone. My basic point is, be careful what you wish for. Have a plan, but base it on hard numbers, not emotion. Then execute it when the time arises. Do not get to tied up in the negativity that will abound on this drop.

I love buying huge drops in things, because most people, even those who planned to do it, get scared when they are in the midst of it. It is not easy to do, yet it is opportunity knocking.

I just think people are under estimating how bad things will be if even a 30% drop occurs, that is a huge drop for an asset essentially "rigged" to go up over time. I remember how OC was during the last crash, and the drop was only about 20% basis the median.

Just my opinion

So is this why no one seems to be getting too excited about Florida and Phoenix? Their situations look even more dire than San Diego's, but maybe it is because the same staggering amount of $$ isnt inolved? Wouldnt have the same effect on the larger economy? Am I following you correctly?

No one can time an event. Never trust a financial advisor who claims they can. You can know what will happen with a great deal of certainty, but not When. I think Talbott took that strong stand because he was either overconfident, or he wanted to sell more books. If he would have said, "Sell Sometime, I just don't know when, but it will be sometime eventually", his title wouldn't be as catchy. Nonetheless, just because his timing is off, doesn't mean I don't buy his premise.

The important thing I look at: does this guy's argument make sense? Can what he predicts come to pass?

I agree with you that economists should admit that they don't know when an event will come to pass.

Good point, and one made by Chris J. also. Don't let an economist manage your money. They do have interesting insights into the economy, because they spend all day tracking trends, and can put the time into forecasting. But their track record on predicting the future is really bad.

Talbott would have done better if he'd advised people to check the real estate leading indicators before selling: days on market (untampered version, if there is one), inventory, affordability index. And buyer psychology. Anyone who made a decision based on his book definitely lost money. Talbott emailed me that I should buy Ibonds with my money. He actually believes the government CPI!

After that, I learned not to let an economist manage my money. I bet their personal portfolios underperform the market by a lot!

A handprinted sign I saw on a street corner today (the misspelling was theirs):

Real estate investor needs apprestice - 20k mo

Anyone please correct me if I'm wrong, but I wouldn't think a direct correlation between number of sales and price should exist without bringing supply into the equation.

For example, over the last 50 years the price of gasoline has dropped (when adjusted for inflation) even though the sale of gasoline has increased greatly. This is due to more production, more competition, etc. However, small adjustments to the supply available creates large adjustments to the price. Changes in price will eventually create some adjustments to sales.

There could be a correlation between number of sales (percentage of overall supply) and price increases.