Home prices fall in dollars not percentages

[bmarum]

Somewhat off topic, but I believe this is a poor example.

“For example, car dealerships would have you believe that they are selling cars at invoice. I don’t think they they could really do that for long. Car dealers don’t go out of busines often.”

Car dealers make most of their money on service and the sale of used cars — there is too much information out there regarding new car pricing for them to profit much on them.

[PerryChase]

You’re right bmrum… that was a poor example. I was simply trying to illustrate the fact that there are many reasons why profit figures are obfuscated. Related parties transactions in RE what makes profit margins very difficult to determine. RE projects often times involve multiple entities, but those entities may all lead back to a controlling entity/individual. The landsurvey company maybe owned the wife, the grading company owned by the son, the roofing company maybe a corporation whose’s shareholders are the son, daughter and husband, etc…

[powayseller]

I don’t know about y’all, but I’m getting bored of the same old stuff about having to explain why prices revert to the mean. They just do! No asset bubble in history has avoided this pain.

My points in regard to asset correction are clear to me, were presented over the past few months, and I am ready to move on.

My most pressing interest is in allocating my financial assets during the real estate downturn and ensuing recession. Housing has become only a secondary interest.

So if I no longer participate in answering objections made to “prices cannot revert to the mean because of demand”, or “Prices cannot revert to the mean because they cannot possibly go under replacement costs”, or “prices cannot revert to the mean because that would mean large unemployment and practically a depression”… I think I’ve heard it all. What all these irrational responses have in common is “It’s different this time. SD housing prices will be the first asset bubble in history to defy correction to the mean because things are different here”. Who really believes this?

There are some homeowners who don’t want to accept it, and I don’t blame you. But you’ve made your choice. You came here to get educated, and decided to ride it out. Now you are upset with the possibility of losing half your equity. Well, you had all the information that we sellers had.

I can’t keep coming here to debate you, because I am wasting my time. All bubbles correct to the mean. Read about it sometime.

Any discussion of dollar vs percentages, demand vs profit margins and replacement costs, vacancies decreasing or not, has nothing to do with the fundamentals: housing has to revert to the basic value where HOUSE PRICE = 8 * ANNUAL RENT.

Study Irrational Exuberance, Manias by Kindleberger.

Just read my thread where I posted Graham’s study, where NOT ONE ASSET BUBBLE studied escaped Correction to the Mean, to the fundamental valuation. For housing, it is wages. Rents are a proxy for wages. So even if housing prices are half of replacement cost (because replacement cost is made up of LUDICROUS land valuations), they will go there.

I’m done explaining this stuff. Some people just don’t get it or don’t want to get it. A good investor prepares for the future, and does not live in dreams and hopes. My goal is being a good investor, and that’s why I study everything I can get my hands on. That’s why I sold my house. That’s why I don’t care if it goes down 75%.

If you are bothered by a 50% loss, then sell. Stop arguing with history, with corrections to the mean. They happen regardless of how many times you want to argue about it, about why it cannot happen to your neighborhood. Yes, even Carmel Valley can drop in half. Only time will tell which neighborhoods are affected most. For now, Rich’s data is only about the price/income ratio for all housing for the entire County, so we don’t have the dataset to know what the mean is for each neighborhood. Unfortunately…

[Carlsbadliving]

Economically, I believe that the stutus quo proctect builders. If other industries found ways to build better quality products at lower and lower costs, I don’t see why, if forced, the RE industry can’t achieve the same results.

It’s because those other industries aren’t regulated every step of the way. When you talk about the cost of the land and the cost to build the homes, you are leaving out a very expensive step in the process. If the land is not entitled, a developer will spend many years and millions of dollars obtaining local, state, and federal permits to build. All of this before you can even talk about the price of lumber or labor. These costs have increased substantially in recent years and won’t be decreasing anytime soon. San Diego is indeed one of the most difficult places in the country to build. I work for a land planning consultant and have seen first hand the red tape that developers must fight through at the local, state and federal levels to be able to build. The only reason my job exists is because the process is so complicated that a company like the one I work for can flourish. All these costs are eventually passed on to the homebuyer.

I do believe this is one reason that the real estate bust will not be as drastic as many believe. The regulations in place today will not be taken away once prices fall. The cost to build a home today is substantially higher than even 10 years ago (regardless of price of land, lumber, labor, etc.)

[(former)FormerSanDiegan]

8 * Annual Rent ???

“…housing has to revert to the basic value where HOUSE PRICE = 8 * ANNUAL RENT.”

In San Diego, I believe that this ratio was actually more like 10x or 12 x annual rent. Where does 8x come from ? National figures ?

I purchased a house in Clairemont in 1996 for $163k. This was within 1% or so of the bottom of the market, at the point which housing prices were too LOW and needed to increase to revert to the mean (mean reversion works both ways). Using your valuation (8x annual rent) gives me a rental rate of $1698 monthly.

I know for a fact that rental rates at this time were far less. I rented out this same house in 2000 for about 1300 per month.

[bmarum]

She must mean 8 * annual income as another portion of her post says rents are a proxy for wages. From what I’ve read rents usually move with wages, but I don’t think that means you can substitute one for the other in the equation and keep the same multiplier. In other words, if you’re looking at the ratio between historic median home prices and historic median income, you can’t assume that ratio is the same for home prices to annual rent. Instead, you’ve got to look at the median price to median annual rent. That ratio may or may not be the same as the home price to income ratio.

For instance, one of the UCLA Anderson guys calculated historic averages of what he called “P/E” ratios for a number of cities from 1988 – 2000, including San Diego, by taking the median home price and dividing it by the annual rent for a two-bedroom unit in each city. San Diego’s average from 1988 to 2000 was 22.8. Now this ratio is probably inflated some because it sounds like he used apartments for the rental portion of his calculation, which I would expect to rent for lower amounts than a house all things being equal, but it shouldn’t be THAT far off.

http://moneycentral.msn.com/content/Banking/Homebuyingguide/P37631.asp

[Daniel]

Docteur,

My apologies for teaching you about land values. Where I’m from, we call that “selling cucumbers to a farmer”. I’m sure there’s a similar saying around here.

Powayseller: you may be done with this subject, but I hope you won’t mind the rest of us discussing it. Docteur here brings very interesting insights to the issue of SD house prices. It’s not always about you, you know.

[HereWeGo]

Some observations on Rich’s graph:

1) The housing price does not revert to the mean so much as it reverts through the mean. It’s interesting that residential real estate has, for the two previous booms, had a somewhat sinusoidal characteristic about the 120% level. There is no appreciable period of time where housing prices settle at the historic mean. Indeed, if the change in housing prices slows or appears flat, that seems entirely indicative of a shift from boom to bust or bust to boom, based on the previous two cycles.

2) Over the first two cycles, the peak above the mean on one cycle was the same distance from the mean as the valley below the mean on the next cycle.

Will that pattern carry through this cycle? If so, that graph implies far more than a 50% drop from peak to valley.

[an]

I completely agree that it will undershoot just like it overshoot. It’s just simple physics. You can’t have things go up and down and not under/overshoot, be it electronics in electronics, stocks, bonds, or real estate. So 50% may revert back to the mean, but my bet is that it will undershoot. Docteur, since you have extensive experience, can you tell us back in the last to bust, did the price fall bellow the cost of replacement? That might give a sign to how far it will fall this time.

[Bugs]

There’s a reason that almost nothing gets built during the slow times, and that’s because there isn’t a profit to be made. At that point, properties are literally selling for less than the cost (including a profit margin of any type) to build. Most development occurs during boom years.

There are a number of markets in the U.S. where you can (still) buy an existing home for much less than the cost to replace it. It may be trite but it’s also true: cost does not equal value.

[SDbear]

Docteur,
You present an important point. If we consider $100 per sq. foot of construction cost (higher end that you mentioned) and the historical norm of land cost (including fees and permits) being a third of the house price; including a 5% margin for the builder we get around $160 per sq. foot. Land prices which are mainly speculatory might come back to historic mean (I don’t beleive in the ‘there’s only so much land to build’ argument). Isn’t this around 50% of what new houses are currently selling for in some neighbourhoods.
Builders might have paid more for the land. Now they have an option of either taking a hit and completing the projects to get some of their money back or sell the land or hold the land. If every builder knows that the market is going down, who will buy the land? If some one does buy, Is’nt he/she bullish on the market and will build? If they are holding the land are’nt they taking a hit on ROI and how long can they hold? There is also the scenario of already constructed (new) inventory which is losing demand. Will builders just hild on to these or sell them below their replacement costs.
I would think all these scenarios will play out in varying degrees. If this happens to the new house market, how will the resale market hold?

[PerryChase]

I like the way powayseller puts it. It only takes 30,000 sellers to automatically re-price 1,000,000 homes.

[sdrealtor]

She is way overstating things. It really only takes several hundred. But prices change in dollars not percentages. Sellers dont say lets drop the price 10%, they say lets drop the price $10K or $25K or $50K. Percentages are simply a way of analyzing things.

[Author]

Posts