It’s different this time…

[carlislematthew]

While I agree with most on this forum regarding some level of price declines, something has been bothering me regarding some of the arguments and logic presented. I’ll try and explain what I’m getting at with a series of classic arguments and the typical responses I see:

Argument: “This time, the bubble prices may not revert to the mean like they did before”
Response: “It won’t be different this time”.

Argument: “Prices have never gone down without employment problems”
Response “It will be different this time”

Argument: “Previous trends hav shown prices decreases back to certain wage/value ratios”
Response: “It won’t be different this time”

I guess what’s been bugging me is that you can’t use the “things won’t be different this time” for some arguments and “things will be different” for other arguments, in order to validate one’s own preconceived theories, without adding something else to the argument. I realize that we add other arguments to the mix and that it’s not as simple as the examples above, but I do feel that it goes in that direction sometimes…

Thoughts?

[JJGittes]

There is also the bear’s argument from 3-4 years ago that prices can’t go any higher because they have never gotten so out of whack before…..but things I guess were different because they went a bunch higher in 2004-2005.

Nobody has a crystal ball.

[JES]

My thoughts are that there is a definate bias out there already in the public and the media the other way, towards the ‘soft landing’ theory. As proof, I am willing to bet that the average person out there would subscribe to the notion that prices will just ‘level’ off, that any downturn will be ‘brief’ and that interest rates probably won’t go much higher. They would probably also tell you that the economy is strong and we need not worry since this is such a desirable place to live, there is a finite amount of land etc. I do agree that people tend to find reasons to back up their preconceived notions, but when it comes to home prices falling most people are dillusional and still believe that they will either keep going up or just level off. In fact, they are already falling.

[Daniel]

Well, I don’t think it will be different this time if you use the correct valuation methods. SD housing may be 100% overvalued on a price/income basis, but this is a very rough metric that doesn’t take into account long-term interest rates and rents. If long-term interest rates go back to where they were in the 80s, then yes, price/income ratios will go back to that “historical” average, which would be a 50% haircut from present values. But if long-term interest rates stay pretty much where they are, we’ll see a much smaller drop.

Let’s just say that nobody can predict long-term rates, so making either assumption is dangerous.

A better metric is the ratio of present value of future homeowner costs to rents. This shows (I’ll try to put together a plot later) that SD housing is well above trend, but not by 100%. Maybe by 30-40% (the result depends on what rent inflation you forecast), which means that house prices need “only” drop about 25% to get back to tre trend line. They may of course overshoot, but that’s another story.

So my argument is that SD housing prices will revert to the mean, as the bears correctly say. But some of them are just looking at the wrong mean.

[Daniel]

Well, I don’t think it will be different this time if you use the correct valuation methods. SD housing may be 100% overvalued on a price/income basis, but this is a very rough metric that doesn’t take into account long-term interest rates and rents. If long-term interest rates go back to where they were in the 80s, then yes, price/income ratios will go back to that “historical” average, which would be a 50% haircut from present values. But if long-term interest rates stay pretty much where they are, we’ll see a much smaller drop.

Let’s just say that nobody can predict long-term rates, so making either assumption is dangerous.

A better metric is the ratio of present value of future homeowner costs to rents. This shows (I’ll try to put together a plot later) that SD housing is well above trend, but not by 100%. Maybe by 30-40% (the result depends on what rent inflation you forecast), which means that house prices need “only” drop about 25% to get back to tre trend line. They may of course overshoot, but that’s another story.

So my argument is that SD housing prices will revert to the mean, as the bears correctly say. But some of them are just looking at the wrong mean.

[waiting hawk]

We are in 1990 at the moment. Just follow this.

http://www.rntl.net/history_of_a_housing_bubble.htm

My website tracking Temecula and South Riverside County

[PerryChase]

Well, I think the big difference this time is the level of debt that people take on to afford a house.

Like the professor said, homeowners are all speculating on a price increase. Once that price appreciation is gone, there’ll be panic. My guess it that 50% of house in SD were bought by speculating resident homeowners or investors.

The new financial products out there have caused buyers to no longer consider the price of the homes they are purchasing and they now look at the monthly payment. Sure with a buy-down to 1%-3% buyers can swing the payments but they’ll be in for a big shock once the loans reset.

I’ve been following the new developments (condos to expensive SFR), and with incentives, I see that we already have an effective 10%-20% price drop from the peak as compared to similar resale homes. That information is not yet reflected in statistics. Houses built in 2003-2004 are only now being listed for sale at a loss. If anyone you of feels like doing so, go to a new project and check out prices. Then look for previous purchases in the same project. You’ll clearly the the 10-20% decline.

As compared to the last RE downturn, the internet will spread the info widely so the depreciation will over correct on the way down. MLS and other data is now widely accessible to everyone. In 5-10 years, it’ll be a different generation of buyers.

I think that the difference this time is the level of speculation out there. That’s what my gut instinct is telling me.

The sentiment for a 50% correction is already out there. But no reputable economist will say so lest he is labeled irresponsible. It’s more circumspect to predict 20-25% decline with price stabilizing.

Remember Bush the father insisting that there was no recession? He was trying to talk up the economy. Now, we have vested interests trying to talk up real estate. But everyone is already feeling the pain.

Yes, yes, you guys want hard numbers… however, compiling that info would become a full time job.

I’m happy to sit back and let time be the judge.

[ybc]

It’s called “comfirmation bias”. That is, people simply look for and believe in evidence that supports their belief. When data points to the contrary, a weak argument like “this time will be different” comes up. But while history rhymes, it doesn’t exactly repeat. So we should just discard any arguments that has nothing but “this time it will / won’t be different”

However, some actually points out what’s different. For example, the exotic lending practices were pointed out as a difference this time around. So the question for a reader is to decide whether that factor is important enough to cause a “difference”. To me, the argument then has some credibility and can’t be immediately ignored. To translate into housing, if in the past (high housing price + recession/high unemployment) –> price correction; then today (high price + low wage growth + higher interest rate/stricter lending) will cause the same impact, because the root cause is always that the borrower can’t shoulder the burden of mortage payments. But without recession and massive job losses, the process probably will be dragged out longer. Before they give up, they always hope…

[Daniel]

Sorry for the double post. I don’t know what happened.

To continue my thoughts about “reverting to the mean”, I will give a simple example: P/E ratio for stocks were in the high single digits and low teens throughout the 80s. During the great stock bubble, average P/E ratios went to well over 30 (even higher for many tech stocks). After the bubble burst, P/E ratios came down, but stabilized to the mid and high teens, which is somewhat higher than before. “Higher plateau”? No. Lower long-term interest rates today compared to the 80s justify higher P/E ratios. It did revert to the mean after all. You just have to be careful how you define the mean.

[PD]

Argument: “Prices have never gone down without employment problems”
Response “It will be different this time”

The argument should actually be: “Prices have never gone down with some kind of shock (like unemployment)”
Response: “It won’t be different this time (crazy loans, possible global recession)”

[JES]

On a less technical analysis, we can simply look at the role that psyschology has played in this last run up in prices. Many buyers the past 5 years have purchased because of an expectation of appreciation, often an expectation of rapid appreciation. No analysis, no thought to whether they can afford the payments, just a desire to ride the wave up. The reverse of this is a huge factor that will now drive the market down and is causing buyers to dissaprear. IMO it has the potential to drive the market much lower than a more technical analysis based on previous bubbles may indicate. You simply cannot compare the speculation factor this time around to previous bubbles, can you?

[ybc]

One factor that “justifies” high real estate price is the very favorable tax treatment – tax deductibility on interest and property tax, and capital gain tax exemption for the first $250K/$500K. No other asset class enjoys this much tax benefit! In California, proposition 13 further strengthens a homeowner’s hand. In an inflational environment, no other asset compares to a home.

But if price starts to decline, some of these benefits will become less meaningful (capital gain). How does prop 13 work in a declining price environment? Do you get to adjust your property value downward and pay less property tax?

Also, if price starts to decline, it’ll reduce people’s tendency to “stretch” to buy a home… by then, the only motivation is a shelter, a home; not an investment.

[VCJIM]

ybc, all of the factors “justifying” higher prices you mentioned were in place during the 1990s decline, save the capital gains exemption. In other words, I don’t believe they will have any impact in an upcoming downmarket.

[JES]

Once homes are no longer viewed as investments then you have to ask yourself why a home in, for example, San Elijo Hills, costs 750k and not 450k. It was driven to 750k simply because of speculation, not any real fundamentals, right?

[lamoneyguy]

Carlisle,
I think the response to all of the above is, “It won’t be different this time.” Have you read Rich’s bubble primer? If so, you know that one of the key components is the runaway job growth in real estate related industries. This may be a chicken or the egg type of thing, but those jobs will not only be lost in a down market, but flat as well. We are in that flat market. The jobs are already being lost. When the built up house ATM reserves runs its course, the game will be lost.

Also, it’s not as simple as saying, “Hey! It’s either different or not!” It CAN be different in some respects but not in others. However, if that is the case, you have to ask why. As state above, I don’t believe it will be different for any of the questions. But if we are to see a decline without employment problems, what would be the cause? Unprecedented lending standards? Unusual rates of investor activity?

If things are to be different for questions 1 or 3, what would be the cause? I can think of no reason.

~lamoneyguy

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