Reversion to mean = 37% nominal price drop, maybe 50%

[PD]

sdduuuude, I think that declining sales are a result of the following:
Fewer speculators
Fewer second home purchases
Reduced upward pressure (first time buyers aren’t buying)
People have cashed in and moved elsewhere to purchase at a lower price.

Although I don’t have any data to support this, I think the number of people who have sold and are renting account for only a small part of the reduction in sales volume. There are many of us on this board who have put their house equity in the bank but I think we are the exception. I made no secret of the reason I was selling in 2005. Everybody thought we were crazy. I sold my house for just under 800k. My neighbor insisted that we were fools and that our house would be worth 2mil in 5 years. He probably still believes that. When the masses start to see the truth, then we will have a wave of people trying to sell in order to save their equity. The period we are in right now is like the strange, confusing quiet when all the water was sucked out to sea before the huge tsunami came roaring through the land.

[sdduuuude]

Keep in mind, we are basically in agreement about the next few years. We differ on the severity of the drop and the supply/demand dynamics are the key to understanding it – not “regression to the mean” which doesn’t take market dynamics into play at all. It is just tinkering with numbers that may or may not predict the future. What regresses to the mean? Who knows. It is an easy analysis that doesn’t tell you much, IMO. Again – supply and demand is the key, not regression to the mean. I just think it is the wrong analysis to do.

We agree the picture is bleak for the next few years, but the long-term demand side is not as bleak as it may appear.

Yes, all those folks left San Diego for Phoenix, Vegas, Texas, and other places they really don’t want to live after living here. Yes, “many people who sell are leaving San Diego.” But that doesn’t mean they can’t come back ever. If prices drop by 30%, they’ll be back, maybe sooner.

When looking at the supply/demand picture, it is important to understand that when prices drop, demand goes up.

As the bubble deflates, and prices come down, people will be attracted to the market. As we’ve all said – it is better to buy a low-priced house with a high interest rate than a high-priced house with a low interest rate. Realtors will push this motto hard.

In another thread you asked (paraphrased) “What does it take to get buyers excited about the market again?” and I said “lower prices.” When the SFR median is 25% down, that means some neighborhoods and condos will probaby be down 40 or 50% and people will start buying again.

These are the kind of market dynamics to analyze to help gain insight into the future, not charts like the ones in your links.

[sdduuuude]

By the way, this comment is much appreciated in your original post:

“Now I will take the liberty to make a subjective adjustment.”

[equalizer]

Sduuude

You said

‘In another thread you asked (paraphrased) “What does it take to get buyers excited about the market again?” and I said “lower prices.” When the SFR median is 25% down, that means some neighborhoods and condos will probaby be down 40 or 50% and people will start buying again. ‘

Where do you get that 25% number from? I gave a number and likely PS gave a number that is a possible target, not 100% chance of happening. Agree with you that market emotion will dictatce the change and amount. I am just looking at possible down targets and historical charts that are RELEVANT. Examine the S&P 500 P/E ratios and recognize that P/E of 30 in late 99 was outrageous. Those who ignored that data (like yours truly, caught up in the mania trying to chase house prices; even after Bob Brinker pleaded with everyone to dump all stocks for GNMAs) were doomed.

The number of people who sold and sitting on cash are probably not that many. There are of course investors who raked in million plus and sold everything except main house. These people will keep limit on down side on good properties with low maintenance issues.

[powayseller]

In a study of market bubbles, Charles Kindleberger and the International Monetary Fund found that every asset reverted to its mean. At the time, the people refused to believe it. Like you, they said it was different this time. Demand for tulips, railroad stocks, tech stocks, housing would be too high.

As you know, Rich’s charts so clearly show that the last two San Diego housing cycles reverted to a price/income ratio of 7. Unfortunately, we don’t have data for the cycles before the last two. In regard to the ratio of 7, edna_mode made an interesting post, speculating that we could rise to a new permanently higher plateau, to a higher ratio. I debunked that theory in my post Can this Bubble Correct at a new higher plateau? . That post definitively explains why every asset bubble in history that we have a record of, has reverted to its mean.

sduuude, you say that as prices drop, demand goes up. But this is clearly *not* happening. Prices are down 10% or more, but demand keeps falling.

Yesterday I copied iTulip’s Eric Jantzen, where he explained why demand actually falls as prices drop. Likewise, as prices rose, demand rose furiously. People want more of the bubble asset when the price rises, less when it falls. So you see, the lower the demand, the lower the prices, and the lower the prices, the lower the demand, and we get into this vicious feedback loop. At some point, in 5 – 7 years, prices will be so low, that bargain hunters will come in and start buying. The median will drop for another 2 years, but those of us in the know, will be out buying at that time, at the very bottom.

sduuude, I ask you to take the challenge Grantham gave to his 2400 investors in the audience (see the link of my post), when he asked them to name just one, *one* asset bubble that did not revert to the mean. The scholars who study this for a living have *never* found one. It amazes me that people still think this is different.

[sdduuuude]

“Where do you get that 25% number from?”

Just an example, my presumption being that people won’t wait until it gets down to -50% before striking. Someone will start buying back into the market before the median is 50% down, though. That’s all I’m saying.

[sdduuuude]

“name just one, *one* asset bubble that did not revert to
the mean”

I’ll assume he meant prices, not the price-to-income ratio.

Pull out a median price graph going back to 1920 and lets take a look. Rich’s graph is convincing enough that a graph is coming – I sold a property in 2005 also because of it – but not sufficient to determine the level to which it will drop.

[sdduuuude]

The thing about reversion to the mean, powayseller, is that you can always look back and say “see – it reverted to the mean.”

What you can do is reliably predict how and when it will do so.

One reason is, the mean changes as today’s data is added to the stats. One could say that in the long term, the mean always reverts to the data as much as the data reverts to the mean.

Second, there is an issue of time. Do you analyze the mean for the year prior to the bubble? 10 years? 100 years? 1000 years? What is the “time constant” of this thing? We don’t really know.

We could revert to the mean by starting on a new housing bubble next year, only to result in an even greater crash 5 years later than we thought. It could also be a soft-landing for 20 years. That would be a reversion to the mean, but at a different rate than you expect, and to a different level.

Perhaps this bubble is riding on top of a bust with a 40 year cycle, and part of what we have seen is a correction of that 40 year bust.

Lastly, reversion to the mean in many cases is a myth. Some would say that when you flip a coin ten times and it comes up heads 10 times, it is now more likely to come up tails so that the statistics regress to the mean. I’d say you have a rigged coin.

There is a reason why on all investment documents, it one is legally obligated to write “the past is no indication of future performance.”

Reversion to the mean is simply not the right analysis to do. I’m done w/ this thread.

[powayseller]

For housing prices, we have data going back to the 1800’s showing prices rise with inflation. For San Diego, we have data going back 2 other cycles, to see how they revert.

Housing prices are basically dependent on the fundamentals: jobs and wages. So it comes down to the price/income ratio or HAI (home affordability index).

I thought bringing in data would keep the emotion out of it. Why can’t we make predictions around here, using proven methods such as reversion to the mean, without people getting upset?

sduude, you sold your house, so why do you care how much houses go down?

[Author]

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