What’s Taking So Long?

[greekfire]

It is evident to the majority of this forum’s readers that home prices are grossly over-inflated here in SoCal. What is not often mentioned is why is it taking so long for home prices to reach levels that are more in line with other economic factors such as inflation and wages. For example, while home prices have tripled in the past decade, the minimum wage has remained the same = $5.15.

Economists and pundits alike can throw out all of the chaff that they can muster to explain the results, such as a diversified economy and reduced interest rates, but the sheer fact remains that a vast majority of the population simply does not have enough income to afford a tripling in home prices. Correction, maybe they can afford it, but the addiitional costs have to come from somewhere – savings, investment, purchases of other items, etc.

According to the NAR (National Association of Realtors), housing prices peaked in August 2005. Here we are 1.25 years later and prices have not yet come into line with other economic indicators such as reduced sales and increased invetory. Correct me if I’m wrong, but the laws of supply and demand still apply to the real estate market, don’t they?

[blahblahblah]

Patience, patience. The FBs are doubling down their bets with borrowed money. Comment #43 from this post over on SoCalMtgGuy’s website reports that many people carrying I/O loans refinanced last year and took cash out. They probably believe they can use that money to ride out the storm. $200K can float a big spender a loooooooong time, especially if they still have some other income coming in.

http://housingbubblecasualty.com/too-littletoo-late/#comments

This is going to take a long time, and the declines may only be in the single digit percentages each year. Speaking of which, cawireman posted this great excel template that lets you compare renting vs. buying. Plug in some negative appreciation numbers (even 1-2% is enough) to get a real feel for just how screwed these people are.

http://office.microsoft.com/en-us/templates/TC010566171033.aspx?pid=CT101444811033

[SD Realtor]

This has been discussed in previous posts. As we have seen previous real estate cycles tend to take approximately 6 years. There already have been certain housing types in various regions that have had major price depreciation already, like in the 20% range. (See UTC condos)

Again, what we have not seen are drastic price reductions by sellers, as well as lenders who have foreclosed and are offering the property for sale. They just are not pricing aggressively yet. Similarly inventory has dropped off by close to 30% from the summer highs. This has been due to sellers giving up, and seasonal adjustments typical for this time of the year.

Finally I think most people who have posted here only forecast single digit drops for the next year as well. We really need a major catalyst to get the bump down you are hoping for. With the 10 year treasury being so low, our or my biggest fear is that distressed homeowners will simply refinance out of whatever mess they are in.

As I am a future buyer, this is not what I want to happen but it is what I think will happen. We just have to be patient. This spring will be a very interesting time. Cross your fingers for high inventory and slow sales.

SD Realtor

[PerryChase]

I agree, it’s going to take a looong time. A lot of FBs refinanced and cashed out, or took out HELOCs for emergencies. We have just entered the “emergency” period of negative cash flows on “investment” properties and people are still hoping that the market will shoot right back up to save them.

I don’t expect a real estate panic until 3 years from now, when the FBs have no more emergency funds to carry them over. At that time, debts would have skyrocketed leaving borrowers no way to service those debts.

Here’s a scenario I envisage. BF his bought house in 2004 for $600k. Refinanced at $800k and cashed out $200k in 2006. He can’t really afford the $800k note (much less the original $600k loan) so he’s using part of his $200k cash horde out to service the debt. He still thinks that in a few years his out will be worth $1.2M, so of course he went out and bought a big SUV.

A few years go by and his cash is running low… but houses in his neighborhood are now only worth $400k. His debt is still $800k and he can’t make the monthly payments. His wife and kids are used to having everything. He’s now worried about paying for the college education of his oldest son who is also clamoring for a new car, preferably a BMW. What is he to do? He’s an FB out options.

Some people might be able to pull themselves out of this quandary. But throw in a few real family emergencies such as medical expenses, unemployment, divorce (ie, the vagaries of life) and you have a nasty mess.

[blahblahblah]

I think Perry is right, there are probably a lot of these people out there. That negative appreciation is the real killer — if homes are only going down 2% a year, you’re losing $10K/year on your $500K home. Even if we had rent/payment parity for the same property (which we don’t), that small negative appreciation throws the renter’s side of the equation waaaaaay ahead. I have been dinged before on this forum for saying that you shouldn’t buy unless it’s cheaper than renting (using 20% down, fixed 30 year loan), but I believe that those days will return. It may be 2010 or even later, but we’ll get there eventually.

[vcguy_10]

Yes, I remember a few months back, someone here wrote that he was thinking of selling his house in L.A., then come back and buy again in six months to take advantage of the expected price drops! Make that six years, I’d say.

As we know, house prices are notoriously sticky on the way down, and a big chunk of the needed correction will be in inflation-adjusted dollars (this means that in some years house prices will be flat, while wages, consumer goods, even the Euro become more expensive).

Prices will drop, that we know for sure, but it’ll be a long and painful process. Houses will remain overpriced for many years, although prices will be gradually less and less “excessive” until we slowly reach a point such as that of 1996.

[an]

CONCHO, I agree with you. One day, it will be cheaper to buy a house than rent an apartment. That’s what happened at the bottom of the last crash. I know someone who bought a 3 bed/2bath house in Mira Mesa and their mortgage was just $100/month more than the cost of renting a 2 bed/2 bath apartment in Mira Mesa. But at that time, only people w/ good credit and down payment can buy houses.

[sdrealtor]

I have a hard time seeing that happen. I bought my house in late 1998 and put 20% down. With excellent credit my rate was around 8%. My monthly PITI + HOA was significantly more than rent Pre-tax I spent about $10,000 more per year. After tax assuming a 37% marginal tax bracket I was slightly ahead.

That was definitely pre-bubble times and some would even say housing was undervalued. At the time we bought our house was 3 to 3.5 times our gross annual income.

[blahblahblah]

sdrealtor wrote: I have a hard time seeing that happen. I bought my house in late 1998 and put 20% down. With excellent credit my rate was around 8%. My monthly PITI + HOA was significantly more than rent Pre-tax I spent about $10,000 more per year. After tax assuming a 37% marginal tax bracket I was slightly ahead.

Why do you have a hard time seeing that happen when that was exactly what happened in your case? Of course you’ll take the tax benefit into account when comparing the costs of rent vs. buy. You bought when it was cheaper (or at least almost the same) as renting, all things considered, using reasonable financing with 20% down. Those days will return, but we’re going to have to wait until all of the big spenders have exhausted their HELOC money. Also, was 1998 the bottom? I thought it was more like 1995.

[an]

A mid 1970s 3bed/2bath 1500sq-ft house with 5000+sq-ft lot in Mira Mesa around 96-97 go for about $170k. The mortgage rate around that time was around 9%. That would mean monthly P+I = $1100/month. A 2bedroom/2bath apartment in Summerset Apartment, about 5-10 blocks away from this house was renting for $1000/month. If you subtract tax deduction and add in Tax+Insurance, it would come out to something very similar as well. That’s comparing buying a house vs rent an apartment. So, sdrealtor, this case plus yours shows that between 1996-1998, it cost the same to buy a house compare to rent an apartment. If you compare it to renting a similar house, I’m sure you’ll come out much more ahead.

[sdrealtor]

AN,
My case was based upon renting a similar house.

Concho,
The marginal tax bracket I used is probably a bit high, I used a 5/1 ARM interest rate and I didnt factor in maintenance. For the record, I didn’t buy when it was cheaper or the same as renting, at least that wasnt part of my decision. I bought what I wanted, where I wanted and what I felt comfortable paying. While 1998 was not the bottom it wasnt much different than the bottom which was around 1996 by me.

If it happens as you expect…GREAT…I’ll buy 2 or 3 more houses in my neighborhood like I should have last time around. I know a couple people that did exactly that.

[SHILOH]

“distressed homeowners will simply refinance out of whatever mess they are in.”

I think this is a strategy also…I wonder if the banks know this –or the gov’t or both…even newer exotic loans to cushion foreclosures.

However, in a scenario like this — banks still want a profit. Refinancing to someone who cannot afford the house in the first place, does not guarantee the bank will make their $ in the long run. Is it that easy to refinance out of a mess –ie, a $500K house that you cannot afford in the first place? It seems to me it could only work if the banks reduce the payments, keep interest rates very low and wait 100 years for the home to be payed for.

[PerryChase]

If the banks are giving out interest only loans, then the principal will just keep on being carried forward with never a prospect of principal repayment. Eventually, when the borrowers default the banks will collapse.

[TheBreeze]

Bubbles can take a long time to unwind and can go on for longer than anyone would reasonably expect. All one needs to do is look at the stock market bubble that popped in 2000. There were several people calling it a bubble in 1997, 1998, 1999, and early 2000. Take a look at this chart of the Nasdaq 100 ETF. If you shorted this tracking index in 1999, just a year before the bubble popped, you had to withstand a near 50% price increase before the top in April 2000. Don’t think that calling tops and bottoms are easy and that they will always be obvious. If it were easy, we would all be rich.

To get some perspective on how long these things can take, read this story about poster “Rimpy” from the Motley Fool message boards. He believed that the stock market was in a bubble back in 1997. I was on the Motely Fool boards back in those days and Rimpy had to endure tons of ridicule. He was one of the few bears amongst a herd of bulls who were making money hand over fist. Internet stocks would double and triple in a matter of months and then, amazingly, double again in a few more months. People thought stocks would go up forever back in those days. Of course, stocks eventually came down, but now before an amazing run that virtually no one predicted.

You can also see from the Nasdaq 100 chart that the value of that index went from 120 in 2000 to 20 in 2003. I don’t think even the most ardent bear on this board is looking for an 83% decrease in housing prices, so that bubble was much more pronounced than the current housing bubble. The collapse of that bubble didn’t lead to a collapse in our economy, so I doubt that the popping of the housing bubble will destroy our economy either.

Another thing that is going to temper the drop in prices is the lack of liquidity in the housing market. Stock markets are much more subject to emotion than housing markets due to the liquidity. It’s easy for most anyone to buy and sell a stock — not so easy to do with a house. Plus, houses have value above and beyond their economic return. Many people will pay more to buy a house than they would pay in rent just so they can have the stability of ownership and can fix up their place the way they want.

Additionally, you would be amazed at the number of people that have no idea how to value a house. I was talking to a colleague the other day and she told me that even if she decided to move out of her condo, that it would provide good rental income. Equivalent condos near her are renting for about half of her ownership costs. It’s so obvious that this would make a terrible rental property given her carrying costs, but she has been brainwashed to think that owning is always better than buying.

Finally, there are several owners that will do whatever they can to hold onto their houses. Their dream is to be a home owner, so they will get a second job or cut back on other expenses in order to afford their mortgages. The extra work and cutbacks will go towards salvaging a terrible investment, but they won’t care. They are just desperate to be home owners.

[powayseller]

Husing busts are worse than stock market busts. First, almost 70% of Americans own a home, whereas mainly the middle class and rich own stocks. So the effect of a housing bust is spread among more people.

Second,the outsized impact and multiplier effect on wealth that housing has, is much bigger than the stock market. “According to the study authors (Christopher Carroll, Misuzu Otsuka and Jirka Slacalek), an increase in housing wealth of $100 will boost spending by $9. A similar increase in stock market wealth “only” creates $4 more spending.” Reverse that for the way down.

Third, the impact of MEW is HUGE. Since rates hit their lows in 2003, MEW has been responsible for more than 75% of GDP growth.

Fourth, housing start downturns lead to recessions. Every time housing starts decline more than 25%, a recession follows. Can the same be said of the stock market? I don’t know.

Fifth, 25% of all mortgages are resetting to higher interest rates next year and millions of people will lose their homes in foreclosure and become renters (or tenants with Mom and Dad).

I disagree that homeowners can cut back on expenses to avoid a 50% jump in payments. At 35% or higher debt ratios, how can you cut back enough to afford a 50% payment increase? And forget that 2nd job – it’s recession time.

I do think that people are desperate to be homeowners, so they try hard to keep their home, but they won’t be able to.

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