Will it burst/deflate/stay flat ?

[lewman]

My interest is in profiting from a housing bubble burst. Please contribute to this thread to help me think thru whether prices will collapse (like the tech bubble burst), deflate (like San Diego housing prices in the early 90s), or keep going up (like prices from ’74 to 1990).

Firstly, I accept all of rich’s arguments that SD property prices are too high to be justified by economic fundamentals. But that doesn’t necessarily mean there’re opportunities to take a short position. On how to profit from a housing market downturn (or just to lessen the pain in case you’re thinking about cashing out of your home in SD and moving to Bangkok in a few years), see http://www.cme.com/trading/prd/env/housingover16250.html

So I was looking to history for help. The data I got is from the Chicago Mercantile Exchange (http://www.cme.com/files/HousingData.xls) and it dates back to 1974.

Period SD Property Price Change
1974-80 +142% or approx. 16% per annum
1980-81 -3%
1981-90 +86% or approx. 7% per annum
1990-95 -15% or approx. -3% per annum
1995-2005 +248% or approx. 13% per annum

From ’99-2005, price increase accelerated to 17% p.a.

So history has shown that property price bubbles don’t necessarily burst like stock bubbles do. They perhaps merely deflate (as in the case of ’90-95). And if you don’t count the small drop in ’81, prices could continue to go up for more than a decade (16 years from ’74 to ’90 and prices went up by approx. 10% p.a.).

If interest rates is topping out and IF the economy continues to chuck along alright, prices could just stay flat for years. And taking transaction costs into account, there may not be much room for profits by shorting the property market.

What do you all think ?

Lewis

[Anonymous]

Personally I am not looking to short the property market. Shorting is very risky game but obviously can be profitable. I do have a strong interest on when to enter the property market. I also agree that California real estate is totally disconnected from economic realities. So what does a correction look like? History can be a very useful tool but doesn’t neccesarily repeat itself exactly. The thing that has me most concerned about this real estate market is the underlying credit bubble. I don’t think we truly know how many people are in properties they simply can’t afford. I don’t think we really know how many people who bought homes before the runup and refinanced themselves to the max. I believe this will be revealed once the appreciation stops which in my opinion is happening now. There is a tremendous amount of debt that is beginning to reset at higher rates this year. The last I looked incomes were growing a little but not by what is needed to finance these new payments. California is especially susceptible to this given that many people have to stretch themselves to the max just to get in and then hope for the best. These are for the teaser rates on I/O loans that I am talking about. I am seeing reports that many people are paying up to 55% to 60% of their gross pay to make their mortgage. That sounds like total desparation and it pretty much is. It shows the extent of the fever that “if I don’t get in, I never will”. Now anyone with a brain can see this will end. Just looking at the fundamentals of the market which I believe shows home prices 10 X incomes means that a larger number of people, than the analyst are predicting, will not be able to make their payments or it will be so painful they will be forced to exit. I believe this will happen even if most of these people keep their jobs.

Once market psychology shifts people will no longer have that fever to buy that home at any price at the same time many people who own those homes will need to get out, not to mention increased foreclosures and panicked speculators. Point being that if there were a real estate market to experience a sharp decline in prices it would pretty much look like this one. I am not saying this will happen but the possibilty of this happening is greater now than anytime in the past.

[powayseller]

leung_lewis: Have you seen this site’s graphs of median home price/per capital income? The data you describe is somewhat different than the data on this website. This site’s graph shows a period of decline from 1980 – 1986, followed by a rise to 1990. This data shows that every rise in prices reverts back to the mean, first overshooting it on the way down.

Prices cannot stay flat for years. Read the Bubble Primer. 80% of loans in SD last year were interest only. Those folks will be selling when their adjustable rates start to adjust.

“So history has shown that property price bubbles don’t necessarily burst like stock bubbles do. They perhaps merely deflate (as in the case of ’90-95).” leung_lewis: actually, the ratio of price/income went back to its trough level, which to me is a bursting.

Currently we are at med home pr/per capita inc = 14.5. To get back to the trough of 9, we would need a drop of 30%. Another chart shows home prices follow inflation. To revert back to that trend line, home prices must drop about 50%.

History has shown that property price bubbles correct. Look at Japan – they are in a 15 yr slump. Of course, it does not happen overnight, as with stocks. It can take many years. The SD correction can take 5 years.

What do the columns in the CM .xls file represent?

I closed escrow last week, and made some good money on my house (which we finished building in September 2005 and it was so gorgeous!). I am putting it all into CDs, and it will be there in its entirety for another home purchase at the trough of the market.

In the retirement account, there is more room to take risks. I heard of many people buying gold, but isnt’ that just speculation also? Since the money supply is no longer tied to gold, then gold is not really a substitute for money any more, and just another commodity, right?

I checked into ProFunds Short Real Estate Fund, and requested an Annual Report. The online Prospectus does not list their holdings. Shorting stocks and buying options can be risky, because you can lose more money than if you bought long. How about buying shares in companies that profit during recessions?

If you have a house, sell it. That’s the safest way to play this market.

[peterm]

i agree with your post. Have read all the RE economic charts and reports over last 5 months and the data is conclusive ; SCal Re is overpriced by 30-40%. LA is one of the most overvalued regions-in the top ten- for inflated bubble prices. As of now Median home price in LA city/metro area is 599,000 which is 7.7% down from 649,000 in august(source is MSL tracker site from prof Piggingtons site).The bubble pop may already be happening in LA as we speak. With new increased min credit card payments added to a sharp uptick in energy prices homeowners will cut out discretionary spending and thus cause a cooling of the economy. The half dozen homes for sale in my stable neighborhood( SFH’s, good family area)have been for sale simce sept-oct and have not moved. I take the extreme pessimists view and see a sharp decline of 10% this year in SCAL overall and 15 % in LA Metro area. Just my hunch-if i’m wrong i apologize.

[lewman]

Powayseller: Thanks for bringing up the point re: median price / per capita income. But you were talking about a price-to-income ratio. I was talking about price. Obviously two different things.

In addition to the CME link I posted, you can also check out the Office of Federal Housing Enterprise Oversight’s San Diego housing index (http://www.ofheo.gov/HPIMSA.asp) and it will also tell you that in the first half of the 80s San Diego housing prices only dipped by a small margin (around 3 to 5% during the whole period) after prices more than doubled in the latter half of the 70s.

You said “currently we are at med home pr/per capita inc = 14.5. To get back to the trough of 9, we would need a drop of 30%”. Actually we don’t, a 30% rise in income will achieve the same thing even if housing prices don’t drop.

What might have been the case was that during the early 80s, instead of a price drop, we saw income rising fast enough to bring the price-to-income ratio back down to a reasonable level, before prices rose again in the late 80s.

I’m not arguing that it would be the same this time around but for someone like me who’s trying to profit from the so-called “burst of the bubble”, I must take into consideration the possibility that if the economy continues to expand and income levels somehow find a way to rise (where the engine of growth will come from I have absolutely no idea), SD prices could stay flat (or just correct by a small percentage) over the next few years.

Having said the above which is me playing devil’s advocate to myself, I still tend to believe that this time prices have gone way too high compared to income, and when the correction does finally come, it will probably be steeper than previous cycles.

Peterm: Unfortunately CME and OFHEO only offer stats up to 2005Q3 so it’s lagging. Could you post the link for this MSL tracker site you mentioned ? thanks

Lewis

[nhamlin]

I would like to provide some insight on the “flat” market of the early 80’s. In constant dollars the early 80’s was a massive crash. Nominal sales prices were essentially flat for about 3 years while inflation was double digit.

In the sales that did happen, the sellers generally carried back financing at below market interest rates making their cash equivalent sale price far lower than the stated price on sale. The market was also propped up by incredible inflationary expectations.

In mid city area apartment buildings, nominal prices stayed flat while rents nearly doubled!!

My point is: Previous soft landings occurred against a backdrop of rising incomes and high inflation. It is hard to imagine a soft landing in a low inflation environment.

[lewman]

Nhamlin: was still in my teens during the 80s so I don’t have much of an appreciation what happened; but that would certainly give a plausible explanation to a “flat” market in terms of nominal prices while the real value actually falls. thanks.
lewis

[lewman]

… and if the cause of the “flatness” was indeed high inflation & rising wages, then I certainly agree that today’s conditions (low inflationary or even slight risk of deflation the way Ben sees it) aren’t conducive to a repeat.

[Author]

Posts