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davelj
Participantsdr,
An anecdote to clarify what I’m talking about. When I moved to SD in 2000 I bought a condo that would have broken even on a cash flow basis if I had decided to rent it out – that’s right, broken even… maybe even provided a small positive cash flow. And this was in a reasonably nice, albeit 20-year old, complex (maybe that’s an oxymoron – I don’t know). From the price history I could tell that buying one of these units at any time between 1996 and 2000 would have given you break even or slightly positive cash flow using traditional financing (20% down, fixed-rate mortgage) and then-current rents. Now perhaps that was unusual at the time. I wouldn’t know as I had just moved to the area. In hindsight, obviously, I should have bought a much larger, pricier place. I had no idea how crazy things would get.
Anyhow, I sold in 2004 (for a bunch of different reasons at the time) as the ownership premium we have been discussing had risen to about 160%. The premium then rose to almost 200% over the subsequent year-and-a-half (yup, I left money on the table) before declining back to around 160% today. (I track this complex as a market bellwether because I’m familiar with it.) My suspicion is that the premium will decline further to 120% or less before this decline is finished.
My point is that the people who bought at 160% probably won’t see much appreciation over an 8-10 year time horizon, so there’s no need take such appreciation into consideration – it probably won’t be there. Which is one of my points – this premium is telling you the degree to which you’re overpaying on the fundamentals. I’m highly confident that if you consistently pay a 150% premium to own/live in a house/condo, in most cases you will experience minimal appreciation over the subsequent 8-10 years.
(Also, I’d love for someone to pull these figures – I’m too lazy – but my suspicion is that residential rents in SD County have not increased by more than 3% per year on a PPSF basis since 1990. They almost certainly have since 2000, but it wouldn’t surprise me to see 2% increases over the next several years. Most this type of rate-of-change analysis is highly dependent on your starting point.)
For the record, the only reason I own now is because I ran across a (crazy) seller in a building I really liked who was willing to leave a big chunk of equity in the unit and assume virtually all of the downside price risk over the next few years. (It’s a very complicated transaction – I won’t bore you with the details.) I’m paying a 115% ownership premium, which is fine with me. Otherwise, I would have been content renting for several more years.
Having said that, I could buy my place and your place for cash tomorrow. But the accumulation of that capital didn’t come from buying dear and selling cheap, but rather the other way around.
ParticipantMasayako, just curious, but are you Japanese (or asian)? I ask because of your screen name and the fact that asians, in general, have a MUCH higher savings rate than non-asians. If you have a lot of asian friends, there may be bias is your sample. But if you’re not asian and/or don’t have a lot of asian friends then your sample results are… well… at odds with my observations.
Participantsdrealtor, a couple of things, in reverse order.
First, where taxes are concerned, you’re not taking into consideration the standard deduction that everyone gets. If the TYPICAL home buyer nets out the difference between what they itemize for interest expense and their standard deduction, the actual tax savings aren’t that great… maybe 10%-15%. This obviously increases as one’s income increases.
Peace of mind is totally subjective. Your 5%-10% number might be a good start. (Although one could argue that this “peace of mind” should be offset to some degree by loss of mobility, from which many people derive value.)
Finally, the rent increase issue is a touch complicated from an analytical perspective. First of all, although your rent will increase in a rental, the cost to owning your home increases as well (upkeep and HOAs if you’re in a condo) – let’s say this adds 1% to your total gross housing payments each year. So, this upkeep/HOA issue has to be offset against the rental increase. So, let’s net the two out and say the difference is 2% annually (that’s 3%-1%). Now you have to figure out what the present value of those increases are going to cost you and AVERAGE this number out over the 10 year average ownership period. (Also, recall that you’re trying to decide whether to buy TODAY but you will be paying your rent or housing payments in inflated dollars tomorrow.) If you work through the math assuming a 6% discount rate, you’ll find that a 7% “ownership” premium, or thereabouts, will negate the effect of the higher rent payments. (Obviously, the higher the rate of rental increases you expect, the higher the ownership premium should be.)
So, the 20% premium may be on the low end, but it’s definitely not out of the question for some people. On the other hand, some people could probably justify a 40% premium depending on their circumstances.
ParticipantOne of the reasons California’s economy is generally more volatile than the rest of the nation is that, on average, the people that live here are much more comfortable with leverage. And when things turn down, they more easily end up on their asses. I know an awful lot of people who live $300K/year lifestyles on $150K/year (and double those numbers). It just seems to be part and parcel of the California Lifestyle. Not for everyone, of course, but for many.
I see a lot of women that make less than $60K/year with $1000 Louis Vuitton handbags. While there are a lot of well-heeled folks in San Diego (and elsewhere), the Louis Vuittons of the world can’t survive on selling solely to the folks who can actually afford their products. There’s too much competition for the wealthy’s dollars. It’s from the people who cannot afford their products that the real profits are generated. Oh how I do love consumerism. 🙂
ParticipantI would be careful about assigning too much value to price-to-income ratios, although they do convey some important information. In my view, there is only one thing that matters in valuing the “typical” home or condo: rental equivalents. At the end of the day, the only thing in finance of any importance is CASH: How much is there? How do I get my hands on it? How much risk is associated with getting my hands on it? For the vast majority of assets on the planet, everything else is, ultimately, just smoke and mirrors. Doesn’t mean that other approaches won’t work for a while… but when the dust settles the only thing that matters is CASH.
The typical home is just a housing unit that you decided to purchase instead of rent. Figuring out the cash flows from it isn’t rocket science. As I’ve said before, a rational person will be willing to pay a premium to own versus renting because ownership has certain advantages that are worth the premium, including: (1) Your “rent” won’t increase (much) if you get a fixed-rate loan (this has value), (2) For some people there is a peace of mind associated with ownership and being “settled” (this has value), and (3) There is a tax advantage to ownership (this has value as well).
Now, what premium a rational person should be willing to pay depends the value attached to these three issues (and perhaps other lesser issues I haven’t mentioned). For some people the premium may only be 20% (that is, they would be willing to shoulder total gross housing-related payments that are 20% greater than the cost of renting the same unit). For others #2 has more value such that maybe the premium is 35%. But no matter how you slice it it’s probably not greater than 50%… which is the REAL problem with the SoCal housing market (and others).
To use an example, a condo in my building just sold for $510/sq. ft. (which is eggregious, by the way). Applying that PPSF to my unit (which I own) implies a valuation for my unit of 19x rent. If I apply a 20% ownership premium to my unit’s rental equivalent (using standard conforming financing) I come up with a “real” value of about 12x rent. So, I fully expect the value of the units in my building to decline 30% (more than they already have), give or take, by the time this bubble hits bottom.
Now, once you get to homes above $1 million this analysis largely goes out the window. Because here you’re talking about art, not housing. The value is in the eye of the beholder. Rental equivalents will send you a signal regarding the value of the piece of house/art, but ultimately it’s “pure” supply and demand – the cash flows aren’t so relevant.
But for the vast majority of housing, the value is ultimately determined by how much cash it’s capable of generating with some premium attached for the items listed above. The biggest mistake a person can make in evaluating an investment decision is losing sight of the cash.
ParticipantRegarding PS’s website I defer to the zen riddle: If a tree falls in the woods and there’s no one there to hear it, does it make a sound?
ParticipantWell, I got the timing right, but my understanding was that they were heading for Chapter 7. I guess their creditors must have found something of value in keeping the operation alive for a while so they opted for Chapter 11. In this case, they say tomato, I say tomahto. Either way… kaput and a big ‘ole goose egg for the equity holders. Good riddance.
ParticipantBloomberg quotes Powayseller, who 95% of the time is merely regurgitating something someone else already said. She’s much more of a subjective reporter than an objective analyst.
So I guess that’s the state of news reporting today. You quote person A who’s quoting person B who’s quoting person C, and so on.
Frankly, I’d prefer they skipped the middle-(wo)men and went straight to the real sources. But I’m funny that way.
ParticipantI am assuming that in the interest of fairness to the taxpayers that all of those homeowners who are “bailed out” will have to return some of the (eventual) appreciation in their homes back to taxpayers in order to repay them for subsidizing their stupidity.
Oh, no… that’s right… real estate is all about “heads I win, tails you lose,” or “If things go down, I need a bailout because I got screwed by my mortgage broker; but if prices go up, well, that’s all mine (I took the risk, didn’t I? I’m a genius!!).”
How deliciously rich in hypocrisy…
ParticipantDon’t know if you guys saw this regarding the steep drop off in closings over the last couple of weeks:
http://www.bubbleinfo.com/journal/2007/3/25/current-read-on-sd-market.html
It doesn’t take a rocket surgeon to see that this is likely a result of the subprime lender implosion and resulting tighter lending standards.
On a side note, do the realtors (sdrealtor and SD Realtor, for example) and appraisers (Bugs…) here see many of their peers switching professions? With closings down almost 40% from 2004 levels I have to believe that people are fleeing in droves. Mathematically there just isn’t enough revenue to support the 2004 folks plus all of the new entrants.
ParticipantWhat a great report. And what a total horror show. Some of those graphs are just jawdropping.
Participantsdrealtor, you’re right – for the foreseeable future – and it’s been the case for many years – Detroit lives and dies with the US Auto Industry. We don’t really know what the very long term holds for Detroit, although it’s not nearly as favorable as San Diego, that’s for sure.
But where San Diego is concerned, I would argue that our city DOES in fact live and die with the real estate industry in the short term, which I’ll define as the next several years. Despite the fact that San Diego’s economy is no longer identified with any single industry – as it was with defense and the military 15 years ago – our over-reliance on real estate will make it seem like death once this downturn picks up steam. Real estate is that pervasive today.
To give you an anectodotal example, I was thinking of the neighbors in my condo complex. Title executive across the hall. Developer executive on one side. Guy that reps for a high-end blinds manufacturer on the other side. The developer that built the building owns a unit further down the hall. And a few with no connection to real estate sprinkled in. I count among my friends several real estate agents, mortgage brokers, etc. and, of course, several people outside of the industry. But I’d guess that at LEAST 1/3 of the people I know in San Diego have employment that is directly tied to real estate and that’s not even including the people I know in the banking industry, which itself is very real estate-dependent.
Over the next several years we’re going to find out just how diversified San Diego’s economy really is… and I’m betting it’s going to be an eye opener.
Participant“Detroit only has the auto industry”. “detroit vs. san diego. asinine indeed.” Is that so?
As of March 2005 Detroit’s civilian labor force was at 2.2 million and its employed labor force was at just over 2 million.
For Michigan as a WHOLE, auto manufacturing accounted for 244,000 jobs out of a total employed labor force of 4.4 million. Now, let’s make the unrealistic assumption that 50% of that 244,000 was in the Detroit MSA and then double it (back) to capture the effect of all auto-RELATED employment. So, to use round figures, let’s assume that Detroit has 250,000 auto-related jobs out of an employed labor force of 2 million. Per the properties of mathematics, that suggests that auto-related employment accounts for around 12.5% of Detroit’s total employment… which is a big number.
Now let’s look at San Diego. What proportion of San Diego’s total employment is tied as directly to real estate as Detroit’s is to automobiles? I think Rich Toscano knows the answer to that question, but I think the number is somewhere around 14% or so (give or take). [Obviously, this includes real estate agents, mortgage brokers, title agents, developers and builders, construction workers, etc.] So, I’m still not seeing an “asinine” comparison when analyzing the relationship of auto employment to detroit vis-a-vis housing employment to San Diego. Help me to understand what I’m missing.
I’m NOT saying that Detroit is anywhere near as attractive place to live as San Diego. I’m merely trying to point out that housing-related employment appears to be every bit as important – if not more so – to San Diego as auto employment is to Detroit. So, let’s keep the discussion focused and not get off track. Please bring data to the discussion.
ParticipantActually, I’d say that the real estate industry is just as important to San Diego as the auto industry is to Detroit. The reason that you won’t see homes in the nicest neighborhoods (like La Jolla or Rancho Santa Fe) selling for $130,000 (as in the above example from Detroit) is two-fold. First, we’re starting from a MUCH higher price plateau so there’s much farther to fall. Second, the market for San Diego real estate is much larger than Detroit’s. As San Diego’s real estate falls there will people from all over the country watching; San Diego will draw buyers from a much larger geographic pool. Detroit, today at least, does not have that level of widespread attraction. Hopefully at least you’ll be able to buy 1200 square feet in Chula Vista for $130,000 within a few years – that would not be out of line.
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