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February 16, 2005



Count me out. My wife and I bought a condo in Santa Cruz County (not exactly the Bay Area of course, but in the same weird bubble universe) a year and a half ago. We sold it this month and made a profit of 36%. That is utterly insane and unsustainable, and it's occurring in a market that was already very overpriced.

What's interesting to me is that many of my contemporaries feel that while they are paying an arm and a leg to maintain their homes, they are going to be vindicated in 20 years or so, when they have their homes paid off. Long-term thinking like that is sensible, but the cost of housing in the greater Bay Area has become so steep that most sub-millionaires are paying a huge chunk of their monthly income toward mortgages.

It used to be that you owed all of your money to the company store. Now we all owe on low-rate (but still high monthly expense) home mortgages.

Thomas Hawk

I'm increasingly convinced that there is a huge bubble being built in California real estate -- and yes, even the Bay Area. I read a similar article to this one last week in the Chronicle but thought I'd post on this topic when I saw Gillmor pick it up as well.

The decline in residential real estate values in Southern California when the last real decline took place was a slow, tortuous painful one which ended in about a 30% decline over the course of about five years. People easily forget. The housing start numbers reported yesterday were the strongest that they have been since the 1970s. Recently someone told me that the average expected permanent return on a home in California is 15%. Wow! Way too high. And then you have all these folks that have jumped on board the ARM train and have stretched to buy even more expensive homes. When rates start going up, and they will - Greenspan seems hell-bent on making sure long term rates eventually will go up - these folks will get squeezed.

I remember back when Nasdaq was above 5000 and people, myself included, were saying things like, "well, yeah it could correct but even if it went to 4,500 or god forbid 4,000 it would come back in a few years. Yeah, right. Now I hear people saying things like yeah but people in the Bay Area always need a place to live, if you live in a desirable neighborhood with a good school district you'll be fine. Things might flatten off for a while... or, but yeah home prices have never corrected as long as I've been alive, prices just keep going up (huh?)... or, well everyone needs the tax break you know (like they didn't three years ago?).

But why is that same home in the desirable school district worth so much more money than it was 3 years ago?

Have more jobs been created in the Bay Area in the last three years? Are people making 50% more money than they were three years ago?

I believe that the answer is more likely speculation and when you combine speculation with an average expected investment return of 15% and huge recent price jumps, look out folks.

Dan is a good man to fire a few warning shots across the bow. If you plan on living in your home for a long, long time, fine maybe go ahead and buy it. But if you are looking for a quick buck or to flip the house and upgrade in 3 or 5 years, watch out. And remember, a 30% decline in home values can easily be translated into a 100% decline in your investment in a down market given the leverage of real estate. Leverage can build great wealth but in a declining market leverage can also destroy completely.


Three years ago, the house we bought with a 20% down payment (at a slight discount through a probate sale) created a mortgage that cost the same as it would cost to rent the house. In the three years since, the value of the house has increased by about 50%, we'll find out for sure how much when the house goes on the market in 2 weeks.

At the time (2002, summer) it would have made sense for an investor to pay the down payment and receive rent to offset the cost of holding the house.

Today, the house has increased about 50% but rents have stayed EXACTLY the same, so to buy this house today would require 50% down to make the mortgage payments equal the current rent. I believe this prices investors out of this market, there are simply other places to tie up $400,000 in a non-liquid asset.

If it made sense for an investor to put $100,000 down and carry the house with renters three years ago, then at the time the people in the market were buyers, investors, and speculators. Now, the investors are taken out by the inability to cover mortgage with rent without putting down 50% in cash.

When the only people bidding are speculators and "regular" buyers, they are relying on low interest rates to buy $750,000 properties in San Francisco. If interest rates increase to "x" then they will be priced out of the market too, as their primary concern is the monthly cost of the mortgage, with the future value of the property as a secondary concern.

When speculators are the only buyers... with prices $750,000 and interest rates higher, or lending requirements tightened... then there will be far fewer buyers for a given property. The investors will still be interested in putting down $100,000k and making a break even on the rent, especially as all the homebuyers that overextended become renters again.

When $50,000 is the down payment on a $750,000 house
then the mortgage is about $4,000 per month. If the house
is only able to be sold for $685,000 and the owner is unable to
continue paying $4,000 (and can only receive $2,000 in rent,
and must also live elsewhere [the garage?]) then... If forced
to sell, the owner will have to come up with an additional
$65,000 to pay off the mortgage.

As long as interest rates stay low, this will continue. We need
it to last about 45 more days.

Steven Ericsson Zenith

Thank god.

Charlie Prael

Y'know, guys, this is starting to turn into one of those situations where you create the reality you want. Beat the "housing bubble" drum enough, and you'll have a bubble-like ending.

Esupido, all around. But I guess it sells.

Dan Gillmor

Create the reality by discussing it? Sure, just like when I was writing about the stock bubble in 1999 I was creating that reality, too.


For first-time home buyers, any talk of a bubble is like a sword hanging over their necks. First time buyers are buying to save money otherwise flushed down the hole in form of rent. Buying a home, even with a 10% down payment allows you to build equity, it is a safer investment than any other option available today.

Charlie Prael

Create the reality by pounding the drum. This article is the, what, fourth time in the last week this has come up - including headline placement on Yahoo and front-page coverage in both the Merc and Chron (and last week, it was the LA Times).

The operative phrase is "there's gotta be a pony around here _somewhere_."

Dan Gillmor

IMO, the operative phrase is "a sucker born every minute" --


Sanjay: Buying a home, even with a 10% down payment allows you to build equity, it is a safer investment than any other option available today.

I dunno about that. Many other investments are more liquid, let you diversify much more easily, and don't require you to be so heavily leveraged.

Thomas Hawk

Dan's a good man to point out this bubble. Really, the housing bubble will not be burst by the ramblings of a few bloggers. It's flattering but the impact of blogs on economic market shifts and reactions are quite simply insignificant.

The housing market will decline, and it will be painful, because the suckers really believe that 15% a year is a no brainer at this point in the real estate market. Just like people expected 20% a year in the stock market at the beginning of 2000.

Investment returns revert to the mean and 15% a year is not the mean for real estate. Just like when folks were saying "this time it is different" with regards to the stock market in 2000, people are trying to justify buying real estate today by saying things like, "people will always need a place to live," or "but it's in a good school district."

Yes, it's not much fun to be a first time home buyer right now. 95% of the time people should be doing everything they can to buy a home. It is one of the singlemost significant tools towards upwards mobilty in the U.S. today. But I'd be careful right now. And Dan's not beating a drum, he's firing a warning shot and you should be thanking him for it.

Ben Jones

I don't wish financial loss on anyone, but this bubble is terribly destructive. If food or gasoline was going up at this rate it would be a national crisis. I would love it if our wages started rising until we could all live in $750,000 houses, but what is the likelyhood of that? (If pay did start to go up we would be told that "inflation must be reigned in"). When internet stocks crashed, it didn't hurt those who stayed out. This bubble can harm us all.

Frank Provis

Actually, lots of ordinary people can afford to live in $750,000 houses in the Bay Area, provided they rent rather than buy.


I hope the supposed "bubble" pops and deflates 50% on all those greedy bastards. I've been scrimping and saving for years to get a down payment together. The condo I almost bought in Santa Cruz in 1999 for $170,000 is now being advertised for $400,000. I just can't get to the point where I can afford it. I make the same $55,000 a year I made in 1999. I went to some condo developments that were advertised for low 300's. By the time they were releasing them to the market the prices were being raised twenty and thirty grand just weeks later. If the prices don't come back to something I can afford, I'm out of here.....

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