Bubble, Bubble..

San Francisco Chronicle: Up, Up and Away. Another month, another real estate record. Median prices for existing homes in the Bay Area hit an all-time-high of $569,000 in February, rocketing 19.5 percent from $476,000 in February 2004 and up 2.3 percent from $556,000 in January.

The most revealing statistics in the story: "Bay Area home buyers in February committed to a typical monthly mortgage payment of $2,549, a record. That payment is up 21.9 percent from $2,091 a year ago."

In other words, more and more people are further and further extended financially. Most of them are on mortgages that will cause their interest rates to rise at some point.

This is going to get so ugly.

Comments

[Joe I.]

Dan I was thinking along the lines of you. I heard some, mainly liberal economists say foriegners would stop buying in the US and interest rates would rise fast. Well last month there was a record level of capital flow into the US which keeps interests rates low. If the current months trends hold it will only become greater in March....Unless the Fed raises them "fast and far" long term interest rates may actually decline as oil prices slow the ecomomy (much more likely). In fact interest rates on mortgages fell even as the Fed raised interest rates over the fall. This would mean adjustable rates for those people would decline and their payment go down. It is just as likely as a rise.

[Joseph Palmer]

Oil hit $65 today. This may simply indicate that world demand has at last outstripped world supply, or it could indicate that "Peak Oil" is happening.

Ugly does not begin to describe it.

Peak oil changes everything.

Mr Gillmore, I don't know if you've researched the concept of "Peak Oil", but I humbly suggest you spend a few minutes with Google on the subject. I think it's the story of 2005. I pray that it's not.

[the mighty jimbo]

oc had a median over 650k last i checked (might be more now). condos average more than 400k. median income is 47k. somebody please explain this math to me.

[AF]

Yet schools are underfunded as ever. Kind of makes you rethink Prop 13.

[Anspar Jonte]

So if I sell my house now and cash out, I can afford some pretty sweet real estate in a year or two. Ugly? I'll be sitting pretty.

[Thomas Hawk]

"Everyone who looks at the market says the price acceleration can't last, but real estate agents and other experts said they expect a gradual leveling rather than a bubble bursting." This is the ultimate last justification for people when they knowingly pay for an over valued asset. "Yeah, I don't expect those returns anymore, but it will probably just level off."

When the Nasdaq was at 5000 did you see stock brokers calling for 1,500? No. What they all said was "yeah it's probably over valued, you might see a 10% decline or so." Folks, stock brokers make money getting you to buy stock. Real Estate Agents make money by getting you to buy real estate. Frenzied markets create the most transactions. When the market declines people freeze and do nothing. Always consider the economic incentive of who is giving you advice and ask yourself if that advice might be influenced by their economic incentive. Always remember the story of Henry Blodgett who told investors to buy horrible stocks in public while telling other folks in private that they were bad investments.

"She just had 22 offers on a small two-bedroom, one-bathroom house in Oakland's Laurel neighborhood. It went for 33 percent above the $419,000 list price." Fundamentally ask yourself, why is this property worth 33 percent more after above average year over year gains? Are people making 33% more money? Are there 33% more people in the Bay Area over last year? Scarcity of Bay Area land is the other rationalization that keeps popping up as well. As though the scarcity situation were any different last year.

"In 1990, the door slammed shut with no warning, and we went through several years of declining prices," Underwood said. "This will probably be more gradual than a door slamming shut." In 1990 in Los Angeles real estate declined about 30% in 5 years -- a long, slow, painful decline with a much less significant bubble.

[George Hotelling]

There's an even better statistic in another article: "nearly 25 percent of homes bought in the United States last year was for investment, not for owner occupancy."

[Thomas Hawk]

Check out this article from the Los Angeles Times

http://www.latimes.com/business/la-fi-econ15mar15,1,2263820.story?coll=la-home-outdoors&ctrack=2&cset=true">

[JennyD]

Five years ago we moved out of the NYC 'burbs. Someone bought our 4-br, 2-bath shed for like $400K I couldn't believe it. But there it was. We left and now can live on half of what it cost there, and live really well, in a university with boatloads of smart people and tons of culture. We both walk to work, or ride bikes. Our kids can roam the neighborhood and go downtown without supervision.

Get out while you can. There's a big world out there. Lots of it has no traffic.

[Rik Gary]

Every time I think the real estate market can't get more surreal, it throws another Kafkaesque curve. Dan, thanks for providing an island of sanity in this sea of frenzy.

[fling93]

Dan Gillmor: Most of them are on mortgages that will cause their interest rates to rise at some point.

Um, do you mean most of them are on adjustable rate mortages whose monthly payments will rise? Yes, I'm ever the nitpicker.

[Joe I.]

mighty jimbo---

There is actually a very easy explanation, a huge down payment. My best friend recieved $300K from his parents on a $500K home. So his payment is about $1,000 a month including insurance. This is very common according to real estate agents. My parents got their down payment from my grandma for their first home in 1964. For others they sell a home for a huge profit and use that capital as a down payment on a very expensive home and have a relatively low monthly payment given the homes total cost. You are right about one thing, no one making $47,000 will afford a home.

[Kyle Hart]

Over-extended indeed.

Also see Dave Pollard summary of the Two Income Trap. I agree that there's room for more government regulation of the credit industry.

[hey]

One thing about real estate... its real... unlike dot-com's. And you can live in it. There really is a limited supply. Even diamonds, aparently, won't be supply limited soon (as they can possibly) be mass produced. So why not buy/hold real estate.

[Steve]

If you want to see ridiculous real estate prices, come down here to San Diego. McMansions are going for $1.3 to 1.7 million. And these are adjacent to railroad tracks, no less.

Oy!

[Garth Gibson]

Dan,

Real Estate financial blunders can be avoided. First you have to learn to make a mortgage payment to yourself not the bank when using interest only loans and the like.

Yes there's danger but there is also the danger of loss wealth when using fixed rate amortize loans as well.

[TomD]

It will be much uglier than in the past, because critical changes were just made to bankruptcy law. Any price drop will also last longer.

In the past, the Fed has tried for a 'soft landing', to gently pop the bubble, in order to avoid a financial melt-down. However, this will be less necessary once the new bankruptcy law goes into effect. Middle-class people will no longer be able to use Chapter 7 to get a clean slate, instead they will have to pay off as much of their debt as possible over the five years, if their income is over the median for the state. The pain of popping a bubble shifts largely to the debtors, and poses much less of a threat to the stability of the banking system. This gives the Fed room for a harder landing. When the Fed will act to pop the bubble? As soon as it becomes safer, when the new bankruptcy law goes into effect.

The real estate market has recovered fairly quickly in the past, in part because people have been able to start with a clean slate through Chapter 7. Now, many will be forced into Chapter 13 for five years, paying off the mortgage on their former house. Only after that will they be able to start saving up for another home. If a significant number of people get pushed into Chapter 13, it could suppress a recovery in housing prices for years.