Bubble, Bubble, Bubble...

NY Times: Trading Places: Real Estate Instead of Dot-Coms. Real estate-crazed Americans have started behaving in ways that eerily recall the stock market obsession of the late 1990's.

And they've been doing it for several years here in California.

In mid-2003, in a Mercury News column, I wrote:

"Just as I didn't understand why stock prices were rising so much in the late 1990s, I don't understand what's going on here, either. Of course, maybe house prices will go up forever at a rate wildly exceeding inflation even as rental prices plummet periodically.

"I'm hearing some circular logic from those who believe this is sustainable. Prices keep rising because -- well, because they keep rising. We heard that kind of stuff in 1999 about stocks.

"Yes, there are some valid reasons, too. Supply is constrained and low interest rates are a huge help. But there's not much room for rates to fall. If true deflation sets in, home values will drop. If interest rates rise, as they seem to be doing now, sales will eventually slow and prices will drop.

"The housing bubble, if it is one, feels doubly troubling for another reason. With stocks, losses were limited. Home buyers, especially recent ones, are vastly more leveraged. Even a modest price correction of tens of thousands of dollars would erase their entire investment, or more."

As I've also said, we have one endlessly renewable resource in America: financial suckers.

I fear what will happen this time, because the damage will be so much worse for our overall economy.

Comments

[John C. Dvorak]

Dan, if anyone had read your 2003 column and then bought a house in the SF Bay Area, they would have made big money! Any other tips that we can use? You seem to be ignoring the simple demographics of the area which has a housing shortfall continuing to at least 2009. There has never been a significant housing real estate crash in California, ever. Why now?

[donna]

Last bobble in CA real estate was mid 80s, prices went down about 10% or so. Since then it's been nothing but up, sometimes faster than others. The last couple years with low interest rates have been crazy. We bought in San Diego 20 years ago, could sell now for 500% profit. Hella return.
Sister-in-law and her husband just sold here and moved to Tucson - twice the house for half the price. Such a deal....

I think why now is that rates are going up so the market will slow a bit, but unless there is a real dollar crash, it will just be a slower market. But if there is a dollar crash, we will all feel the result...at this point, though I would be selling CA if I could and buying in the next "hot" market - Tucson market looks like here did a couple years ago, houses going up everywhere...
and with a new refinery being built near Yuma, gas and fuel will be lots cheaper there... CA is expensive to live in as well as expensive to buy in.

[ted]

I agree that this cannot be sustainable. My friends and I just formed a housing coopertive and bought a building in Chicago, hoping to keep it affordable for people like us for the long-term.

But I can't help thinking that a crash doesn't matter unless you have to sell. When you leveraged in stocks and they go down, a margin call screws you, but when you're highly, highly leveraged in real estate, as long as your income doesn't go down, you can continue making the monthly payments and you still have a place to live. Even if the market never comes back, you can still live there until you die. And if it's paid for, then the loss at that time isn't really even a loss for your heirs, they still reap that lower market value at that time as inheritance. Everyone wins?

[F Ho]

There was another housing slump in the bay area in the early 90's. I bought a house and got married in 1990. The seller at that time had already dropped the listing price around 15% by the time I made my offer. The housing price continued to go down afterwards. I could only guess how much my house was worth at the bottom; it could easily be a 15% drop from my purchase price. I still remember one day my next door neighbor (who bought the house a few months before I did) simply loaded everything up including the drapes and moved out. I heard that he did not put in much down payment, and decided to just hand the keys over to the lender.

I also bought a house in 1980 in a similar situation. Interest rate was sky high then, and housing price started to drop a bit, but my recollection is that most of the drop was after I bought the house, and the drop was more than 10%.

[Grow-a-Brain]

The market still has a lot of affortability, even in Southern California

[fling93]

John C. Dvorak: Dan, if anyone had read your 2003 column and then bought a house in the SF Bay Area, they would have made big money!

Also true of anyone who invested in the stockmarket after Greenspan's "irrational exhuberance" speech. Just because a bubble is still growing doesn't mean it won't burst. And just because bubbles are relatively rare doesn't mean they don't happen.

It's hard enough trying to time the top in the stock market. Good luck trying to do that with a home. But go ahead and add REITs your investment portfolio right now if you think it's a good time to get in.

[VA]

I thought the housing market out here was crazy... until I went to India couple of weeks ago. Land and house prices double every 3 yrs or so. People buy acres of empty land or plots with nothing but dirt roads and sell them for many times over within years. As I flew in Hyderabad, I could literally see thousands of these empty plots.

My modest house in the Silicon Valley doesn't appear as crazily over priced anymore.

[Joe I.]

This is nothing like what is going on in London and parts of France. Homes there are being purchased Americans, Indians, and Middle Eastern folk. Supply is much more limited than in the US and prices are going up faster.

Also with the exception of the above mentioned India, the Chinese city of Shanghai is seeing massive appreciation. I invested with two partners (an American and a Chinese national) and we expect to triple our money in 24 months if not more....Dan I do not disagree with you but I must say I would much rather own something tangible that I can live in or rent than paper (stocks)....

Most major wealth is generated in real estate. Look at history. Finally the one thing going for real estate there is no more dirt being added to the Earth and the more that is locked up for environmental reasons the higher price the other dirt will go for.

[Thomas Vincent]

Sustainable, I don't know but I know Californians have been driving housing prices up around the West since the early 90s with no sign of change. This 'trend' doesn't seem all that new.

[odograph]

I'm reminded of the only saying that "the market only cares if you are right - you don't have to be right for the right reasons."

[fling93]

Matt Yglesias blogged on this today, linking to this New York Times piece.

I do own a condo, by the way, but I never view it as part of my net worth in terms of retirement planning.

[jerry]

I was somewhat forced to move to Phoenix (the now overturned marriage of Burgess).

There is a very good reason why housing is half as expensive here as in California. And it's not that the buyers are getting a good deal. In fact, housing here should be one tenth the price as in the SF Bay Area.

The houses themselves are the same, but the area here lacks walkable neighborhoods, culture, good markets, good restaurants, diversity, good weather, interesting jobs, good skiing, good sailing, good boating, water, clean drinkable water, good highways.

We excel in malls and minimalls. Everything cultural here is forced to be in a mall parking lot. Due to the heat, no one can walk anywhere. Everyone is forced to drive. Hence parking is a premium and malls rule supreme. Shop till you drop at chain stores. Oversize yourself and your kids at the food zoo.

Are prices unsustainable? I don't know. I think a crash would be terrible for the economy and people, but it might mean that I could buy.

I recall that after the oil crash in the mid 80s, people in Houston were walking away from their condos and homes and letting the banks reclaim them....

[edmos]

This is not a new issue in CA- the housing market has been surreal for over 50 years in one part of the state or another.

But I keep pondering, what other industry besides Real Estate/Realtors have their own free PR puff-piece weekly newspaper section in every major newspaper in the US?

There are no checks and balances and few journalistic standards applied to the real estate section of our newspapers. Business, IT, and even Food sections are more rigorously vetted for journalistic integrity than the Real Estate section of the papers.

The whole industry is a little obscene and out-of-control.

[Hybrid Daze]

HELLO. Notice anything about all the posts? They are all talking about different markets. That is a KEY difference between RE and equities/financial securities. There are others major differences -- including liquidity, ability to control asset directly (RE) vs. versus hiring professional managers (angency problem) at publically traded companies. I think I may be getting boring. Sorry.

BTW, about Phoenix -- a major reason, in my opinion, that it is the way it is (minimalls,etc.) is obvious. Its all new. No one builds like the Marina or North Beach in SF. The existing supply of RE in SF is garbage compared to other major cities. I was just in Scottsdale for a week and loved it. It was very refreshing and easy compared to day to day life in SF.

[Epacris]

Remember the Japanese land price bubble of the 1980s - 1990s?
Gigantic prices, mad building, massive collapse & the economy is still fairly cactus after quite a few years.
People are not spending. Banks are giving no interest to try and encourage people not to save.

What happens when the market goes down and your job goes? You can't keep up mortgage payments and the lender sells the property for whatever is left owing.

If you're unlucky the price has dropped so far that the price doesn't cover the amount still owing, so you have no place to live and a large debt.
If you're slightly luckier, the place still goes at a low amount, but at least you don't still owe them money. You still need to find a place to live, having expended your savings on the now-defunct place.

[standa]

I recall that after the oil crash in the mid 80s, people in Houston were walking away from their condos and homes and letting the banks reclaim them....

Posted by: jerry | March 26, 2005 09:44 AM

In the next 2 - 3 yrs I predict you will see a 15 - 25x catastrophic shock to the US real estate market ( yes that's 10- 25 Houstons in mid '80's ).

Caveat Emptor and LOL ...

[pancho]

Great story posted 3/27 on the LATimes:

http://www.latimes.com/news/nationworld/nation/la-na-property27mar27,0,626986.story?coll=la-home-headlines

[DonBoy]

But I keep pondering, what other industry besides Real Estate/Realtors have their own free PR puff-piece weekly newspaper section in every major newspaper in the US?

Autos, for one.

[Dave Johnson]

Yesterday's San Jose Mercury News had a piece on housing prices, and pointed out that 82% of mortgages so far in 2005 are adjustables, many with interest-only payments. They're offering no-down-payment mortgages now, too.

Does anyone remember the S&L collapse? S&Ls loaning for real estate on really easy terms with very little security...

[Ran Talbott]

According to some friends who've lived in the Phoenix area for many years, the "mall-ification" is at least partly a result of official government policy encouraging it.

I've forgotten what the rationale is/was, but it's definitely part of some Cunning Master Plan (tm).

ted: the problem with your scenario is that, while it's workable _some_ of the time, the odds are good that some event will disrupt it. A job loss or relocation is much more common than it was even as recently as 20 or 30 years ago, and very few people in areas like Silicon Valley will be settling into one house until they die.

Additionally, people are both maintaining a smaller cushion of savings and leveraging themselves more deeply by borrowing the equity out of their homes than they used to, increasing the probability that they'll be stuck with selling under unfortunate circumstances.

For a large segment of the population, owning a home has become more similar to owning stocks than your "old-fashioned" view of careers and lifestyles would suggest. If that segment is large enough (and I believe that, in many of the "hot" markets, it is), external events like currency devaluations of minor recessions would have a far greater effect than they could if everyone were able to stick to your "conservative" plan.

[Alice Marshall]

The Housing Crash Blog
http://housingcrash.blogspot.com/

[jerry]

I would not be surprised to find that the mallifcation is encouraged by developers and councilman, who have quite the revolving door out here.

If when you think Scottsdale, you think rich, well think again.... Less than two miles SE of Tony downtown Scottsdale is a pretty run down section.

Oh, fifteen years ago, that used to be a very nice upcoming place to be. It was near the Los Arcos mall. But when the Los Arcos mall closed in the early 90s, that are went straight to hell.

Scottsdale's solution? Expand (and die) in rings. Builder newer fancier strip malls a few miles away from the older ones. Let the older neighborhoods decay. Repeat.

Galleria. Borgata. Oaxaca....

Yeah, malls and strip malls all owned by an enormous developer are good.

[Rory]

Don't let the theory that low interest rates sustain a market fool you.

In 1992, when the market last crashed, and it was a big one, interest rates were low at the time and not on the rise.

[mythago]

As has been pointed out elsewhere, eventually people will move. They do now, to farther-away places where the houses aren't quite as unaffordable. The immediate SF bay is out of dirt, but the rest of the country is not--and employers will eventually figure out that if all your employers moved to Tracy because they can't afford Berkeley, you may save money by moving your business out of Berkeley. And businesses will start up in Tracy because all the commuters need stores, daycares, parks, libraries, coffee houses....

[John C. Dvorak]

Tracy? As in strip-mall, windswept, no culture, rural Tracy, California? Hmm. I think not. You may as well get it over with and either shoot yourself or just take the leap and move to Wells, Nevada.