Editore"s Note
Tilting at Windmills

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August 16, 2006
By: Kevin Drum

HOUSING BUBBLE WONKERY....In my housing bubble post this morning, I mocked the idea that the bubble would end in a "soft landing" and rashly predicted that home prices in Southern California would drop 10-20% over the next two years. A few commenters suggested that (a) a 10-20% drop would be a soft landing and (b) a 40% drop might be more likely.

As to the first, you can decide for yourself what constitutes soft and what constitutes hard. A 20% drop seems pretty hard if you're the one trying to sell a house, but it probably seems soft if you're figuring its effect on the overall economy. Eye of the beholder and all that. As for the second, though, here's what my prediction is based on. It's a wildly simplistic analysis, but hey this is a blog! If I can't be simplistic here, where can I be?

Take a look at the chart on the right. The dark blue line shows the actual median price of new and resold homes in Southern California since 1988. Prices peaked in 1991, then dropped, and then started shooting upward again in 1996.

Now, where would home prices be if they had increased steadily since that time instead of booming and busting? If you assume a "natural" rate of growth of 5% per year, the median price today would be about $360,000. If you assume a 6% growth rate, the median price would be $430,000.

The actual median price today is $492,000. So how much is that overvalued? If you assume that houses "should" appreciate at 5% per year, prices are 36% higher than they should be. If you assume 6% per year, prices are 15% higher than they should be.

My guess, based on the record of long-term historical growth, is that the 6% number is closer to the truth. Thus, even after the skyrocketing growth of the past few years, houses in Southern California aren't that overpriced. I'd be surprised if prices dropped from their peak more than 20% though of course, if someone lobs a nuke at Abqaiq and oil prices go to $300 a barrel, all bets are off. On the other hand, if the bubble bursting of the early 90s is any indication, it might be four years before prices start to rise again, not two. We'll see.

POSTSCRIPT: Needless to say, there are much more sophisticated ways of estimating the "true" value of housing, including comparisons with rental prices, number of homes bought as speculation, and so forth. This is just the one that seems to make sense to me. Take it with a great big shaker of salt.

Kevin Drum 7:35 PM Permalink | Trackbacks | Comments (88)

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Comments

Your graph only works if you assume "real estate prices always go up". This is not true for any other category of investment, so why should it be true for real estate?

Posted by: fiat lux on August 16, 2006 at 7:46 PM | PERMALINK

Kevin, you are also assuming that despite the fact that home prices overshot during the bubble, they somehow won't undershoot during the burst.

Posted by: no name on August 16, 2006 at 7:47 PM | PERMALINK

The conclusions you draw from this plot will depend strongly on whether you believe "natural growth" should have begun in 1988, or 1995, or, (presumably) 1963. I imagine the same argument you made could be used to support an statement for most any price level drop or increase, simply by changing the baseline year.

Posted by: Professor Foland on August 16, 2006 at 7:52 PM | PERMALINK

It seems to me, Kevin, that you've skewed your numbers a little by beginning them in 88, which was the peak (iirc) of the last boom. How about we begin in, say, '98 or '99? Eye-balling it, 5-6% growth would be in the 280-300k range, which would mean that current princes have a long fall. (Also, I'm not quite sure about the "natural" growth of 5-6%--I doubt whether over the long term housing prices can out-pace wage-growth, etc., by that much.)

Posted by: buckets on August 16, 2006 at 7:53 PM | PERMALINK

Al,

It doesn't really matter what you (or anyone else) believes. The question is, how do historical analyses of supply-side economics pan out? Ask liberal or conservative economists, and you'll find that supply-side econ hasn't worked out on the ground. The theory doesn't hold much water these days.

Posted by: Scott Swank on August 16, 2006 at 7:54 PM | PERMALINK

My main question would be why did you pick the 1991 peak as your starting point? If you picked the 1995 trough by my eyeball it looks like you would expect a 40% drop.

If you are after long term fair value it seems like you should pick something between the peak and the trough, maybe 1992.5?

Posted by: jefff on August 16, 2006 at 7:55 PM | PERMALINK

Fiat: I'm assuming that, over time, real estate prices tend to go up. I think there's plenty of historical evidence for that.

No name: No, I'm not. I'm guessing that prices won't undershoot by very much. The reason for my guess is that there really are lots of fundamentals that are likely to keep prices afloat. Southern California, after all, is a genuinely desirable place to live and there's a limited amount of land for new development.

No guarantees, though. As I said, this analysis is just a guess based on the historical record.

Posted by: Kevin Drum on August 16, 2006 at 7:55 PM | PERMALINK

Of course, how the f' are we supposed to afford a home on these prices, if they're appropriate?

Posted by: Crissa on August 16, 2006 at 7:57 PM | PERMALINK

I picked 1988 as a starting point because that's the data I happen to have. However, that's several years before the 1991 peak, so it's probably not too bad a starting point.

FWIW, Southern California housing has been appreciating at about a 6% rate for many decades. Obviously it's changed some during booms and busts, and also during periods of inflation. But it's not a bad average to use.

Posted by: Kevin Drum on August 16, 2006 at 7:59 PM | PERMALINK

Are L.A. home prices appropriate? All I know is that here would have to be a good earthquake or riot to drive prices down before any of my friends or I could afford to buy here (and we all make pretty decent livings, relative to the rest of the country).

Posted by: Samba00 on August 16, 2006 at 8:01 PM | PERMALINK

"a genuinely desirable place to live and there's a limited amount of land"

Wasn't this a true statement in 1991?

Posted by: jefff on August 16, 2006 at 8:01 PM | PERMALINK

The only way one could assume a valid housing value increase of any percent is for that percent to match the population growth divided by the housing growth.

Of course, we have huge housing growth and pretty solid population growth.

...I just wonder how we can continue when families live in postage-stamp apartments and singles and couples live in houses. I think we're the only family in our complex which has only one person per bedroom, and these apartments don't come with anything but entry/kitchen/bedrooms/baths...

Posted by: Crissa on August 16, 2006 at 8:06 PM | PERMALINK

Jefff: Yes, though more so today. But keep in mind that prices only dropped about 10% when the 1991 bubble burst. There were plenty of people predicting a much greater drop.

Samba00: Yeah, that's one of the fundamentals working in the downward direction. At some point, there just aren't enough people left who can afford a home, no matter what kind of bizarre financing options the real estate folks come up with. And of course, once the market softens, lenders are suddenly less willing to make cockamamie loans, too.

Posted by: Kevin Drum on August 16, 2006 at 8:09 PM | PERMALINK
As to the first, you can decide for yourself what constitutes soft and what constitutes hard. A 20% drop seems pretty hard if you're the one trying to sell a house, but it probably seems soft if you're figuring its effect on the overall economy.

Whether a 20% drop in SoCal is "soft" or "hard" probably depends largely on whether it is an isolate local bubble bursting or broadly representative across the nation of a series of bursting local real estate bubbles. That's a lot of spending power in the hands of consumers that is going away. If it happens locally, maybe not so bad for the overall economy. If it happens, with slight differences in timing, across most of the country, or even just many of the bigger urban centers, it could mean a big national slowdown in consumer spending, and hit lots of segments of the economy pretty hard.

My guess, based on longer term historical growth, is that the 6% number is closer to the truth. Thus, even after the skyrocketing growth of the past few years, houses in Southern California aren't that overpriced.

I'm not sure that matters. Those "natural" price levels (whether the 5% or 6% lines is "right"), if they are meaningful at all, suggest where, after the bursting of the bubble, the actual numbers are eventually likely to return (assuming, of course, that the late 1980s prices are really the "natural" baseline, rather than representing the peak of the previous bubble, with the mid-1990s really representing the baseline from which your 5% or 6% lines of "natural" price should be drawn).

But even if you assume all that, it doesn't mean the prices with the bubble bursting won't fall far below the natural prices, just as they did in the mid-late 1990s; if prices fall in a burst bubble as far, relatively, below the "natural" line at 6% as they did in the mid-1990s, that would be (eyeballing your chart) a little less than a 50% drop from current prices.

Sure, you'd expect within a decade or so after that they'd recover to or above that natural line, so a burst bubble would produce a great time to buy. But I don't see anything in your chart that supports a "soft" landing conclusion, even if you suggest that a 20% drop is a soft-landing, and even if you make the assumption that your 6% line from the late-1980s prices really is the "natural" price.

On the other hand, if the bubble bursting of the early 90s is any indication, it might be four years before prices start to rise again, not two. We'll see.

If you are recognizing that the early 1990s was a bubble burst, than clearly you ought to consider the trendline you've drawn as being drawn from the peak of a bubble, which sort of makes it an invalid basis for the natural price, instead, its more like a natural peak which was overshot (perhaps because of more successful selling of novel financing means), which would suggest we're in for a big correction, and the "natural" prices, if such things exist,would be well below the lines you've drawn, if 5% or 6% is the rate of natural increase.

Posted by: cmdicely on August 16, 2006 at 8:09 PM | PERMALINK

San Diego 70% overvalued

From http://money.cnn.com/2006/07/25/real_estate/housing_market_values/index.htm

"Each quarter, Local Market Monitor, which provides research to the real estate industry, assesses 100 markets, comparing selling prices to "equilibrium" values. Company president Ingo Winzer bases those values on local economic and population growth, construction costs, vacancy rates, household income in the area and interest rates."

The chart you will find at this link shows San Diego overvalued by 70%, so a 41% drop (70/170) would be required to reach fair value. And as someone already pointed out, these things tend to overshoot. So a 50% drop would be quite conceivable.
BUT it gets even worse. Because a 40-50% drop, would do so much damage to the economy and to family budgets that the fair value level itself would drop, possibly quite a bit. Studies have shown that real estate drops hurt the economy much more than stock market drops.
These numbers are so ugly that I just can't really imagine this happening. Is that my common sense speaking? Or is this August 2001 and I am President Bush being warned about Al Qaeda and thinking, "nah, that couldn't happen"?
If a fall does happen, past a certain point, it will not be economics, but politics.

Posted by: kevin_r on August 16, 2006 at 8:13 PM | PERMALINK

Fiat: prices go up. Deflation is rare, bad, and the Federal Reserve does what it can to keep it from happening. Various other forces in the economy cause prices to go up. Prices go up.

It sounds like you're saying "prices don't always go up" when what you mean to say is: "real estate isn't always a good investment." These are two very different things, but I hear them conflated often.

Crissa: for transaction to occur, nothing can be "too expensive." The important thing for me is that I can afford it; as in "That 5 carat pink diamond is too expensive." But I'm really just kidding myself when I say that - if the diamond gets sold it was properly priced.

It's fair to have expectations about what individuals are able to expect from society - but we should understand these as political problems and not pricing snafus.

Posted by: Saam Barrager on August 16, 2006 at 8:19 PM | PERMALINK

A median price of almost $500,000 is crazy. What is the median income?

Posted by: Mudge on August 16, 2006 at 8:20 PM | PERMALINK
I picked 1988 as a starting point because that's the data I happen to have. However, that's several years before the 1991 peak, so it's probably not too bad a starting point.

The 1991 "peak" isn't significantly above your "natural" line; if it was a "peak" of overvaluation before a burst bubble, then 1988 was still during that bubble. And whether it was or wasn't an overvaluation, the housing slump after it saw prices drop to something like 2/3 the "natural" price projected from that year, so I don't see why you are suggesting that the fact that the "natural" price line that was imperceptibly below the 1991 prices, and substantially below the current prices, suggests anything happy about where the floor of a current bubble bursting would be.

Posted by: cmdicely on August 16, 2006 at 8:29 PM | PERMALINK

Near where I live in the S.F. Bay Area, homes run about $1M. There are at least half a dozen homes on the market within a quarter mile of where I live, and nothing has sold for at least 4 months. The asking prices for the homes have dropped 10-20% during that time. With interest rates higher than they were, nobody can afford these ridiculous prices, so the bubble is bursting in a hurry. With prices falling so fast, it might be foolish to buy right now anyway since we don't know where the bottom is.

Posted by: CA Pol Junkie on August 16, 2006 at 8:31 PM | PERMALINK

By the way, the last 2 grafs in this NYT article might interest you all. Apparently, they've set up a futures market for home prices in metropolitan areas. What does the market say? 12-month drops of 3-7 percent depending on the area. My guess is that drops of these magnitude are going to acrete over 4 or so years for an inflation adjusted drop of 20-40%, depending on the market.

Posted by: Wagster on August 16, 2006 at 8:32 PM | PERMALINK

Note that if housing prices drop 30-40% on average, some homes will drop by something like 70% in value.

Plus housing prices should roughly match the rate of inflation plus a little. So a more accurate number of appreciation would be something like 4%, not 5 or 6%.

Posted by: mickslam on August 16, 2006 at 8:44 PM | PERMALINK

One of the things to remember about the housing market in particular is that the volume of transactions typically decreases during a downturn -- anyone who can pay their mortgage and doesn't have to sell (perhaps they can rent, perhaps they really don't need to change houses, whatever) will simply wait for the market to recover. So you don't see the full distribution of lowered values, just the prices for the people who are willing to do a transaction (or must do one). If the popping bubble is widespread enough to have a general economic impact, you're going to have a lot more people who have to sell whether they want to or not, which would tend to push prices down both because you're seeing the full distribution (rather than the upper tail) and because there would be more of a glut of sellers.

I think that a better model for such an event might be the high-end real estate market in Manhattan after the '87 crash. Not pretty at all.

Posted by: paul on August 16, 2006 at 8:49 PM | PERMALINK

If firemen, teachers, and police can't buy a house close to yours, your house is overpriced and I hope they stay far away from it.

I make six figures in SV and I still can't afford a house- there's just no way. I can't even consider buying in this market until prices fall about 60-70%. I'm not paying more than $250K and I can rent a long time. It's a much better deal than buying.

Posted by: MillionthMonkey on August 16, 2006 at 8:52 PM | PERMALINK

No Name hit the nail on the head. Irrational exuberance is often followed by irrational despair.

In fact this is apparent in the comparison of actual versus constant growth rates.

It might be a good time to sell your house and buy other assets.

Posted by: NeilS on August 16, 2006 at 8:55 PM | PERMALINK

The monthly payments on a 15-year fixed loan at 6.6% interest are roughly 1% of the initial loan amount per month. Considering property taxes, maintenance, possible tax writeoff, etc, it would be bad business to purchase any property that whose rent was much less than 1% of the purchase price per month. I now live in a house that rents for 0.4% of the price my landlord tried last spring to sell it for.

We have a long way down.

Posted by: troglodyte on August 16, 2006 at 9:16 PM | PERMALINK

Kevin, if you're assuming that house prices will bottom out in 2008, why not estimate that they will drop to the value of the exponential curves 2 years from now? That is, by the time houses reach their natural prices, the natural prices will be 10-12% (or so) higher than they are today.

Then again, that's still broadly consistent with a drop of 10-20% if you're thinking more like a 5% natural rate.

Posted by: anno-nymous on August 16, 2006 at 9:26 PM | PERMALINK

My comment about the 1% monthly-rent/purchase-price relation can be tested anywhere that craigslist operates. Where Kevin lives craigslist covers the entire county

http://orangecounty.craigslist.org/apa/

The comparisons between rental properties and for-sale properties are squishy because the properties are not identical, but the broad pattern is clear. The median price for a house sale in th OC right now is north of $600k. Houses for rent in the OC on craigslist rarely exceed $3000/month. In fact some of the rentals with photos look pretty nice and ask for closer to $2000/month. Look for yourself.

Hard landing.

Posted by: troglodyte on August 16, 2006 at 9:35 PM | PERMALINK

I'm renting a two bedroom duplex in Santa Clara. Big front yard and big back yard, with a big ass pepper tree casting shade across most of it, and surrounded by a tall privacy fence. The "market value" of the place is north of $800000.

Rent is $1300 a month.

If I were to buy I'd be looking at a mortgage payment two or three times that size. You'd have to be crazy.

Posted by: MillionthMonkey on August 16, 2006 at 9:38 PM | PERMALINK

Your graph only works if you assume "real estate prices always go up". This is not true for any other category of investment, so why should it be true for real estate?
Posted by: fiat lux on August 16, 2006 at 7:46 PM | PERMALINK

Supply and demand. People keep squirting out more little people, and those little people need someplace to live. But there is a finite amount of land to put them on.

Posted by: John Worfin on August 16, 2006 at 9:44 PM | PERMALINK

I appreciate your conventional wisdom that the pain will be worst in "high appreciation" markets like Washington DC, California, New York and Florida. But here in amply-supplied Atlanta, there are some very worrying trends.

http://www.voic.us/danablankenhorn/1106/in_vote_entertainment_the_economy

(excerpt) Based on data from The New York Times, the Atlanta area had the highest percentage of interest-only loans granted in the country in 2003, and those will either adjust or come up for re-negotiation over the next few months.

Much is written about the California housing market being ready to crash, with 22-26% of loans being interest-only. In Atlanta the figure is 32%, by far the highest in the country. And in Athens it's 30%.

What this means is hundreds of thousands of loans are going to be re-negotiated, at higher rates, over the next year, and thousands more are likely to go into foreclosure.

Posted by: Dana Blankenhorn on August 16, 2006 at 9:49 PM | PERMALINK

MillionthMonkey, just made a brilliant point. Ultimately market value has to have some connection to rental value. Normal rental value of an $800,000 property isn't $1,300 per month. If you are only taking $1,300 a month out of an $800,000 property (actually you are taking much less given the cost of owenership) you are losing your shirt. No prudent real estate investor would pay $800,000 for a property with a $1,300 per month rental value. Such disparity cannot be sustained.

Posted by: Ron Byers on August 16, 2006 at 9:54 PM | PERMALINK

What proportion of residential real estate purchases are rental property investments rather than primary residences or second homes? A gross disparity between rents and values may be sustainable for a long time depending on the characteristics of each market.

Posted by: GOP on August 16, 2006 at 10:03 PM | PERMALINK

It's interesting to compare the chart of NASDAQ over the same time-period (linear-x).

http://finance.yahoo.com/q/bc?s=%5EIXIC&t=my&l=off&z=l&q=l&c=

It peaked right around the time the housing bubble started to rise (ie. profit-takers moved their money out of tech stocks into real-estate).

With stocks, the supply is flexible (when someone wants more stocks, they just split em - in a psychological game to keep the price of 1 share in that magic 20-60 buck range; hurts quite a bit if there's a price collapse, as 2000-2003 shows.)

Posted by: John Worfin on August 16, 2006 at 10:04 PM | PERMALINK
Much is written about the California housing market being ready to crash, with 22-26% of loans being interest-only. In Atlanta the figure is 32%, by far the highest in the country. And in Athens it's 30%.

I'm not sure the IO percentage is all that important; I just bought last year with an interest-only loan, but its interest-only for ten years, and fixed rate for the (30-year) life of the loan.

What's going to get people who bought near the peak of the bubble (i.e., in the last couple years) in the near term is loans that were interest only (or negative amortization!) for a short period, or ARMs that floated after a short period.

Posted by: cmdicely on August 16, 2006 at 10:11 PM | PERMALINK

Assume 1988 housing prices were appropriately priced.
Assume housing prices should grow at 1 or 2% above the riskless rate offered by T-Bills.
Assume the stock market plunge of October 1987 had no impact on 1988 prices for houses.

What else did I miss?

Posted by: Birkel on August 16, 2006 at 10:27 PM | PERMALINK

It's simplistic but it's still very good blogging. Thanks for the chart.

Posted by: paradox on August 16, 2006 at 10:32 PM | PERMALINK

Dana,
I read that unlike other areas, Atlanta always has had a high percentage of mortgages written for short-term not long-term benefit because so many people move in and out. If that is true, more people will have to sell and not be able to wait for a recovery, so a drop in Atlanta might play out faster. Not necessarily farther, but faster.

Posted by: kevin_r on August 16, 2006 at 10:37 PM | PERMALINK

I can't wait to pick up a nice foreclosure in San Diego in 2009.

Posted by: Republican on August 16, 2006 at 10:38 PM | PERMALINK

I can't wait to pick up cmdicely's foreclosure. He bought at the height of the boom, it'll be 10 years before he pays back any of the principal on his mortgage, and he's at serious risk of negative equity if values decline. It's a recipe for disaster...

Posted by: GOP on August 16, 2006 at 10:46 PM | PERMALINK

Thirty nine posts, and no one has mentioned the fact that, on an international scale, housing prices in Southern California are fantastically cheap.

The comparison is not what a fireman can afford, the comparison is London, Paris, Manhattan.

Basically, we've had a 200-plus year free ride in a country with much more space than people, and as a result we've gotten used to the idea that its somehow the normal state of affairs for the average person to live in a detached home surrounded by some plot of land.

That is hardly the normal state of affairs. There is simply not enough land to give everyone who wants one a single family 2000 sqare foot detached such a home at a price they can afford in a neighborhood they want to live in.

Now, consider again what a "bubble" is.

My prediction is that for the next 100 or so years, each generation is going to get less "house" than their parents got. Eventually, people will be so used to living in small apartments (like the rest of the world) discussions like this will seem quaint, like discussions of blacksmith shops in the 1800's.

As it will take along time to play out, its a pretty safe prediction!

Posted by: hank on August 16, 2006 at 10:59 PM | PERMALINK

Seems to me things continue on the same path until they hit a singularity that knocks everything off kilter. It doesn't have to be an earthquake, it could be $300 oil or China going into convulsions and unloading and/or scrambling for T-bills or a critial mass of illegal immigrants breaking our current consensus and causing a crackdown. I know it's mostly off topic but I just read one of the most eye-opening essays on the immigration issue I've ever seen, written by one of Vincente Fox' foriegn policy wonks:

http://www.cis.org/articles/2006/back706.html#author

I'd recommend everyone check it out.

Posted by: minion of rove on August 16, 2006 at 11:00 PM | PERMALINK

The bottom line is that real estate does not always go up. Look at the late 80s - early 90s and it's quite clear that there were year over year housing price declines, significant ones, in many areas.

Posted by: fiat lux on August 16, 2006 at 11:13 PM | PERMALINK

hank,

My prediction is that for the next 100 or so years, each generation is going to get less "house" than their parents got.

Your prediction is contradicted by actual experience. Houses are getting bigger, not smaller. And household size is getting smaller, so each member of the household also gets a bigger share of that bigger house.

Posted by: GOP on August 16, 2006 at 11:23 PM | PERMALINK

The historic rate of appreciation for real estate over the last century has been 0.4% over the rate of inflation. Assuming the current rate of inflation is about 2%, your estimates of 5% and 6% seem to be wildly optimistic.

Posted by: Name on August 16, 2006 at 11:26 PM | PERMALINK

The bottom line is that real estate does not always go up.

No kidding, I got screwed when I was investing in land speculation in Kiev in the mid-1980's. Boy, did that stuff drop in the toilet quick!

Posted by: osama_been_forgotten on August 16, 2006 at 11:37 PM | PERMALINK

Well, GOP, the problem is that at a certain point simply building bigger houses farther and farther out in the middle of bumfuck Egypt reaches a certain limit.

As someone who's actually lived in Southern California for over 30 years I've seen plenty of bigger houses built. The new ones at the intersection of the 210 and 15 freeways are certainly larger than average, although having your house four feet from your neighbor's house is kind of stretching the definition of "detached house" to its limit, wouldn't you agree?

The reason that prices in Brentwood are what they are, and for that matter in Irvine, is that no one really wants to live at the intersection of the 210 and 15.

Posted by: hank on August 16, 2006 at 11:43 PM | PERMALINK

Unfortunately I live in Fresno, the most over-priced housing market in the country. My wife and I are looking to buy, my wife wanted to buy last year but I was waiting for the big POP.

Housing in Fresno is reported as 46% above actual real world prices. We are basically a blue collar town surrounded by farm land in the middle of the San Joaquin Valley; the majority of the population here doesnt come close to qualifying to purchase a house.

Earlier this year a house was built down the street from the house I rent; it has a price tag of 400K. Fresno has a median income of a little over 32K a year. My wife and I make just over a 100K and we are having trouble finding a house in our range.

Posted by: nutty little nut nut on August 16, 2006 at 11:43 PM | PERMALINK

Housing in Fresno is reported as 46% above actual real world prices.

WTF? What's the draw? Are dotcommers commuting to Mountain View from there now? Is Salinas full?

Posted by: osama_been_forgotten on August 16, 2006 at 11:46 PM | PERMALINK

Why make so many arbitrary assumptions, and present such a ridiculously simplistic--and perhaps misguided--analysis instead of linking to a more sophisticated analysis by someone more qualified?

For a good take on housing, with lots about SoCal, go to

http://calculatedrisk.blogspot.com/

Posted by: dts on August 16, 2006 at 11:48 PM | PERMALINK

Well, GOP, the problem is that at a certain point simply building bigger houses farther and farther out in the middle of bumfuck Egypt reaches a certain limit.

Well, yes, eventually it must, assuming the population keeps growing, because land is a finite resource. But clearly we're not even remotely close to reaching the limits of that resource yet, and the booming cities of the south and west just keep expanding with new and bigger housing. I see no sign that your prediction is likely to come true in the foreseeable future.

Americans just are not going to start trading in their expansive McMansions for tiny, cramped eurohovels any time soon.

Posted by: GOP on August 16, 2006 at 11:52 PM | PERMALINK

Fresno is becoming a bedroom community for Nor Cal with many people coming back to the valley just for the weekend.

Posted by: nutty little nut nut on August 17, 2006 at 12:00 AM | PERMALINK

Well GOP, on a countrywide basis you are correct. As for Southern Cal, which is where Kevin and I live and which is the market which drives these posts, its a different story. Basically, the beach area from San Diego to Santa Barbara is completely built out. This was not the case 35 years ago.

The developements headed inland, but they had to head inland along an existing freeway, and there are really no new major freeways to be had.

All people in Southern Cal talk about at cocktail parties is how cheap housing is elsewhere.

But my point is this, every time these topics come up the underlying assumption is that there is some problem that needs to be fixed becuase housing in California, usually Southern Cal, is "too expensive."

Its basically not too expensive. The test is not whether the average person can afford the average house. An average house in Southern California is one of the best places to live, bar none, on the entire planet, and it is priced accordingly.

Don't buy here because you think its some sort of great investment, it could be, but it could be flat for a few years, certainly.

But I've seen so many people, so many, get burned by "waiting" for prices to come down to their idea of what is reasonable. And over the last 35 years they have never come down to whatever the "reasonable" level would be.

Posted by: hank on August 17, 2006 at 12:07 AM | PERMALINK

Well, yes, eventually it must, assuming the population keeps growing, because land is a finite resource. But clearly we're not even remotely close to reaching the limits of that resource yet, and the booming cities of the south and west just keep expanding with new and bigger housing. I see no sign that your prediction is likely to come true in the foreseeable future.

Americans just are not going to start trading in their expansive McMansions for tiny, cramped eurohovels any time soon.

The problem isn't that we're out of land, obviously there's plenty of it in Nebraska, but that doesn't do any good if you live in New York. The problem is that a cities overall sprawl size is eventually limited by commute times. Americans have an unreasonably high tollerance for sitting in traffic, but people do reach an upper limit at around 1 to 2 hours each way and you're starting to see that in Atlanta, Houston, Dallas etc. There's no choice except densification (or eurohovels as you call it). Not to mention the rising gas prices.

Posted by: Adventuregeek on August 17, 2006 at 12:09 AM | PERMALINK

hank,

I agree that housing is, for the most part, a bargain in the U.S. compared to Europe. It's just one of the many ways in which Americans enjoy a much higher standard of living than Europeans.

Posted by: GOP on August 17, 2006 at 12:15 AM | PERMALINK

My wife and I make just over a 100K and we are having trouble finding a house in our range.
Posted by: nutty little nut nut on August 16, 2006 at 11:43 PM | PERMALINK

And that's the way it should be. If you're only making 100K, you're "little people" and don't deserve a huge house. You should be looking for a much smaller house. The generation of our parents lived in much more modest accomidations. This generation is just spoiled.

Posted by: American Fuck on August 17, 2006 at 12:22 AM | PERMALINK

The problem isn't that we're out of land, obviously there's plenty of it in Nebraska, but that doesn't do any good if you live in New York.

But most people don't live in New York, and most of the growth is happening in the sprawling cities of the south and west, where there's plenty of land.

The problem is that a cities overall sprawl size is eventually limited by commute times.

Not really. Places of work tend to expand into the suburbs along with housing. And the rise of telecommuting and flexible work schedules also eases commuting.

Posted by: GOP on August 17, 2006 at 12:24 AM | PERMALINK

This conversation hasn't touched on several problems in the U.S. housing market:
- Lax lending practices by financial companies, resulting in too many people living in houses they can't afford.
- Fed's "easy money" policy, resulting in homeowners using the inflated price of their houses as collateral to borrow money for other assets they really can't afford.
- Highest percentage of home buyers ever using ARMs and "no-down" financing.
- Increasing inflation (real price increases in food, gas, medical care, etc., not manufactured CPI data) that takes a greater share of family incomes and makes mortgage payments more difficult.
- Record number of loan defaults and bankruptcies because wages can't keep up with rising ARM payments.
et cetera

Collectively, these factors could contribute to a much more brutal landing than anyone is contemplating.

Posted by: DevilDog on August 17, 2006 at 12:35 AM | PERMALINK

The comparison is not what a fireman can afford, the comparison is London, Paris, Manhattan.

Do no firemen live in London, Paris, or Manhattan?

Basically, we've had a 200-plus year free ride in a country with much more space than people

It's still a mostly empty country.

and as a result we've gotten used to the idea that its somehow the normal state of affairs for the average person to live in a detached home surrounded by some plot of land.

We're going to get unused to it fast within our lifetimes and it will not be pretty. Do you know why you need a car to get around? Because you have to drive past a couple hundred backyards and parking lots on the way to work. Before the oil age this would have meant several blocks.

I think we are going to see row homes being built again just like in the last century. We should be building them now. I look at all the condoplexes in Santa Clara and they still manage to look like prisons even though they're surrounded by their nice little sterile yards between the building and the parking lot.

What are these yards good for? Nobody is going to drag a lawn chair onto one, with all the chemicals and sprayers and exposure to traffic. Why do we insist on useless yards that we then have to drive past?

McMansions are the worst. If you think the front yard of a McMansion is totally useless, that's because you haven't seen the back. A McMansion typically has a flat, unadorned backside and a barren back yard that offers no shade. If you're lucky, a tree will be growing with stilts on each side to support it. I don't know why people jeopardize their futures with million dollar gambles on such vulgar places.

Posted by: MillionthMonkey on August 17, 2006 at 12:47 AM | PERMALINK


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Posted by: hsdfgf on August 17, 2006 at 12:58 AM | PERMALINK

We're going to get unused to it fast within our lifetimes and it will not be pretty.

The evidence contradicts this prediction, as I have explained.

Do you know why you need a car to get around? Because you have to drive past a couple hundred backyards and parking lots on the way to work. Before the oil age this would have meant several blocks.

Before the oil age, you wouldn't have been driving at all. If you lived in a city, your home would likely have been a tiny, filthy tenement. If you didn't live in a city, you probably would have been living and working on or around a farm. I can't imagine either scenario would be very attractive to many people today, including those with long commutes.

I think we are going to see row homes being built again just like in the last century.

I don't, except in certain niche markets, like upwardly mobile yuppies who like to live in or near a big city and are willing to live in a smaller house for the privilege.

Posted by: GOP on August 17, 2006 at 1:17 AM | PERMALINK

Before the oil age, you wouldn't have been driving at all.

Well, yeah, that was sort of my point.

The reason you need a car is to drive past oversized backyards.

Posted by: MillionthMonkey on August 17, 2006 at 2:12 AM | PERMALINK

Before the oil age, ...
Posted by: GOP on August 17, 2006 at 1:17 AM | PERMALINK

I would have driven a wind-powered ocean-going vessel, landed on your beach, slashed and burned my way across your hinterlands until I reached your town, then rape and pillage, and sold you into slavery.

Here's hoping the oil age ends soon so things can go back to normal.

Posted by: Eric the Viking on August 17, 2006 at 2:37 AM | PERMALINK

LOL, Eric.

Posted by: Birkel on August 17, 2006 at 2:53 AM | PERMALINK

Being rather pedantic this evening aren't we? By "oil age" I was referring to the 20th century.

Posted by: MillionthMonkey on August 17, 2006 at 3:04 AM | PERMALINK

If housing prices rise faster than average income rises, then houses price themselves out of reach (in a while). So, how does a 'natural' 5% increase look compared to the rise in average income?

If you look at the post-WW2 UK & European housing markets, it would suggest that a 20% fall in prices is a pretty damn hard landing - a fall of 5-10% seems to be fairly bad, and in some cases prices just stagnate for a half-decade. (Sorry, dont have access to US historical data)

Posted by: firefall on August 17, 2006 at 6:31 AM | PERMALINK

Kevin: Why not delete the insane irrelevant posts, usually with all or some Chinese (?) characters, that crop up here?

Posted by: mja94116 on August 17, 2006 at 9:47 AM | PERMALINK
Americans just are not going to start trading in their expansive McMansions for tiny, cramped eurohovels any time soon.

That's true, their not going to start any time soon because they already started that in the past, which is why more and more even suburban developments are attached condos rather than single-family detached homes, and comparatively minor cities like Sacramento (population

People may want large detached single-family homes as much as ever, but if so something (cost?) is making them accept something else.

Heck, the McMansion itself -- a large detached home in a planned development taking up virtually the entire lot -- is itself, really, a similar compromise, the start on the road to what you call "eurohovels", as the component of traditionally desirable housing (which was the same thing but with a substantial yard) which people were most willing to sacrifice for the convenience of suburban vs. rural living was the large plot of land.

The only thing that saves large single-family homes in the long-term is a radical decentralization of both economy and social lifestyle, or a transportation revolution, that reduces the concentration of desirable residential locations. OTOH, any kind of radical increase in the cost of transportation without some kind of economic and social revolution, the kind of increase that peak oil or another Middle East crisis might produce quite easily, is going to push very hard the other way.

Posted by: cmdicely on August 17, 2006 at 10:37 AM | PERMALINK
Houses are getting bigger, not smaller.

Houses (detached single-family homes) are getting bigger, among other reasons, because small houses are being displaced by various attached units.

Posted by: cmdicely on August 17, 2006 at 10:42 AM | PERMALINK

"The reason for my guess is that there really are lots of fundamentals that are likely to keep prices afloat."

The one fundamental that is NOT keeping up, and the most important, is income. Income is not rising anywhere near the pace of housing, and without that, prices are not sustainable.

Posted by: Mel on August 17, 2006 at 10:52 AM | PERMALINK

I bought a two family house in 1994. When I bought it, I paid about 60 times monthly income. The latest sales of multi family houses in my neighborhood have been at about 185 times monthly income. Reversion to the mean (90 to 100 times income) is going to be painful, especially as there has been a lot of development versus a fairly stable population here in Rhode Island.

Posted by: PetervE on August 17, 2006 at 11:00 AM | PERMALINK

For me, the price of houses is like the price of any other commodity, physical or financial. If there is sufficient capital (or over-abundant capital), then prices will go up. The point of emphasis should be on the availability of capital (where did this money come from and how long will it continue to flow?). If the price of houses was rising because of additional capital provided by growing wages, then that's one thing. If the price of houses was rising because of historically easy money, then that's another.

Posted by: David on August 17, 2006 at 11:26 AM | PERMALINK

Geez, its like you guys are talking about the ocean and no one's mentioned the water.

Restrictive zoning is the reason California real estate is a bubble. If you take the implicit zoning tax (see the linked article), doesn't look like Anaheim should be much more expensive than Atlanta.

http://www.heartland.org/Article.cfm?artId=10635

Of course, its a holding the tiger by the ears situation. If CA chose to reform its zoning law and the zoning tax is gone, there would be a tremendous drop in real estate values. Great for renters who want to buy, not so great for existing owners.

Of course, if the median homeprice is half a millio, at some point (if not already) there will be an electoral majority of Californians who cannot affored and will never be able to afford a house. Why not vote to throw the existing homeowners under the bus financially so needed housing can be built?

Posted by: beowulf on August 17, 2006 at 12:26 PM | PERMALINK

Wonder what a crash would do to prices here in Houston. I mean, you can already get a new 5-bedroom house inside the belt for $125k...

Posted by: Avatar on August 17, 2006 at 12:35 PM | PERMALINK

That's actually one of the easiest questions to answer Beo. Take San Marino. No renter wants the city to bulldoze half of the houses and build the first apartments in the city so that they can live in an apartment in San Marino.

They want a house in San Marino. This isn't Doctor Friggen Zhivago. Professionals who thirty years ago could buy, as thier first home in their early 30's, one of the smaller homes in San Marino now are fortunate if they can buy ANY home in San Marino on their second or third home before age 50.

Human nature actually seems to indicate that the desire for a detached home of any kid is so strong, that many people are basically willing to expend a lifetime of savings to work their way up the housing ladder to get it.

Posted by: hank on August 17, 2006 at 12:38 PM | PERMALINK

cmdicely,

That's true, their not going to start any time soon because they already started that in the past, which is why more and more even suburban developments are attached condos rather than single-family detached homes,

Show me your evidence that the share of new suburban housing that is "attached condos" has been rising and the share that is "single-family detached homes" has been falling. Of course, single family homes are not necessarily detached; they may be attached to other houses on one or both sides, as in row houses, town houses and patio homes. And condos may be also be only partially attached, as in a duplex. So your "attached condos"/"detached single-family homes" dichotomy does not reflect the range of housing types.

Heck, the McMansion itself -- a large detached home in a planned development taking up virtually the entire lot -- is itself, really, a similar compromise,

No it isn't.

The only thing that saves large single-family homes in the long-term is a radical decentralization of both economy and social lifestyle, ...

No kidding. And that "radical decentralization" has been going on for half a century or more. It's called "suburbs." There is no sign that the growth of suburbs is going to stop.


Posted by: GOP on August 17, 2006 at 12:41 PM | PERMALINK

cmdicely,

Houses (detached single-family homes) are getting bigger, among other reasons, because small houses are being displaced by various attached units.

Amoung those "other reasons" that houses are getting bigger is that newer houses are larger than older houses.


"The average American house size has more than doubled since the 1950s; it now stands at 2,349 square feet. Whether it's a McMansion in a wealthy neighborhood, or a bigger, cheaper house in the exurbs, the move toward ever large homes has been accelerating for years."

Average footage of a new single-family home:

1950: 983 sq. ft.
1970: 1500 sq, ft.
1990: 2080 sq. ft.
2004: 2349 sq ft.

[source]

And as I said, household sizes have also been getting smaller, meaning that each household member has a larger share of that larger house.

Posted by: GOP on August 17, 2006 at 12:53 PM | PERMALINK

I just woke up for today's round of unemployed obsessive posting. Show me your evidence. Show me your evidence. Show me your evidence. Watch me post this for the next 15 hours straight.

Posted by: GOOP on August 17, 2006 at 1:24 PM | PERMALINK

I have no life except for attacking GOP. Sometimes I steal his handle, and sometimes I post under this one.

Posted by: GOOP on August 17, 2006 at 2:04 PM | PERMALINK

Hank,

How many single family detached homes are in Manhattan? Yet its full of millions of people who choose to live there. Its a big country, if you must live in a house with a yard and that's your primary concern, they're practically giving them away in North Dakota. I always thought the prime benefit of being a homeowner is that you're paying off an investment every month and not just "throwing away" rent. .

Of course SoCal isn't anywhere near Manhattan levels of population density, so you don't need highrises to expand the housing stock. Townhouses with plenty of green space (to give one example) look nice, are affordable and you're not living in a Good Times-style public housing project.

Posted by: beowulf on August 17, 2006 at 2:06 PM | PERMALINK

This discussion is mixing two very different questions. The outlook for the California market and the outlook for the national market are not the same. The 6% average number for Southern California has held true, since about WW2. It actually lags alternative investments, like the stock market which averages out around 8% over the same period.

It is also true that California has gone through several boom and cycles over that period. During up cycles, the average price will over-shoot historic trends and the reverse will happen during down cycles. However, these cycles move much more slowly than you would expect, since houses are not liquid assets that can be traded easily. During down trends, home owners will tend to avoid selling if they can avoid it. Therefore, even an extreme decline of 20% would occur over several years. Even a severe spike in interest rates would effect only owners whose rates are floating at that time. 5 and 7 year ARMs being effected today are reflective of prices in '01, or '99. Therefore, the bottom won't be clear until about 2010 when peak prices meet what are likely to be higher interest rates.

That said, the folks that expect a 30-40% drop are probably dreaming. Yes, rents are a huge factor in valuing real estate as an investor. By that measure, real estate is a poor investment and anyone speculating right now is going to be in trouble. However, the vast majority of people buying single-family homes are doing it for reasons that have very little to do with speculative price appreciation. They are buying them as a place to live and as a kind of savings plan. They bought the biggest house they could afford with their income and plan to live there for the long-run. To those people, housing peaks and valleys are kind of trivial.

Remember, the last housing bubble in Southern California did not burst by itself. It was sparked by massive lay-offs in the defense sector that was the major employer in Orange County. That huge job loss sparked a population outflow. The economy in most metro markets throughout the state is more diverse now. Anything that is a large enough to cause massive job losses in California would probably have a similar effect on the nation as a whole. That would probably prompt a round of rate cuts by the Fed, which would help (not hurt) the housing market.

That said, the short-term market has moved beyond the long-term trend, which usually means a correction is coming. In some markets, it has already started. My best guess is an average of 4-5% per year for the next three to four years. That is a harder landing than you might think, since it is going to ruin some people who were agressive buyers at the peak. There are going to be people who cannot make payments on $600,000 mortgages when their house is worth $500,000.

To me, that is not a 'soft landing'.

Posted by: Dean on August 17, 2006 at 3:55 PM | PERMALINK

The 1988 value is biasing your conclusion Kevin.

Please check out Professor Piggington at
http://piggington.com/node?page=1
for some graphs that go back to 1976 for both LA and San Diego where housing prices are normalized by income levels. That's when you see how overvalued the current market is.

Posted by: D_Rumsfeld on August 17, 2006 at 4:04 PM | PERMALINK

The overcrowding theory is tempting, especially when one considers zoning and the doubling of the US population in the last 40 years.

However, if it was truly a matter of overcrowding, i.e. the new reality is that a bigger slice of our paychecks must go to housing, then you wouldn't see these ridiculous disparities in California between rents and purchase prices.

One of the reasons it is so hard to predict what is going to happen to Manhattan real estate is because that disparity doesn't exist here. Both rents and purchase prices are outrageous. Furthermore, since the city is now so safe and clean, the general consensus is that foreign interests will pick up any slack left by an economic downturn.

Fresno, on the other hand, has a long way to fall. The entire San Juaquin valley is plastered in large detached houses (all 6 feet apart) that start in the mid 300s. No one can afford them and those that have tried have only been able to do so through creative financing. Meanwhile Fresno might be a stable job market, but it is no economic superstar city. There is simply no real justification for what has happened in Fresno (and other similar cities all across the country) over the last ten years.

I'm guessing Coastal California and NYC, and anywhere that is somewhat "nice" with a strong job market, will see a slight deflation -- or the absence of increases for a while. The rest of the country, on the other hand is going to go into free-fall. Homes on the market today in Tracy, CA for $350k won't even be worth the cost of upkeep in a few years.

Posted by: Zac on August 17, 2006 at 4:18 PM | PERMALINK
Amoung those "other reasons" that houses are getting bigger is that newer houses are larger than older houses.

That's not a reason, that's just repitition. But not all homes are houses. Saying houses are getting bigger isn't the same thing as saying homes are getting bigger; houses are getting bigger because smaller homes are less likely to be "houses".

Posted by: cmdicely on August 17, 2006 at 5:19 PM | PERMALINK

cmdicely,

That's not a reason, that's just repitition.

No, it's a reason.

Saying houses are getting bigger isn't the same thing as saying homes are getting bigger;

True, but irrelevant. "Homes" are also getting bigger. This includes houses, condos, apartments and mobile homes.

Still waiting for your evidence that the share of new suburban housing that is "attached condos" has been rising and the share that is "single-family detached homes" has been falling.

Posted by: GOP on August 17, 2006 at 6:50 PM | PERMALINK

There is no sign that the growth of suburbs is going to stop.

Apparently GOP hasn't looked at the price of oil recently.

This is too easy.

Posted by: Disputo on August 17, 2006 at 9:16 PM | PERMALINK

Disputo,

Apparently GOP hasn't looked at the price of oil recently.

Huh? How is an increase in the price of oil a sign that the growth of suburbs is going to stop?

Fish in a barrel, I tell ya.

Posted by: GOP on August 17, 2006 at 10:35 PM | PERMALINK

As long as 20 Mexicans are willing to split the costs of living in one dwelling, the cost aren't going to come down.

Posted by: Two Ton Tessie on August 18, 2006 at 12:00 PM | PERMALINK




 

 

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