Maniaville,
California
While there is some spurious logic in the above reasoning [for instance, wasn't San Diego’s weather just as nice 10 years ago, when housing cost 1/3rd as much?], for the most part it sounds reasonable on paper and in the press. There's only one problem: as often as the above hypothesis is repeated by amateur and professional alike, nobody ever bothers to check whether the underlying assumptions are actually true. A while back I set out to do just that. I was pretty surprised at what I found – no, actually, I was shocked:
Since 1996, there has been no surge in population. And the growth in population has been matched exactly by a growth in the supply of housing units. Household income has barely kept pace with inflation. During this time, the median home price tripled. I grew suspicious in my shock therapy. So, I looked a little further back – those electrodes at your temples provide a real jolt! Lacking local income figures going further back than 1992, I instead used inflation-adjusted home prices. Adjusting the prices for inflation reflects how much San Diegans have been willing to pay for homes in relation to other goods. Also, since wages tend to track inflation, it gives a rough idea of how much they have been willing to pay in relation to income.
What I saw is that ever since a slowdown in the early-90's San Diego recession, population and housing supply have grown in line with historical growth rates. I also saw that the inflation-adjusted median home price is astonishingly high, making the peak of the late-80's real estate bubble seem insignificant by comparison. Turn off the electricity to the electrodes at my temples! Another way I looked at the "real" value of homes was by how much rental income they could generate. This is a good method because it abstracts out consideration of population or income growth. If the population surges or gets really wealthy, that should be reflected in the cost of both renting and owning a place to live. As the following graph shows, home prices have grown 6 times as fast as rents since home prices started surging in 2001:
All evidence pointed to the same conclusion: that the meteoric rise of San Diego home prices is not remotely justified by fundamentals. The vaunted "shortage" has nothing to do with demographics and everything to do with the fact that everyone in San Diego, fearful of being priced out of the market, desperately wants to get in on the housing gravy train. The so-called shortage is no different than the "shortage" of amazon.com stock in 1999 – there were a lot of eager buyers and enough sellers – but then, as now, the actual value of the asset being bought was not taken into consideration. San Diego is in the midst of a speculative real estate bubble, and that bubble will eventually burst [based on my data, and my interpretation of the justification and support within my data]. Common Objections The shortage hypothesis, while the most ubiquitous argument to the idea that San Diego prices are too high and must come down, is not the only one. Other common objections follow, along with brief counterpoints [these may be the same rhetoric you hear in your micro realty market as well?]:
I take issue with this definition of "speculation." Most people who are buying right now are stretching themselves to the limit [as evinced by the pervasiveness of interest only, negative amortization, no down payment, other ARM gimmick loans, and the pervasive use of social capital] to put themselves at the closing table to buy a house. These people are almost without exception, speculating that real estate will go always up. [More here, in Maniaville!] As is the case as in all speculative bubbles, expectations for future gains are completely unrealistic. During the 20 years prior to the bubble’s onset in 2001, San Diego’s median home price increased by an average of 5.5% per year. Given that homes are so expensive, people should expect them to appreciate at less than the average historical rate, not more. But in 2002 Yale economist Robert Shiller asked new homeowners in Orange County, CA [sorry, no San Diego data but OC is close by] how much they thought their home prices would increase annually over the next 10 years. The astounding mean response was 13%! That's 13% per year, compounded every year for the next decade, starting from an already very high base in 2002. Good thing this isn't a speculative mania!
Yes, just as they did 10 years ago when homes cost 1/3 what they do now. This argument is effectively saying "homes can't go down," an assertion which has been proved wrong many times in the past. Take the oil bust in Houston, Texas in the 1980s for historical perspective. Folks left their big debts in the middle of the night, when they could not sell them in a flooded housing market that went bust linked to the bust in the oil industry. On the planet, some people live in tents! You can move a tent. You cannot move a house from San Diego to St. Louis!
As absurd an argument as this is, I saw this malapropism just a couple weeks ago in a local newspaper and felt compelled to include it. The debater is apparently a proponent of [In] Efficient Market Theory [evidently trained at the Federal Reserve]. This theory holds that the price of an asset is the sum of all knowledge of all investors, so it can't ever be wrong [which is similar to Greenspan saying all real estate markets are local, thus cannot be a market bubble]. Proponents of [In] Efficient Market Theory, while a somewhat endangered species today, were readily spotted as late as February 2000 at Pets.com shareholders' meetings.
People think that, because the last housing bust in San Diego was caused by a local recession with attendant out-migration and unemployment, that a housing bust can only be caused by job losses. This is absurd. To these people, the median price of a home could go up to $10 million, and they'd still think everything was fine as long as job growth continued. The greater macro global market financial influences are just as important here in San Diego as they are in Kansas City, St. Louis, St. Paul or Ft. Lauderdale! Give me oil at $100 a barrel, and $5/gallon gasoline, and some San Diego suburbs could feel a squeeze in realized property sales prices. In reality, there is an upper limit to how justifiably and sustainably expensive housing can become in comparison to incomes. San Diego has long since passed that limit, in my view. Consider also that 50% of San Diego's job growth over the past three years has been related to the housing industry. This time around, a housing slowdown could cause a recession instead of vice-versa. Nope, we didn’t even mention that nasty “D” word.
This may have been true a couple years ago, but at this point home prices are so out of scale with wages and rents that there is no way that inflation can catch incomes up to prices in any reasonable amount of time to sustain the possible debt implosion. This is a very complicated topic on which I have already written a previous essay and analysis – but a “soft landing” is looking more and more like fantasy.
This argument actually has some validity. However, even as interest rates have dropped, monthly payments have far outgrown incomes:
More importantly, though, this argument is unconvincing because it acknowledges that if interest rates go up there would be trouble. This is a very real possibility: the Fed and the Asian Central Banks have manipulated the bond market to keep rates low, but these types of market manipulations never last. Interest rates will go up – maybe a lot. For more detail on the effect of rising rates, see this Realty Reality Forum Topical Panelist Essay Series.
Agreed. Housing would never "crash" over a short period like stocks. Real estate market moves take months and sometimes years. The last bust took 5 years to get from peak to trough. When real estate markets implode, 30 day marketing times become 180, 240, 360 Days on the Market and sometimes beyond. Inflated asking prices above the debt carried by the property keep getting reduced during the marketing time, as the weary seller begins to get a full bladder since their kidneys keep on functioning. Sellers’ markets, in effect become buyers’ markets when those folks have the effective purchasing power in lieu of sellers who bought at the top of the market. Speculators enter the market to buy low, ride out the depressed market, with expected profits selling on the rebound. Realty market crashes are a very slow and agonizing method of financial suicide – one can sell a bond or a stock or a T-Bill in a heartbeat. To sell a piece of property, or real estate, you are transferring the debt the property entails in fee ownership! Profound, huh? Plus, in a buyers’ market, the seller still has to deal with Realtor sales commissions and sales concessions to the buyer to make the deal happen, to get out from under the debt-load of the property. Not a very pretty picture, is it?
To paraphrase The Economist – The first rule of bubbles is that they always go on longer than anyone would think humanly and financially possible in the markets. The second rule is that they always eventually burst. One tenet of the Austrian Economic School is the concept and premise, proven in economic history, that the bigger the boom is, and the longer a central banking system continues the market rigging suckering everyone in on the boom by providing liquidity to the financial markets [your friendly GSEs and the use of social capital]… the bigger the eventual bust. Conclusionary Remarks Maniaville, California is but one micro real estate market with many sub-markets of varying realty, diversity, dynamics, and buyer-seller appeal. Based on our global markets contacts, it really isn’t any different here that it is in London in the UK, other foreign cities, and great towns in other parts of the USA like Denver, Atlanta, Boston or NYC. The same economic principles apply under the influence of the hypnosis of central banking systems creating money out of thin air. With the depreciation of money systems, the hypnosis is that real estate will continue to be a store of value forever. Forever is a very long time, isn’t it? After all, real estate is a depreciating asset – it is only new once, isn’t it? ©
2004 “Professor Piggington” |
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