Housing Bubble?

[JayB]

I am going to have to make a move fairly soon, an event which prompted the buy-vs-rent discussion.

 

So - the first thing I tried to do was locate statistics for housing that are comparable to those available for stocks and bonds, in order to get a sense of how the current metrics stacked up to the historical averages. This meant looking at the historical ratios of mortgages to rents for similar propterties, rates of appreciation versus income growth, appreciation versus population growth, ratios of home prices to annual incomes, percentages of homes purchased by owner-occupants versus investors, traditional mortgages (20% down, 30 year, fixed) as a percent of loan originations, etc. What I found is that this sort of data, where it exists at all, is incredibly hard to come by, is of unveven quality, and covers a rather short period of time. This is important information, as I'd only be living in the place for three years - and even in a normal market that'd entail a fairly significant amount of risk as an investment - as a certain amount of appreciation is required just to break even with such a short time horizon.

 

Anyway - the short term stats that I found pertained to housing values relative to income growth, population growth, household formation, screamed anything but "Buy!," especially in the hotter markets. Ditto for the percentage of homes by investors rather than owner occupants, the percentage of homes purchased using interest-only loans, ARM, or some permutation thereof, etc. Then there's the anedotal information about condos being flipped several times before construction in Florida, people quitting their jobs to invest in real-estate full time, the popular notion that home prices can never go down, etc, have always appreciated steadily, etc.

 

This last point is interesting - as the only long-term data for US home prices that I was able to find were in Robert Schiller's update to "Irrational Exhuberance," and his data - currently the best available as far as I know - show real rates of appreciation between 1890 and the present averaged 0.4% per year, and that the vast majority of the appreciation occured in the period just after WWII and in the period since around 1997. Otherwise - no appreciation beyond the rate of inflation over the entire period.

 

Anyway - I'd be curious to see what other people think about the current state of the market? Are the increases we've seen in home prices fundamentally sustainable or not? Are we in a bubble that will result in a broad decline in house prices or will the rate of appreciation just cool off for a while?

[Peter_Puget]

JayB - Location,location location

[JayB]

True - but this is a broad national increase relative to incomes, population growth, rents - and increasingly financed by what essentially amounts to subprime lending agreements - suggests that there's more than location at work here.

 

I agree that a desireable location close to an employment center is consistent with high real estate prices, but not necessarily with rapid appreciation over and above prices that are already high relative to other areas. In those cases it seems like the fundamentals that should drive prices would be an increasing population, average real income, or borrowing power in the area under consideration. In King County, the last I heard was the there's beeen a net population loss of 50,000 since 2000, and home price increases have by now increased far faster than personal income growth or the rate of appreciation in the average mortgage that one could qualify for due to lower interest rates.

[Jim]

About 12 years ago I was debating about buying in Seattle. I was renting a 2 bdrm house for $500 a month and decided to get some advice from a financial sort. His comment was at $500 per month who needs equity? Bottom line however, is I wished I bought then instead of waiting another 5 yrs. I think Peter is correct, it depends on where you are and the market pressures. The other item is lenght of time you're expecting to be around here. If it's 5 yrs or less then rent.

 

Bottom line is that if you rent then all your money goes down the rat hole. With a house, and long-term view, you get some equity and some tax benefit. The availability of rental units in Seattle is improving with the move to increase density in urban cores related to the Growth Management Act. So rental units are pricing better than in the past.

 

If you're going to be around here a long time I don't see why you wouldn't want to buy. On the other hand you shouldn't buy just for speculative purposes. I have a friend who prefers to rent because he doensn't want to deal with the upkeep portion of home ownership - so lifestyle is a consideration.

[downfall]

Bottom line is that if you rent then all your money goes down the rat hole.

 

This isn't true in the current market. Since rents are well below the average monthly mortgage payments for a similar place you have that extra capital to invest and make money on. You also don't have maintenece costs when renting which are typically underestimated by home owners as well as most rental places include certain utilities like sewer, water, and garbage. And you don't have to pay property taxes. All in all renting, especially in the current market, will probably save you money especially if you are only going to be in the place for 3 years.

 

The best data I've seen on housing performance and bubble indicators is included in the economists housing market index (I think thats what it's called; just look around on their site and you should find it). The main statistic they look at is the historical ratio of rent to mortage payments which right now strongly favors renting in our market.

 

There hasn't been much historical data on housing prices kept which is why you'll probably have trouble digging up the wealth of info you could for other investements.

Edited May 27, 2005 by downfall

[JayB]

I agree with you about the long-term benefits Jim.

 

I also started to look at the appreciation vs. inflation, value of taxes paid on a property versus the value of the tax-deduction (deduction against income rather than taxes), typical upkeep, closing costs, broker's fees, etc. and the short term picture looked less than compelling. I also concluded that most homeowners seem to omit these costs when calculating their potential gains from a sale, and that their nominal gains (sale-price versus purchase price) typically omit the effect of net taxes, upkeep, insurance, financing costs, etc when comparing the economic benefits to other investments.

 

I plan to buy a home eventually, but it will definitely be for the long-term, and mostly for non-financial reasons.

[Jim]

I did say if one were going to be around less than 5 yrs than renting would be a better choice.

[Jim]

Absolutely JayB - when folks calculate their profit they tend to forget the intrest on the home equity loan, the remodel costs, etc. And there is the sweat equity of any home. I think it would be more fair to say you loose less, or make some profit, on long-term home ownership than renting. And if you are a savy investor you might do better than local real estate - but that seems quite a challenge these days.

[cj001f]

If you weren't scared before. 2/3's of Bay Area homebuyers choosing intrest only loans

 

An increase of margin trading activity often preceds a ????

[olyclimber]

It seems that this sort of risk is something that the Banks offering and the people taking should bear the burden of. I don't know the details of that type of loan, but basically if the market goes to pot, there is going to be more people declaring bankruptcy, if they can. I certainly hope the cost associated with the risks of these loans are built into the cost of the loan....but I highly doubt. It just sounds like a way for banks and real estate people to make money while others take the risk, if the cost isn't built in.

[PaulB]

Since rents are well below the average monthly mortgage payments for a similar place you have that extra capital to invest and make money on.

This assumes that you have the discipline to set aside the "extra" cash and actually invest it. Most people don't.

 

When you're a tenant, you're renting space, when you're an owner, you're renting money to pay for your space. Conventional wisdom is that over the short term neither option has a real advantage. Traditionally, the benefits of ownership aren't realized until a large amount of equity has been built up in the property, and the value has appreciated enough that it could be sold for a profit (not sure how it works in the US, but in Canada, that profit is tax free if the property is your principle residence).

 

These days, owning a home is more of a lifestlye choice (an emotional decison) than an investment vehicle (a fact based decision). Unless you live in a crazy market (e.g. Vancouver) where prices just keep going up and there is potential to profit quickly, there are lots of other ways to make returns on your money without the hassles of ownership.

 

That being said, I just bought condo in January, and ownership feels good (once you get used to having an almost incomprehensible amount of debt).

[RichTurley]

I have recently bought, renovated, and sold two houses. I don't get tangled up in the economics of the industry so I can't argue the value of it, but I know that if you buy a house that needs some work, and is in a good location, you will make some money. And if you live in it a while you'll make more money than someone like me who doesn't live in them. I have a friend that has done that for the past 7 years, moving up in price. He is on his last one and making plans to build the home he will live in for a good long while.

 

Rich

[ChrisT]

Is it more prescient to wait for the bubble to burst and then buy a house? Be patient with me - economics is not my strong suit. I'm actually looking for a fixer upper which I plan on taking my time to fix up.

[JayB]

From what I have seen - predicting when a market that seems to be driven by speculative investment will correct itself is a lot like predicting when an avalanche will occur on a particular slope.

 

We all know the factors that increase the risk that a slope will slide - recent snowfall, pitch, wind loading, rising temperatures, which direction its facing, etc - but there's no way to predict exactly when (or if) a slide will occur, how bad it will be, etc. Heck - Greenspan made his "Irrational Exhuberance" speech in 1996 - and for the next few years investing in stocks produced record returns, despite the alarming metrics and the chorus of voices cautioning investors to consider the risks of investing in such a market.

 

With respect to home prices - no one really knows, and all markets are different. Some areas where prices seem to be impossibly high by all of the usual metrics, the prices may continue to go up then level off for a period of years, stabilize at present values, drop, etc - there are just too many variables involved to make specific predictions about a particular outcome occuring at a particular point in time in a particular market. However, I think it is possible to look at the numbers, get a sense of the personal risk involved to you in a spectrum of scenarios - and base your decision on that information if buying a home is something that you are contemplating doing for purely financial motives (turning a profit).

 

For example, it seems clear that taking out an ARM to buy an investment/rental property in a market like San Francisco would be an incredibly risky proposition at the moment - at least for the average person who's contemplating sinking a significant portion of their net worth and future earnings into such a property.

[Fairweather]

Get the smallest/shittiest house on the nicest block.

Buy a house that is 65-75% of what you are 'qualified' for.

Get a 30yr fixed-rate...and pay it off in 15 or less.

NEVER take out a home equity loan.

 

It sounds like you and your wife's financial/employment picture is very good based on what I have read in other posts of yours. If possible, dedicate one income to mortgage payoff/debt elimination, and home upgrades out-of-pocket.

 

As for the bubble; WHO KNOWS? I would think that buying out on the suburban frontier is still the best bet. I've been looking at Wilkeson/Carbonado.

 

Remember. You will never really own your home and land. The day you default on your property taxes the government will foreclose. If you buy in King County, Ron Sims and his enviro-commie financiers own 65% of your land outright.

 

Good luck.

Edited May 28, 2005 by Fairweather

[tomtom]

Get a 30yr fixed-rate...and pay it off in 15 or less.

Huh?

 

If you're going to pay it off in 15 yrs, get a 15 yr fixed rate mortgage with a lower interest rate.

[TheJiggler]

Hmm, its not that clear to me.

 

House price = $350000 (median these days in seattle)

Going rental rate = $1300 or so for a similar place.

25% tax rate.

4.0% CD rate

0.4% return on real estate.

 

At the end of 4 years you lose about 32K from the sale. But you save around 6K by not paying rent. So net you lose 26K.

 

However if you make the rate of return 2.0% You lose only 4500. And you break even at 5 years.

 

If you wanna go for broke and put in a 7% return. Which we've been averaging in some areas. You break even in about 16 month. And at 3 years you will be about 40K ahead of renting.

[PaulB]

Get a 30yr fixed-rate...and pay it off in 15 or less.

Go variable and pay it off as fast as you can! You can lock it in at any time. Long term fixed rates are expensive insurance.

[cj001f]

Long term fixed rates are expensive insurance.

Depends on the rate, doesn't it. There aren't many people who are betting interest rates will go down

[Fairweather]

Get a 30yr fixed-rate...and pay it off in 15 or less.

Huh?

 

If you're going to pay it off in 15 yrs, get a 15 yr fixed rate mortgage with a lower interest rate.

 

Why eliminate that flexibility? Unless you totally lack financial dicipline? The rate 15 vs 30 isn't significant enough to commit to 15 years, IMO. If you're 100% certain you will be taking in your current salary (in today's dollars) for the next 15 years, then by all means, go ahead and lock it in. In Washington State, I don't know who can be 100% certain there won't be an employment bump in the road.

[Skeezix]

I bought a house in Bellingham 8 years ago for $150K. If I put it on the market today, the bidding would start at about $375K. The house is making money faster than I am.

[Bronco]

I did say if one were going to be around less than 5 yrs than renting would be a better choice.

 

Good advice, great actually. I think the stock market holds more "short term" potential than the Seattle RE market.

 

(love that guy!!)

[BrotherNex]

Houses are a great investment. The house I live in now cost 170k 4 years ago. The house next to us, which is only one story where ours it two, and on a smaller lot, sold for 360k.

Alot of the current buying spree is from the crash of the stockmarket. People see the stockmarket now as a risky market that is totally based on thealmost random popularity of any given stock. Because of this they see houses as real, viable things. They can see the value of the money they pay everyday.

 

Eventually people are going to realize that the RE market isn't all its cracked up to be and start investing in stocks. When this happens the value might drop, but if your going to stay there a long time, or own it and rent it out later, that will not matter because it will rise again. Though if you continued to rent and invested the money you whould otherwise use for your house payments and down payments into a percentage based investment plan, when the stock market started to rise again you could find yourself with a very nice portfolio and able to buy your dream house.

 

Either way, invest in RE, stocks, mutuals,or anything. Just DO NOT let your money sit in a bank doing nothing for you.

[JoshK]

Remember. You will never really own your home and land. The day you default on your property taxes the government will foreclose. If you buy in King County, Ron Sims and his enviro-commie financiers own 65% of your land outright.

 

[AlpineK]

I would think that buying out on the suburban frontier is still the best bet. I've been looking at Wilkeson/Carbonado.

 

Yeah if you want to be a sucker and spend 2 hrs a day commuting. You'll get more for your money buying out in the suburbs no doubt, but you're going to pay at the pump and waste your life commuting. Time is money after all; instead of spending your life in a car you could be relaxing at home listening to the traffic reports and laughing.

 

I'll mostly agree with your views on the home equity loan with the exception of doing major capital improvements to your property. I'd never use one of those loans to pay off stuff not related to your house.

Edited May 29, 2005 by AlpineK