Housing Still Overpriced

I stumbled across this version of Robert Shiller’s famous inflation adjusted home price index, and it provides a really great visual for what’s going on with home prices right now. The red line shows the price level we’re at now. You can see clearly that home prices nationally are still higher than ever before in history despite a 30% fall from the peak of the bubble. You don’t need to understand the math or any complicated economics in order to imagine the trajectory here will continue to head south for a while.

For those of us watching the California real estate market, there are two things to keep in mind looking at this chart. For one thing, the chart is tracking the national market. California is a much more extreme case than that represented by national statistics. It was pretty much at the epicenter of bubble price distortion and held out longer than most of the country before beginning its drop back to earth, especially in Los Angeles. So it has farther to go and will take longer to do it. Los Angeles and other west coast cities in the state are still considered to be some of the most overpriced cities in the country and therefore face a more dramatic correction ahead than most of the rest of the country.

Another thing to keep in mind is that bubbles always overshoot to the downside before reaching stability. This is evident when looking at the history of market bubbles. There is never the “soft landing” we heard so much about in the press when we were first beginning our descent. (Don’t hear much about that anymore, eh?! I guess Depression era unemployment numbers and the threat of a total banking system meltdown blew that one out of the water.) I wouldn’t be surprised to see housing undervalued before this is all played out, especially in California.

“The harder they come the harder they fall, one and all”
– Jimmy Cliff

From: Pragmatic Capitalism
U.S. HOUSING PRICES STILL MORE EXPENSIVE THAN ANY POINT IN LAST 120 YEARS
June 14, 2010
http://pragcap.com/

Recovery is Not

There is a prevailing attitude in the press that we are in economic recovery, but I would be hesitant to trust that. Off the top of my head I can see a couple of reasons we seem to be in recovery, but they are not fundamentally sound.

One is that government bailout money and incentives have temporarily supported the housing, auto, and stock markets as well as the banking sector. Much of the banking system is in a “zombie” state, meaning it would be bankrupt, dead and gone if the government wasn’t supporting it with tax dollars. All this bailout money went to the banks so they could continue operating and lending, but they have hoarded the money instead of lending and made a lot of investments for themselves in the stock market. In this way the stock market has been artificially supported and is riding much higher than fundamentals would have it. The housing market has been supported in too many ways to count. The government has been the sole investor in mortgage backed securities since the crisis hit full force in 2007. They’ve been buying a bunch of junk assets way over market price (or WE have, actually, as tax payers). They’ve been subsidizing home buying with tax credits and wasting a whole bunch of money on foreclosure prevention that is totally failing and in my opinion unethical to start with.

But the time has come where the money well is running dry. The mortgage buying scheme has ended. The tax credit has ended. Unemployment insurance extensions are ending. The efforts to stop foreclosures have all failed and been a complete waste. Citizens are growing angry. They no longer want to support all this nonsense. Renters and responsible homeowners are tired of paying for other people’s financial folly. The middle class grows poorer and the poor grow desperate. The powers that be are going to find themselves having a harder time getting support for this sort of aid to the irresponsible. Traditional economists say we need more bailout money, that we learned from The Great Depression we need to keep spending. Perhaps this would have been a viable plan if we’d invested those tax dollars more wisely. In any case, I doubt it will continue because people are becoming distressed about it.

Everyone’s excited that we’re in a recovery and consumer sentiment is up. Spending has increased. Well, I hate to be the bearer of bad news (no, actually I love it- the truth sets you free!), but there is no fundamental support for this sentiment. Unemployment continues, property prices are still moving downward, the stock market is creeping down as well and most importantly there has been absolutely no increase in household income. So where is the money coming from to support this spending? For one thing, people have stopped saving again (after a brief move out of negative territory in the wake of the crisis of 2007). For another, they have stopped paying their mortgages en mass. They are living in their houses but not paying mortgages, insurance, or rent. That’s a pool of money that adds up quickly, and as fast as it does people are spending it. Banks are so overwhelmed with the backlog of distressed property on their hands they are taking up to two years or longer to process foreclosures and evict the squatters. That’s a lot of spare cash redirected into the marketplace. But of course it won’t last forever.

Don’t believe the hype. Be prepared for a second leg down. Banks are beginning to miss thier TARP payments and many are at risk of failure. The FDIC is in the red. California is definitely not out of the woods. The situation here is extreme. There will be more cuts in the public sector. There will be a second wave of foreclosures in the mid to upper tier housing markets. There is even a possibility that Los Angeles may be forced to file for bankruptcy. That said, I leave you with words of wisdom from my old fictional film friends and spiritual advisers, Bill and Ted,

“Be excellent to each other.”

L.A. Housing Still Too Expensive

The So Cal housing market is still vastly overpriced in the medium to high price ranges.  The subprime blowout has caused lower end markets to drop closer to sustainable prices in areas like Riverside and Lancaster.  However, medium to high range markets have remained stubborn in returning to affordable pricing.  This is due to a number of factors.

For one thing, the medium to high priced housing market is supported by more financial cushion, as opposed to the subprime where people tend to live paycheck to paycheck with no buffer.  When funds become short for low income families there is no extra money to keep them from slipping right into foreclosure and bankruptcy.  For another thing, the reset dates for subprime loans have come and gone already and we have worked through that end of the “exotic loan” funded housing crisis.  However, this is not so in the medium to high end Alt-A and prime lending markets.  The exotic loans originated for this sector had much longer teaser rate periods before recasts would set in.  There is a huge tsunami sized wave of Option-ARM loans just now beginning to recast.  The medium to high range market will see vast numbers of foreclosures over the next two two five years.  Areas where prices have held up relatively well so far are now going to fall in much the same way the subprime areas did.

When the higher end markets start to fall in price the low end will see further reduction due to the downward pressure.  The further collapse of the housing market comes at a time when there is a huge level of unemployment.  California has one of the highest unemployment rates in the country.  We are also in the middle of a huge budget crisis with years of further revenue loss ahead, which means more unemployment.  Former Mayor Richard Riordan predicts bankruptcy for Los Angeles by 2014.  Mayor Anthony Viaraigosa is proposing massive cut backs.  Banks are not lending and access to credit continues to dry up.  Commercial real estate has begun to follow the collapse in suit.

How do we know when real estate is fairly priced at sustainable levels?  One key indicator is to look at income to price ratios.  Put roughly, the median household income in any given community should be able to support the median price of a home there.  In this respect Los Angeles is still very overpriced.

I recently took a closer look at the situation in the city of Burbank, for example.  The median annual household income is around $65K.  The traditional formula for measuring the affordability of a house is that the price not exceed 2.5 to 3 times annual income.  That would place the correct median house price in Burbank at $195,000.  The Los Angeles area has historically run a little bit higher in that ratio, with prices running around 3-3.5 times median income.  Even if house affordability is evaluated at four times annual income, the median home price in Burbank should not exceed $260,000.  The current median home price in Burbank is over $500,000.

To comfortably afford a $500,000 house, household income would have to be $200,000 a year.  Fewer than 5% of households in the whole nation make that kind of money.  The average household income in LA County is around $55,000.  The average household income in the city of Los Angeles is under $40,000.  And these are numbers that may diminish as unemployment persists.  Housing has a long way to fall in this neck of the woods.  And it will.

Burbank median price:
http://www.zillow.com

Bankruptcy for LA:
http://www.latimes.com
http://money.cnn.com

Option ARM resets:
http://financemymoney.com

Interest Rates: Buy When They’re High

I have written on this topic before but I believe it is worth reiteration, as some of you have voiced concerns recently about rising mortgage interest rates.  It is GOOD news that interest rates are going up for anyone looking to buy property.  Many articles you read will say rising rates price people out of the market, but this is true only inthe very short term.  Longer term, higher rates force housing prices down.  Whatever the economic forces at any given time, life goes on and people need to sell houses.  On the other side of the equation, buyers have a limit to what they can afford.  When interest rates are high people are forced to sell at a lower price in order to compensate and make the property affordable.  Conversely, when rates are low prices are allowed to climb.  The housing bubble of the last decade is a caricatured example of what happens when interest rates on mortgages are very low.

It is much better to buy when home prices are low and interest rates are high.   For one reason, the home can be refinanced later when rates fall, which they will inevitably do before you pay your loan off.  The initial purchase price, on the other hand, will forever be fixed.  If you buy at a high price you will be stuck with it.  Real estate investors know there is a lot of money to be made by purchasing when rates are high and selling later when rates are low.  The price trajectory runs opposite to that of interest rates.  (It’s also probably easier to sell when rates are low because people think it makes expensive houses more affordable when it really doesn’t!)  Another reason to buy when rates are high and prices are low is that you will pay much lower property taxes.  Property taxes in California are based on the purchase price of the home.  That will save a tremendous amount of money for you over time.

It is not wise to buy when rates are low because you will pay top dollar for your house.  Then there is nowhere to go.  Rates can only go up, which eliminates the option of refinancing.   And as interest rates inevitably do rise, your home value will in turn be forced down.  You could well end up in a situation where you are “underwater,” owing more on your house than it is worth.  When this happens you are automatically shut out from any refinancing options and become trapped and unable to sell and get your investment money back.  This becomes very troublesome in the event you need to move.  You cannot move without facing great financial loss, credit damage and possibly bankruptcy.  And life tends to go on- people move for all sorts of unpredictable reasons.

When you count on a low interest rate to make a house affordable you really cannot afford that house.  You put yourself in a very tight and dangerous spot.  Buying when rates are high will leave you with the proper amount of wiggle room and you’ll save a tremendous amount of money over the long haul through refinancing.

Low interest rates are only good for the purpose of refinancing.  If you are wanting to refinance, now is still a good time.  Despite the rise in rates we are seeing historical lows.  All this said, I don’t think rates are going to go high for a long time.  They may even go down again.  The “recovery” in housing you hear about in the press is government sponsored and illusory, and that’s about to run dry.  I’m guessing we’ll see low rates overall on top of continued price correction to the downside.  The post housing bubble economy is a very odd market indeed.  The best time to buy in this climate is after you see a consistent (non-government funded) climb in home prices at around the rate of inflation for a year or two.