I did a video interview yesterday with Forbes’ online unit (you can see the whole thing here). This is what I look like after too little sleep and too much food:
click for video:
After one witnesses the enormous video machinery of CNBC or the new Bloomberg studios, its fascinating to see a print outlet use a simple set up and a few cameras to put up 5 minutes of video daily.
Incidentally, Forbes’ Scott Reeves has a column explaining some overlooked factors about the Real Estate boom (its worth reading). He quotes a Merrill analyst who — somewhat belatedly– discussed what we’ve been saying for quite some time now: Real Estate is the prime driver the US economy:
"We find that the red-hot housing sector alone, which typically represents just 5% of the total economy, accounted for an astounding 50% of the overall growth in the U.S. economy by the first half of this year, and more than half of the private payroll jobs created since fall 2001 were in housing related sectors," Merrill Lynch (nyse: MER – news – people ) economists Kathleen Bostjancic and David Rosenberg said in a economic commentary.
"We argue this represents an unhealthy and disproportionate share of economic growth. The over-reliance on residential investment leaves the economy very vulnerable if housing demand and prices cool–prices do not need to even fall, just a slowing in the pace of home price appreciation would have a noticeable negative impact on economic growth–not unlike the fallout following the frenzied tech over-investment in the late 1990s."
Interesting stuff . . .
>
Sources:
Awaiting Housing’s Big Chill
Forbes.com
August 23, 2005
http://www.forbes.com/video/?video_url=http://www.forbes.com/video/fvn/business/ab_maxim&id=ab_maxim&title=Video%3A+Awaiting+Housing%27s+Big+Chill&tab=Business
Don’t Believe The Hype
Scott Reeves
Forbes.com, 08.22.05, 3:29 PM ET
http://www.forbes.com/home/personalfinance/2005/08/22/investing-realestate-flipping-cx_sr_0822reflipping.html
“+ Robert Shiller, Yale economist, famous for his stockmarket book “Irrational Exuberance” published in 2000 now believes that the housing craze is another bubble destined to end badly.”
It probably will feel bad when the turndown comes. However, in many areas of the country like Ohio, Pa, Mi, Mn, Wi, upstate NY, Tx, Al, Ak, Ms, etc., there never was a a “housing craze”. I am hearing from San Francisco realtors that there is a slowdown underway and it has come rather quickly. They do not seem alarmed……..stay tuned.
Shiller had a terrific call onthe stock bubble — although in 1996, he was quite early. Some people credit him with the phrase “irrational exuberance.”
He may ultimately be right about a housing bubble, which he started beating the drum about nearly 2 years ago — suspect he’s early again . . .
(I wouldnt be surprised if he is eventually proven right)
Barry: good points about trying to time either. Better to have game plans for both asset classes and review regularly for adjustment. Without an investment plan, how can one achieve financial goals if they are undeclared?
NYT had a piece on Shiller over the weekend. Intersting bit of historical trivia over genesis of “irrational exuberance.” Shiller’s confident it isn’t his baby.
“He recently called some local markets “frothy” but emphasized that there was no national bubble.”
Well, he is determined to raise by a quarter point for the next 20 meetings. He created a “credit bubble”. Thanks Alan.
Use Reno as your barometer, baby.
We think climibing rates, stubborn oil prices (Goldman Sachs told us last week to “get used to $60 oil” after they conveniently backed off from their earlier and exagerrated $105 oil forecast), and a speculative fervor driving real estate will hamper the market for the short term as investors continue to invest in property rather than common.
Too bad, because historically, the market rocks during the Fall.
Not this year.
OK, here’s the problem. The real estate bubble warnings started in March 2000 (See Wall St Journal).
Let’s say you bought a house in Scottsdale 18 months ago for $275,000 and got scared out after 6 months at $300,000. Now, today, 12 months later the house appreciated 47% to $441,000. But, you bailed out because you “timed” the bubble. Looking back at California’s worse year in the last 30, – 3.79% (1993), and triple it, if the $411,000 house declined by 11.37% ($50,000)…..you would be out $90,000 and WHEN WOULD YOU GO BACK IN? Those who decide to actually go back in after being out, help to define and shape a financial bubble.
One thing to add to your problem though, is that the same thing happened in the stock bubble. Just because timing is off when it comes to a prediction doesnt mean the prediction is necessarily wrong.
People started declaring a stock bubble back in 1996 and 1997. In the meantime, stocks continued advancing into 2000. Furthermore, the stock market has had localized bubbles as well that, when they popped, affected other sectors of the “market” even though they may not have been connected in any way to the original bubble.
You seem to be arguing that it is not good to time a bubble becuase you could lose out on additional appreciation.
The problem with that thesis is that you are now dealing with appreciation figures that far exceed anything in past history, which make that argument hard to make. Furthermore, you are dealing with financial instruments that are far different than any other time in history (what other time in history had interest-only ARMS and cash-out refinancings)
Also, you are focusing on the getting out/getting in phase of housing, which is far different from stocks. You argue: how would you get back in? I would argue: how do you get out if you want to move or unload your asset but no one is buying? How do you adjust when it comes to real estate? A stock is a click of a button or a call and you are out. How do you adjust on a house, especially if it is bought with an exotic financial instrument?
” A stock is a click of a button or a call and you are out. How do you adjust on a house, especially if it is bought with an exotic financial instrument?”
You just made my point. The “clicking” can hurt stocks on the way down. There is no clicking in RE transactions. These “exotic” loans ARE NOT NEW! They just happen to be getting a lot of press. I make no predictions about a so called bubble. I make it my job to know the markets that I play in. However, let’s say the bubble pops next week……my property still exists, my rent still gets paid and my mortgage payment remains the same. And, if it does pop, the fed will have to lower rates again in the face of a bad economy and ARM rates will go down. I DO NOT HAVE TO TAKE ANY ACTION AND NEITHER DO YOU. (I just wouldn’t be a buyer here)
“Just because timing is off when it comes to a prediction doesnt mean the prediction is necessarily wrong.”
When it comes to buying or selling assets, thats PRECISELY what the definition of wrong means.
Either you profit from the directional move in asset prices, or you don’t. From my perspective, that is the only definition of being right or wrong.
Those people who got Bearish on equities in 1996, 97, or even 98 were wrong.
On a trade, it doesn’t matter if you miss 1000 points down — if in order to do it, it also means you miss 3000 points up . . .
There is clearly a real estate bubble when one looks at fundamental ratios such as price/income, price/rent, price growth vs. income growth, etc. However, prices continue to appreciate because falling interest rates and creative mortgage products allow people to stretch their monthly payments to afford more expensive houses. Prices will top out once interest rates bottom and the marginal borrowers exhaust their creative financing possibilities. If rates rise on the marginal buyer the market will sputter out slowly. The impact will be fewer home sales, longer time on the market, and slightly lower prices.
I believe only if the cost of owning a home (ie. interest rates rise) for the average home owner will prices fall dramatically. The only means for a current owner’s costs to rise is for their interest rates to adjust upward. From a recent article in the NY Times, about $1 trillion in loans should adjust in the next 18 months. If the Fed continues to push up the short end of the curve (where adjustable rates are indexed on), then the cost of owning a home could increase drastically for much of the country.
I believe the Fed will not stop until 4.25-4.50%. This would lead to ARMs written in the last 2-3 years adjusting up 150-250 bps. The shock of monthly payments going up 50-100% could lead many to sell their homes to lock in their “profits”, causing prices to tumble. Of course, wage growth would mitigate this outcome, but that has yet to materialize. And of course, the Fed can always bail everyone out and lower rates again.
Paul: As I have noted, these price increases are not in all markets. Som emarkets have gone up and others have stagnated.
“However, prices continue to appreciate because falling interest rates and creative mortgage products allow people to stretch their monthly payments to afford more expensive houses.”
PRICES INCREASE BECAUSE OF SUPPLY AND DEMAND.
Low rates and lower “qualifying” monthly payments have helped more particpate, no doubt.
“There is clearly a real estate bubble when one looks at fundamental ratios such as price/income, price/rent, price growth vs. income growth, etc.”
Paul: what do these silly ratios mean? If the price to rent ratio is out of historical whack, couldn’t we see rent prices go up instead of home prices go down? In fact, as prices have gone up, won’t that throw more people into the rental pool, driving up price on more demand? Just asking, not telling.
“I believe the Fed will not stop until 4.25-4.50%. This would lead to ARMs written in the last 2-3 years adjusting up 150-250 bps. The shock of monthly payments going up 50-100% could lead many to sell their homes to lock in their “profits”, causing prices to tumble.”
Not trying to pick on you: But, you are talking about the typical HELOC tied to prime. Most ARMS are locked for 1 month, 1 year, 3 years. or 5 years. And, they ALL have maximum annual payment adjustments of only 7.5%. (possibly throwing the loan into neg-am)
Posted by: Barry Ritholtz | Aug 23, 2005 3:45:19 PM
Either you profit from the directional move in asset prices, or you don’t. From my perspective, that is the only definition of being right or wrong.
===============
Barry: that is exactly why I read your site and many other smart people who have the ability to look into the near future. I’m not that smart. But, when it comes to real estate investing, I have rules to invest and live by and I don’t violate them. I don’t see periods of time not to be invested in my market, ever. I just make that the numbers work on every property going in and then manage it like a small business. That’s why I don’t buy out of state. (btw, I am looking at office condos and not residential anything)
In his new book Unconventional Success, David F. Swensen tears shreds off the mutual fund industry and concludes “Nearly insurmountable hurdles confront ordinary investors.”
There are no such hurdles facing individuals investing in their local real estate markets.
Barry,
I did not mean to argue that bubble predictors are necessarily right. You can still be in a bubble and make money; that does not mean its not a bubble.
My point was more based along the lines of a proverb that Jim Cramer’s wife (Trading Goddess) used to instill when she was a trader.
“Sell when you can not when you have to”
My overriding concern is that too many people are trying to profit from the same directional move. Usually the best course is to go against that trend, though in housing thats tricky (you can’t short homes). Whether its a bubble or not is simply a matter of semantics. The most pressing concern is what potenitally could happen if overly leveraged consumers are strained to the point of all wanting to sell at once (or being forced to)
Fascinating new article on 40 year mortgages
http://www.msnbc.msn.com/id/9042826/
When are 100 year mortgages coming?
Erik wrote: “The most pressing concern is what potenitally could happen if overly leveraged consumers are strained to the point of all wanting to sell at once (or being forced to)”
========================
If housing were to go down, “leveraged” consumers will not be any more levergaed and therefore they do not need to sell.
The media is playing a real number on people’s psyche regarding the premise that everyone will be selling once real estate stops going up.
According to PMI, the number of investor loans taken out increased slightly from 7+% in 2000 to 11% in 2005.
huh?
When housing prices decline, the underlying equity evaporates. No equity, and the loan goes upside down (you owe more than its worth). If that condition is combined with an adjustable rate or option/interest-only ARM, then the possibility exists of making rising payments on a declining asset. Kind of like a margin call for real estate.
Use the logic of “leveraged” consumers will not be any more levergaed and therefore they do not need to sell” with those people who experienced the Texas real estate bubble of the late 70’s and 80’s and the California real estate bubble of the late 80’s, or even the recent Hong Kong, British, and Australian real estate bubbles.
Now imagine that condition across multiple markets of the US and imagine that scenario.
“and the California real estate bubble of the late 80’s,”
Erik: Do your homework. There was no real estate bubble in California in the late 80’s. The market did decline (no more than 3.7% in 1993) a bit in the recession of 1990-1994. Hardly a bubble.
I PREDICT THAT THE BUBBLE IS ABOUT TO POP ON REAL ESTATE BUBBLE ARTICLES!
Erik: In San Francisco, in 1990, I bought a SFR at the very top of the market and saw that property decline ($25,000) two years later. It had no affect on my mortgage payment (which continued to go down) nor on my rent (which had annual increases built in). I did NOT have to sell under the scenario that you laid out above. So, what are you predicting?
Btw, everything that goes down, is not in a bubble just because of a decline in price……
again, huh?
Read this from CNN/Money. Seems like a particular nasty decline from 1989 to 1996.
http://money.cnn.com/2002/12/02/pf/yourhome/q_housingbusts/
In Los Angeles, home prices shed 21 percent of their value between 1989 and 1996, with the typical house selling for $172,900. (The peak was $214,800 in 1989 following a five year, 77-percent jump.)
I am not mentioning the word bubble; i agree with Barry; its not a real estate bubble so much as an unsustainable level of appreciation. But I dont discount what the bubble articles say simply because they yell bubble. I evaluate the underlying factors surrounding the appreciation. And they dont appear promising.
1. I find errors in fact and judgement in these articles daily. That’s a problem to me, for those who need the right information.
2. One can always do fine in real estate, provided you buy right.
3. My market (Phoenix) appears to be very healthy, however, I would not be investing any new money on the residential side. Meaning: the easy money has been made IMHO.
Erik: I just read the article from 2002.
“In Los Angeles, home prices shed 21 percent of their value between 1989 and 1996, with the typical house selling for $172,900. (The peak was $214,800 in 1989 following a five year, 77-percent jump.) ”
Los Angeles went through a unique period after 1,000,000 lost their defense plant jobs.
The arcticle has a box showing loss in value for some key cities. The warning: “You could years to get your money back”
Isn’t real estate a long-term investment?
Larry-
You are correct, most ARMs are locked for 1-5 years, but if they were written 2-3 years ago, then many will adjusting in the next 18 months. To be precise, $1 trillion or about 12% of outstanding loans will adjust in the next 18 months. These borrowers will have 4 options: First, pay the increased mortgage, Second, refi using an ARM (but rates have risen on ARMs), Third, refi using a Fixed mortgage (which was too expensive originally so they went with an ARM instead), or Four, sell. I believe many will elect to sell.
Paul said: “Four, sell. I believe many will elect to sell.”
Paul: That’s not what history tells us. History says that people will sell in the face of job loss.
As I have noted, they have been writing these loan for ages and increased payments did not force people into panic selling. Example: What’s to say that someone can’t go and refinance an ARM with a new option ARM with a start rate of 1.6%, providing a very low monthly mortgage? See how easily the problem gets solved?
The housing boom is ebbing, not collapsing: From today’s New York Times:
Rents are rising again across the country, squeezing tenants who are already coping with high gasoline prices and improving returns to landlords after a deep five-year slump.
The turnaround appears to be another sign that the boom in house prices and sales is finally slowing, as homes have become so expensive in many metropolitan areas that some people have decided to rent instead.
A government report yesterday also offered new evidence that the housing boom could be reaching a peak. The median price of a newly built home fell to $203,800 in July from $219,500 in June, after having risen in the winter and spring, the Commerce Department said.
Still, the number of new homes that were sold continued to grow, and economists cautioned that the recent housing slowdown could turn out to be a pause.
But rents have clearly changed direction, even if the increases have been relatively small. With the economy growing and mortgage rates inching up, more people are looking to rent apartments and homes rather than buy them. At the same time, many buildings are being turned into condominiums, reducing the supply of rental property.
“It seems like the tide has finally turned,” said Michael H. Zaransky, co-chief executive of Prime Property Investors, which owns 15 buildings in Chicago.
Larry,
Agree 1000% that real-estate is a long-term investment. The problem is that I don’t think most people share your viewpoint; to them its a bank. Yes, I think jobs are the greatest driver of underlying real estate value, but its hard to map that to the fact of anemic wage growth and uneven jobs growth.
“The problem is that I don’t think most people share your viewpoint; to them its a bank.”
Erik: you are probably right and I say, thank God. Ain’t life grand?
“Prices are supply-and-demand driven, and we have record housing demand going on in the economy today, and in many parts of the country, increasing supply constraints,” says David Berson, chief economist for mortgage giant Fannie Mae. “There’s no surprise that housing prices are strong.”