Chuck Ponzi June 27th, 2005

Is anyone else here bored of hearing about real estate? If the din of clamoring for a piece of dirt hasn’t left you stiff and sick to your stomach, sit right down and let’s talk about it more.

Recently, there have been an avalanche of new articles released in the press media about the real estate bubble. In fact, it’s so common, we no longer need to use quotation marks, kinda like the Great Depression. What it still lacks though is the proper noun status… maybe that is still to come. This gaggle of new stories has some interesting twists to it. First, I started noticing that there was a clear divide of opinion. Academics and economists (not associated with real estate) almost always warn of danger in the housing markets. On the other hand, self-proclaimed real estate experts, builders, and “investors” (note the proper use of quotes to show disdain) opine that no bubble exists in their town. Their babble seems eerily familiar to each other, they all decide their neighborhoods are not in a bubble, often for the same reasons. I have highlighted some of the most common for the sake of sick curiosity

1. Everybody wants to live here. Seriously. I have heard this from nearly 25 locales. These include some obvious places like San Diego, Los Angeles, and New York. But, you may not also realize that people in places like Florida, Connecticut, Arizona, New Mexico, Virginia, Washington, Oregon, Nevada, and even Minnesota have said the exact same thing… Can you believe that? In fact, never once have I ever heard anyone say that their home town is not desirable. Could it be that this opinion is just a little biased from the writer? Or, is it possible that truly everyone wants to live every place? I have heard this argument from people in Los Angeles, and believe me, noone wants to live in Los Angeles. It gets old very quickly. Besides, are there any hard facts to back this up? Do we have a national raking of best places that “everyone wants to live”? I think this would go a long way to silence those in Kansas City, MO, defending their speculative bubble.

2. Retirees are flocking here. This is a derivative of #1, and has been noted in the same locations. This is also interesting because it forebodes legions of baby boomers with vast wealth accumulated over 40 years of hard work and copius savings, willing to plunk down a sizable chunk of their retirement money regardless of price, just to have the right location. This in effect would mean that local economies don’t have to be a driving force in price and affordability, since well, everybody wants to live there. While I know that retirees usually have more money than I, I also know that they want to get the most for their money. I have a hard time seeing this one, and frankly a list like #1 would be helpful, something like, “best places to retire” list just so we can settle it. The study, however should not look at the cost of living, because, well frankly, they have all the money in the world, so who cares how much it costs?

3. Immigrants are driving up prices. This assumes that immigrants buy homes in as high or higher ratios than exist US homeowners. While we all know that the population is growing, this also assumes that with the doubling or tripling of prices, immigrants have unlimited price elasticity. They will buy, no matter the price. However, unless you’re a criminal in your own country with no extradition treaty with the US, why would you want to buy a 2 Bed cottage in San Diego, Connecticut, Virginia, or Oregon for the same price you could have a mansion, servants quarters, and servants in Buenos Aires?

4. Foreigners are driving up prices. This would a derivative of #3, but worth looking at. This would assume that wealthy foreigners with money coming out their ears, see no better way to spend their Euros, Yen, or Yuan than to invest in some real estate in the US. While the US dollar is remarkably weak, you would need to assume that these foreigners either plan on settling here (as in #3), or they are interested in some fairly risky currency speculation with unbelievable transaction costs. I find this a little hard to believe. While a vacation home in Yalta, Spain, or Italy seem believable, and perhaps even San Diego (it’s a stretch, I’ll admit), non-full-timers would more likely be interested in timeshare or luxury timeshare rather a separate property with all of the taxes, fees, maintenance, and headache that this presents.

5. Job growth is great here, and only recessions trigger housing downturns. This is really 2 issues, but intertwined. I can’t speak for other areas, but it’s clear to locals in SD that our entire economic rebound is based on housing. This includes real estate agents (too many to count), loan processors, banking, construction, architects, surveyors, cement, building suppliers, contractors, home improvement stores, oh… and let’s not forget nearly every retail job within 50 miles that is supported by home equity. What their disputing is that things can’t go wrong because that’s what policy makers tell us. Is it possible that despite UCLA’s economists’ predictions that we are entering a recession are right, and that policy makers are telling people this to keep panic from ensuing? The second is really a question… do recessions only trigger housing downturns? Just because the last one did, does that mean all of them do, or that it is a prerequisite? I have a hard time swallowing “always” for most anything. I don’t see myself as a contrarian, I just have learned that most rules have exceptions. Perhaps, this isn’t even a rule. How can you base a theory on a few data points? This gets into the realm of sociology, and consumer sentiment. Last time I checked, this is difficult to predict with single events without understanding the environmental factors. Humans do strange things when put in strange circumstances.

Well, if this has struck any of you as strange, feel free to post any other interesting defenses of price increases. I’d like to hear if any of the can truly be translated from one statistic to specific price increases through long-term trend analysis.

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Chuck Ponzi June 19th, 2005

June 15, Dataquick pronounced the death of reasonable real estate speculation in San Diego. Although they didn’t say it specifically, it’s easy to read into their statistics. You’d have to be insane or stupid to put your “investor” money into real estate: the annual price appreciation dipped below 10% for the first time in 6 years. From May 2004 to May 2005, the rate of appreciation registered a measly 7.5%.

While some would argue that this is not a bad return, after all, the stock market only averages 12%, and can’t always be depended on to even return anything. This is true, but what is more important about real estate is its illiquid nature and high transaction costs. You can’t sell your house for $9.95 on E*trade.

The recent spate of “investors” buying up properties, renting them for a year, and dumping them for a fantastic return in a year is at an end. We will no doubtedly look back to June 15, 2005 as the day the bell tolled. With such rapid deceleration in price increases, there has been a rash of people ready to “call the top”. So many articles come online every day, John barely has time to read all of them, much less comment on them all.

Now, one might ask how I come to the death of speculation… After all, 7.5% isn’t that bad… Well, you have to look at the numbers. Transaction costs, I mean. Holding costs…, all out of pocket expenses we can expect here in California. Here are a couple, if it’s a smooth transaction. Real estate disputes such as title disputes could make this much, much messier:

1. Realtor brokering costs. Many people mistakenly think this is 6%. Actually, you will more likely pay 5.5% due to current market conditions. So, we’ll give them this one.
2. Purchase closing costs. Typically, these run 2-3% of the purchase price, but since prices have doubled in recent years, I will be generous and give it 1%. This pays for origination fees, title transfer fees, document fees, appraisal fees, etc…
3. Sales closing costs. Typically, these run 3% on top of the brokerage costs due to title transfer insurance (1% alone), inspection reports, and a myriad of fees. I sold my home in May 2004, and found that I spent 2.5% of my sales price for ancillary fees, but I am willing to concede to 1%, just to be non-contrarian.
4. Yearly taxes. This is a biggie. In California, property taxes are 1.25% of the purchase price minimum. No exceptions unless you want to lose your property to the state.
5. Vacancy costs. Typically, 15% vacancy is normal. This means, it takes you some time to find a renter, move them in, move them out. This is really low, and would most typically be much higher with a short-term rental. I am going really low here, but .5% is the absolute minimum of the purchase price. This means, basically $2500 for a $500,000 house (about 1.5 month’s rent)
6. Rent Shortfall. This is really going to blow you away. In San Diego, it is a fact that rents are only 40% of the cost of owning. This considers out of pocket expenses. Considering that you can typically rent a $500K house in SD for about $1800 per month (I know since I live in one and rent it for that amount), the typical out of pocket expenses for this loan will be $3600 per month (not including the taxes I included above). This amounts to $21,600 per year shortfall, for a 4.3% of the purchase price total.
7. Average time to sell. Average time to sell is now 2 months. This means, you need to move your renter out and put it on the market. Holding costs being $3600 per month, or .72%, for a total of 1.44%

In total, you need to appreciate 14.99% in the year to break even. If you’re only getting 7.5%, you have a 7.5% shortfall, or about $37.5K for a median home.

While most prudent investors have left the market (and never dealt in single family dwellings in the first place for the reasons I mentioned above), novice investors perhaps don’t see the risk of losing, and might just hold on for a few more years. While you can spread out the nonrecurring costs, hoping to at some point break even, your money become even more illiquid. You really need to be in for the long-haul. Exactly the point that I am making. The fast money is over. The tombstone is carved, and placed above the buried coffin. It’s already in the ground. Anyone arguing otherwise is not working with the total picture.

One last argument that would be “investors” could make is about the tax benefits… Well, just think about all of the capital losses you can deduct on your tax return. It’ll really reduce your tax base.

Short-term investors are also notorious for offloading bad performing investments as soon as possible. None of us would be surprised if there is even more inventory on the market in one month’s time. Prices peaked in December 2004, and as soon as we see year over year appreciation rates of 0%, panic should set in nicely. For those a bit more prescient, the game is already over.

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Chuck Ponzi June 12th, 2005

For those who have checked back, waiting for my next post, I thank you for your patience. I have been on quite a trip, and currently am in Ireland. During my travelling, I have continued to read as much as possible about the ongoing bubble in Southern California and the rest of the US. Reflection on my experiences reminds me of a quote by Douglas Adams:

“Human beings, who are almost unique in having the ability to learn from the experience of others, are also remarkable for their apparent disinclination to do so.”

As I read, I find that the discussion of of a real estate bubble becomes more and more divided. Those on the “boom” camp, nearly almost always point to history (recent history only, the old stuff is boring to them), saying that the old rules are not important, and simply not worth looking at. Those on the “bust” camp nearly always rely on the “fundamentals” argument, citing examples of rents, wages, and interest rates. I find myself solidly in the “bust” side, thank you.

A great article came out recently highlighting something that surprised me before my travels to Europe: many of the world’s industrialized nations are experience extensive real estate price increases. What’s surprising is that the numbers are so much higher than their historical averages. The US has averaged 1.3% per year since 1971, but 13% in 2004, ten times the lst 35 years! Anecdotally, an acquaintance told me that his house in rural Ireland was worth 80K Euro when he bought it 8 years ago, but that it would now fetch a price of 700K Euro! He doesn’t plan on selling. Ireland has averaged 3.4% the last 35 years with 10.8% last year.

What we’re seeing is that real estate is a global obsession. The article from the New York times points out an interesting, but dangerous phenomenon. When the US cut interest rates, this did not only have an affect on the US economy, it affected the entire world by providing cheap money. Being in an increasingly global economy means we will not only affect our own asset prices, but those across the world. While this doesn’t mean I will be changing the blog to a global real estate bubble site, it would be useful to keep an eye on what is happening across the pond as well.

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