Local economists agree that SoCal Real Estate is a great investment. It *Always* increases in value.
We took at look at this some time ago with the article “Trees Cannot Grow to the Sky” Now might be a good time to review some of our assumptions now that we have hit 0% growth in housing prices.
Is there a limit to the growth over time?
We have heard local economists such as Gary Watts say time and time again that the “average” return we should expect over the long term is 8% per year because it corresponds with typical gains for an international supercity.
I say Baloney.
To test this theory, let’s consider one of the better documented sales of real estate in the US from a long time ago, the sale of Manhattan Island.
According to the story, Peter Minuit purchased the Island of Manhattan for approximately $24 worth of Wampum in 1626 from local Native Americans. Was this a good trade? Many consider it so, however we need to look at the facts before we just come to that conclusion.
Today, Manhattan is one of the most wealthy parts of the world. It is home to investment banks, trading houses, and some of the priciest real estate in the world. Much of the world’s assets are either traded here or tracked here.
Let’s consider our Local Real Estate Economists’ assumptions. If we were to take that $24 and reinvest it in 1626 at a return of 8.065% per year compounded (We’ll see later why we chose that number, but it’s close enough to 8% for our purposes), we would end up with $140,232,329,364,918.00 in 2005. That’s a lot of semolians. Over 140T to be general. (Yes, Trillion, not billion or million). All from $24 and 8% compounding return. The stock market has done better over the past 100 years.
How much money is $140T anyway?
It’s a lot. Trust me. Not even adding together all of the assets of Orange County would come close. Neither would adding together all of the assets of California, or even the entire United States would even come close. Still don’t believe me?
Thanks to Barry Ritholtz at The Big Picture, via the Wall Street Journal, the worlds ENTIRE Financial Assets equalled $140T in 2005.
Let that sink in for a moment.
$140T represents more than 3 times the worlds entire production for a year. Do you still think that Manhattan has seen an 8% return over time? Can Orange County or anywhere in the Southland achieve that over long periods of time? And if not, what would have to be the down years after returns of 30% or more per year for several years some areas? 0% for 10 years? -5% for 5 years? -10% for 3 years?
The reality
Over long periods of time, real estate approximately matches inflation with a huge jump in the past 10 years. Real estate is normally a great inflation hedge. There are periods of time when returns will defy logic, and then snap back into line with fundamentals. However, the current period is marked by an out of control psychological mania.
To get an idea of how strong these types of manias can be, I recommend reading “Extraordinary Popular Delusions and the Madness of Crowds” also available at Amazon or B&N. They can go on for years and decades. Their ends, however, are as mysterious as their beginnings. One day, the euphoria just wears off and people go back to being normal.
Are we there yet?
Not quite yet.
I remember when the study came out in 2003 that LA County property owners expected a 23% annual rate of appreciation for the next 10 years. Bamboo doesn’t even grow that fast.
Oh, if only the masses could do a little math. Compound interest is indeed magical. What’s funny is that Warren Buffett has become the second richest man in the world by compounding his money in the low 20%/year area. Yet, after a five year period where an investment appreciates at 20%/year, the public generally thinks that is the norm. Hardly.
Maybe the sky is growing!
I am White and I was brought up thinking that I need to live with my family alone. That means Mom, Dad, and the kids. Well that isn’t what is happening any more in SoCal. Many immigrant families live 2-3 families to a home. So your home at 2X the value is easily paid for when you have 2-3 generations in the home.
Also with some other immigrants they have multiple (non related) families living in one home. These conditions are far better then where they would otherwise live, but they are not conditions that most WASP families are used to.
This isn’t something to be taken lightly. It’s the new shift in SoCal and it’s very unlikely to change. Start looking forward to 3+ families living in a “single” family home.
So the home costs may be out of line, but they don’t look so bad when you have 12-15 people in the home.
Thoughts?
Anonymous,
All of the things you said are true.
However, lowering the desirability of a location has the nasty little surprise of having people who can afford otherwise to simply leave.
In other words, its not the absolute change of desirability, but rather the relative change. In other locations, they may not have the weather, but their housing is much cheaper per sq ft. That may not matter to you, but for many people, it will. The area will then rebalance itself relative to other areas.
Think of it in this way. SoCal weather was just as good as it was 15 years ago. There were a large number of immigrants then too. They were also living many to a house then as well. Yet housing was 1/3 of the price. We in OC (or LA for that matter) are nowhere near built out. Rather, there is a large feedback lag in demand for housing and the ability to deliver. This is precisely why busts follow booms, because by the time land speculators can raise enough capital to provide supply, demand has found an alternative. Housing shortages are ALWAYS temporary.
John Doe
It’s worse than that. Recent translations of the Dutch West India Company records (16th century Dutch apparently required translation even two hundred years ago) indicate that Manhattan was only sort of purchased, and for more than $24. Basically, they obtained the right to build there, but the tribe still owned the right to hunt as they pleased AND could demand hospitality (living space and feeding for a few dozen) when they pleased. It was a change in leadership and a couple of decades before the tribe was forced to leave the island entirely.
So the conversion rate is even worse and more than $140T.
(The Island at the Center of the World by Russell Shorto is a great book. I highly recommend it, especially the introduction of why the book was written.)
IDIOTS! Let them all die by the sword of greed the weilded. I laugh everyday watching smug know it als who bragged about paying only 500,000 for a 100,000 home .
On the desirability index…
I love LA… the crest mountains, malibu, Pacific ocean, Catalina Island…
OTOH: Crime is rampant, polution is awful, mexican gangs, crowds, traffic…
Considering I have a very young child and since education is not a priority here (poor schools). I’m considering leaving.
Right now, I’m renting for 1350 per month so its not too bad. Still not sure the quality of life will be good here in 10 years.
My old home in New Jersey… 1:15 to New York/1:15 to Philly…. much lower costs… Weather is moderate and water is warmer in the summer. Appalachians are about 2hrs or less away. Beautiful trees and plenty of water.
Cost of living is 70% of here.
Chance of getting caught in a drive by shooting… about zero.
Yeah. I only feel at home in LA but sometimes I think its just a little silly. If I get an offer back there for similar money… Also North Carolina in the Research Triangle area (inland)…
LAEF2
Interesting article.
But can someone enlighten me as to why median OC home prices continue to rise going into 2007?
Bubble bloggers have long suspected a significant correction in OC occuring sometime in 2007, not to mention a predicted glut of homes placed back on the market for sale following the holidays.
Yet inventory in OC keeps declining (homes, condos).
What gives?
Are home buyers in OC saying to themselves: “Oh yeah, $642,000 is a reasonable price for this cement matchbox of a house with no basement!”.
I must be an idiot for not to understanding what OC homebuyers in Nov, Dec and Jan have been seeing…
Markus:
Wallstreatspeak: Short-term Oversold Technical bounce
AKA Dead Cat Bounce.
BTW, even with the median price down, it is clear (at least where I live in South OC) that prices are off 10% or more from Summer ’05.
Same Model comparisons
’05 1 sold for 725K
Now:
1 list for 645K
1 list for 649K
for 90+days both.
Original asking of first (now 645K was 729K)
Original asking of second was 689K)
One closed late ’06 for 635K, but after talking to one of the above homeowners, they are hoping people will ignore it as a comp based on advice from their agent.
They have serious pressure from a 4BD in same community priced at 660K with 30+days. Same model sold in ’05 for 829K (with nicer yard, but similarly situated). I didn’t go to open houses on either one, so I can’t comment on interiors, but the one on the market now has all of the normal OC accoutrements (perganiteel).
I wouldn’t be surprised if the technical bounce lasted a bit longer, but if you read the DQ numbers, it’s clear that resales are down 3% on median, and it’s the new home sales that are lifting them up. Still, volume is the primary leading indicator of shallow markets (I’ve also traded penny stocks, and technical analysis is a must there), so I would expect weakness at least through ’07 (just from a technical standpoint, not looking at any of the fundamentals.
John Doe
“it’s clear that resales are down 3% on median, and it’s the new home sales that are lifting them up.”
The new home sales prices are inflated because of the huge incentives required to move product.
I don’t think a dramatic price drop will occur. I used to agree that a large correction in housing prices were in order to bring appreciation rates to the norm of 6-7% (here in the Bay Area, that historical compounded rate of return is about 8-9%), but something else can happen, and probably will, barring a nationwide recession: house prices will stay flat for a LONG time. I think this is the most likely scenario. Based on historical data of most major metro areas, e.g. Boston, L.A., S.F., Miami, Dallas, Houston, Austin, etc… majority of the housing busts were associated with local economic factors. I know that during the 80′s, L.A. experienced rapid contraction of housing prices due to a blow out in the aerospace industry. Houston had the same effects due to the oil turmoil. Honolulu had major drops in real estate values in the early 90′s when heavily dependent Japanese tourism took a major dive (Japanese economic fallout) and Japanese real estate investors began selling their holdings in droves. Overall, though, during long boughts of economic uncertainty, housing prices in majority of the markets, including the aforementioned, stayed flat. Infact, most markets, excluding probably Dallas, has returned to their previous levels including annual compounded rates of return of 6-7%. This leads me to believe that housing prices are starting to normalize and will stay flat vs. bust. The only thing that will change that is a big recession. Even a rate hike or two won’t derail the recovery.
To the gentleman who’s thinking of returning to the east coast. I found myself in the same predicament in late 05. After a divorce which cut my income drastically I tried to eek out a living for almost six years. My rent wasn’t bad but i really had to shop hard for cheap rent in a decent area (not easy).
In a few short years I was priced out of the condo market as properties went to 2-3 times the price in just a few years. Gas shot up eventually well over three bucks. My kaiser health insurance got so expensive I had to let it laspse (not wise).
I decided like you that I’d probably fare better in another state. I sent out resumes flew out for interviews and finally accepted an offer in the south. I can tell you in hind site I should have never stepped foot outside of southern cal. Even with all it’s ills I regret leaving.
The company that hired me for a new upstart canned me in less than a year hired someone for my job at half salary. They just wanted someone to do the dirty work of an new upstart and threw good money just to get me to leave my last job. Now I’m stuck in a small town where there not much to do with or without money. Not the best situation. I’ve not looked for a job as I can’t bear the thought of staying here.
Thankfully my boyfriend’s job is keeping us afloat until I can get another job. But I can tell you that getting hired out of here to the west coast again won’t be an easy task. Be careful the grass isn’t always greener.
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