The San Francisco Real Estate Blog

I'd guess that, at this point, the "bigger fool" theory is driving this. It would be interesting to know what percentage of sales is from one speculating property-flipper to another. If the bubble pops, new speculative buyers will become nonexistant overnight.

Another interesting stat would be, what percentage of properties (especially condos) that were bought during the steepest part of the price runup are held by someone holding more than one property? These people might have a very high exposure to interest rate hikes, and it might not take much to push them over the edge - especially if some of the properties are new builds without paying tenants.

If people are starting to make "new paradigm" noises, it's time to sell. NOW.

My wife's a broker here in Ventura County, and I was reading something in one of her trades the other day, citing the Mortgage Bankers Association. It said that in the last half of '04, 2/3 of mortgage originations were ARMS or Interest Onlies.

The bubble is going to pop, and the carnage is going to be severe. The banks get the properties and they will also be able to attach the borrower in near perpetuity as BK will no longer be an option for these folks.

Cynic that I am, I have to wonder how much of this bubble was contrived by the administration. Bush needed an economic turnaround prior to the election. He certainly got one...of sorts. I work in the industrial sector, and from that vantage point, I saw no recovery; wages stagnating, orders down, investment in capital equipment down, raw material prices higher along with energy costs.

It looks to me like an awful lot of the 'recovery' involved Americans selling their houses to each other.

RE: Lee's comments - I work in industry (sales) and we are hving second record yeearina row.Demand is up across the board,in spite of runups in oil related raw materials.

I think every president (I can rmember back to LBJ) has concern about interest rates and housing - I am not so sure about the ability to manipulate the outcomes. The market has a lot of power. I doubt the Bay area real estate buyer is marching to Karl Rove's plan.......

Many people throw around the adjective "bubble" to almost anything these days - housing, oil, hedge funds, etc... There is actually an empirical measure - a price level that is 2 standard deviations above the long term trend. GMO (an institutional money manager) has studied this topic and found 27 historical bubbles in stocks, real estate, commodities, currencies, etc. globally. EVERY bubble eventually reverted to the long term average!

So is housing a bubble? Many of the major cities are - places in CA and Boston and others are actually 3 standard deviations above trend and would have to fall 25%+ in real terms over a 5 year period to get back to the trend. This flies in the face of those who argue that prices won't/can't go down. Other areas of the country are simply expensive and prices are likely to flatline and/or decline slightly.

The problem with all of this is that bubbles are fairly easy to identify but extremely hard to time. The US stock market reached bubble levels in 1998 yet exploded higher for almost 2 more years! Once behavior becomes detached from economic value, people can get crazy. For anyone who doubts this just read the history of the tulip mania in holland in the 17th century.

The final days of a bubble are often the most explosive - the nasdaq doubled in the last portion of that bubble. So, markets could get much more nuts before they fall. Finally, the broader risk is that of the impact on consumer spending - which has been hugely dependent on cash out refinancing. Also, Merrill Lynch put out a report recently that estimated that well over 1/2 of all new jobs since 2000 have been real estate related - what happens when that reverses?

The runup has taken prices to dizzying heights, but all of this "bubble popping" hype is overblown. This is not a highly liquid market. It's estimated that under 5% of homes are owned by speculators, and that may be very high. Everyone else faces high costs and tax implications of a quick sale, not to mention having to find somewhere else to live, meaning that a meltdown is almost impossible.

Even a 20% decrease in prices wouldn't cause your "bloodbath". The media will hype it, of course, but we could easily see a 20% decrease in the AVERAGE price of a home sold just by reducing the number of $5 million+ homes sold, and without impacting prices in certain bands (like 800-850K) at all.

The use of ARMs and interest-only notes is troubling, but the ability of homeowners to pay their mortgage won't cause a meltdown either. Even a drastic hike in interest rates will have a significant delay before it's felt here -- those ARMs won't adjust overnight. You're hoping for a panic, and those are extraordinarily rare in real estate because it's so illiquid. Most homeowners will fret, but will stay home.

The Bay Area has the lowest home ownership rate in the country, and that's what really should be troubling you, because it has all sorts of societal implications.

I love the twit who thinks the bubble was contrived by Bush -- talk about your conspiracy theories!

"The banks get the properties and they will also be able to attach the borrower in near perpetuity as BK will no longer be an option for these folks. "

Actually, here in California we have deficiency protection -- meaning that the borrower, after foreclosure, cannot collect the difference in the value of the loan and the amount recovered in foreclosure -- so bankruptcy isn't even necessary. I don't know if that's a federal or state statute, but even if it's a state statute, I doubt California is the only one offering it.

Which actually makes the current speculation even more insane, since lenders underwriting these inflated loans stand to lose almost as much as the borrowers.

I looked at a study of the collapse of the housing market in California during the early 90s, just the other day. The results were, for the particular market that they were looking at, there was about a 25% drop in valuation, and for California overall there was somewhere around a 15% drop. Those don't sound like huge percentages, but for a $700,000 home, it's a six figure loss. However, the problem becomes even more compounded by the mortgages people have. If interest rates rise payments become higher, and this sometimes forces people to sell. Suddenly to get out of a house that you might not be able to afford the payments on you have to come up with tens of thousands of dollars or default. The situation causes people become upside-down in their investment, with no way out. The whole process is similar to buying stocks on margin.



The market may, however, not collapse. If there are enough investors who don’t have huge debt to equity ratios, then the market may pull back or stagnate for a few years while other markets catch up to correct the imbalances. The investors in your area have to be willing to take a 15-25% hit on their investment, maybe sell a property to cover some of the payments on the rest, and considering how much money investors in the housing market have made over the last 5-8 years losing 15-25% doesn’t sound like much of a problem for careful investors.



One other item from the study was that a drop off in the number of houses sold (10-20% drop) preceded the large drop in price (the price declined slightly), by about 6 months to a year.

I have to agree with the illiquidity statement for various reasons:

1) in other markets the price per 'share' is small enough so that (with the exception of Birkshire shares) anyone can buy a few shares here and there. You can't buy a few 'shares' of a house (yet?). Therefore the total housing market experiences severe stratification: the behavior of buyers in the sub-$500K level rarely affects the market at higher levels.

2) I live in Georgia but have spent some time in the bay area and while you guys might _think_ that places like Santa Clara and Redwood City are different cities, they really aren't. They're just exit numbers. But you guys do have very significant 'pockets' that for some strange reason seem very independent of each other when the only difference is one more exit further along 101. So you might have a bubble in one 'city' but still have room for appreciation in a 'city' that's just a mile a way.

3) Even if you do experience a bubble you can _still_ take a 20% value hit and buy 5 times more house out here for cash. 6600 square feet on an acre next to a state park that's considered close in (even though its still OTP) goes for $400K. So sell that house in SFO and come live like a king out here!

-MM

The May numbers came out just now and May transactions were the second highest in history AND they came with a price rise over April and YonY.
In 1997 Bill Clinton signed a Republican tax bill that allows a couple to exclude $500,000 every 2 years from capital gains. Real estate is far and away the most tax-advantaged investment in the US. The 10 year note is back under 4%-mortgage rates have gone DOWN since the FOMC started tightening. Since no one is changing the tax law, and the rates are NOT going up, there won't be a dramatic correction in primary home prices. 2nd homes and resort property maybe slump a bit but the worst that will happen in primary homes is a leveling. When people call an investment a bubble it ain't one.

Brent writes about the 1990's reduction in home prices. That was primarily a Southern California issue although it did spill a bit to the Bay Area. It was caused very directly by the elimination of hundreds of thousands of defense industry jobs due to the end of the Cold War. Since the Southern California economy is booming, unemployment in places like Ventura County and Orange County are sub 4%, family incomes are at all time highs and demand far outstrips supply in the housing market the 1990 scenario is not relevant to 2005.

TO: Lee
RE: Malevolent Intentions

"..I have to wonder how much of this bubble was contrived by the administration." -- Lee

There might be some truth to the idea of nefarious parties involved in a 'conspiracy' {horror!}. But I wouldn't let your political predilections limit the range of possible parties involved.

I think the banks and loan companies are more likely to be at fault. Something to do with a land-grab while making money in the process leading up to the grab part.

I don't think we've seen that sort of activity on such a grand scale before. Maybe something like it during the collapse of the economy at the start of the Great Depression, but that was only indirectly. This will be something completely new.

The banks will have 'lost money' on defaulted loans and claim said loss on their IRS statements. Then, they'll seize the property and sell it at whatever the market will bear. However, since they'll have a LOT of property, they'll have the marketplace pretty well cornered. The government will have to keep a very close eye on them to prevent unfair business practices (price fixing) from occuring.

Regards,

Chuck(le)

Look to the UK, you are about 6-18 months behind the UK cycle.

Volume has collapsed. Rental Investment yields are below keeping money in cash.

Prices have started to slip, and BtL investors are starting to sell.

Monkeydarts is correct in pointing out that there were many contributing factors to the early nineties crash in California, and I didn't mean to imply that a crash or pullback was going to happen tomorrow. I was just looking, because my parents, and extended family have a lot of property in Naples, Fl (the highest market in Fl), and I wanted to see the general mechanics of how a real estate crash might occur, and what the losses might be. It turns out that generally the losses are manageable if people are careful not to overextend themselves, and a drop in sales numbers may be a leading indicator on the real estate market. By the way for little more then a median priced condo in the bay area you can get a small condo across the street from the beach in Naples.

Real estate is only of value if the local economy provides jobs so that people have the income to
pay mortgages. I personally have seen many communities where housing prices have fallen through the floor when the local economy slumped.

Contrary to the claim above, people don't necessary hold onto their homes if the market falls. If they have been laid off, they HAVE to
sell-- even when it means taking a loss -- so that they can move somewhere else to get a job.

If they have any equity in the home, the bank will foreclose quickly --as soon as some payments are missed -- and sell the home at a low price in order to recover their principal before the house depreciates in value further.

E.g, If someone has $300,000 equity in a $800,000 home (with a $500,000 mortgage), then the bank may foreclose and sell the home for $500,000 just to get their principal. The owner is forced to take the $300,000 loss.

If the home only sells for $400,000 then the homeowner may have to cough up the additional $100,000 from personal savings if he wants to maintain a credit rating ; i.e, if he ever wants to take out a loan again.

At one time, a person could declare bankruptcy but the new FEDERAL bankruptcy law makes it a lot harder. I don't know if the new law lets a bank file a lien on personal assets to gain the rest of the principal in a mortgage.

Compare the rise in housing prices with the corresponding personal income for an area.
Given the competition that Silicon Valley faces from China and India, I don't see why homeowners expect a booming economy in the next decade that would justify bidding up prices.

Chuck Pelto implied that the evil banks somehow want to own real estate. This is hogwash. Every month the bank owns some dirt or a house represents a massive loss on intitial investment. Banks truly have no interest in forclosing seeing as the average forclosure takes almost a year. Each month the hit gets harder. That's time where the bank collects nothing on its initial investment, and the house degenerates from non-maintanace.

I'm in Salt Lake and it can be estimated that on a cheap forclosure (sub $250,000) a bank will lose something close to $75,000 for a laundry list of reasons. That figure is rough and dirty and says nothing of lost interest and the stagnant investment problem, aka, the longer the length of time between vesting, the smaller the rate of return. Over hear in Utah-land, the bank forfeits all proceeds above intitial investment back to the defaulted buyer, so a turn for profit is impossible. I don't know how that works in Cali.

I agree that the availability of cheap money and interest-only loans have saturated many markets with amatuer investors, but ultimately, real estate will always present investment oppertunities to the wise.

All those exits on 101 might look the same, but there's a big, big difference betwen Palo Alto and East Palo Alto.

Oh, yes, I forgot to mention forced sales of homes by Sheriffs to collect back taxes.

Here's a contrary view: http://www.marginalrevolution.com/marginalrevolution/2005/06/bubble_schmubbl.html

Wow, it didn't take long for that jackass to claim that the President of the United States somehow is responsible for real estate investment. Well, I'm game. It's supposed to rain this weekend, and if it does, do you know who I'm going to blame?

BOOOOOOOOOOOOOOSSSSHHHHHHHHHHHHHHHHHHH!!!!!

Housing is not like the stock market and the bubble popping will look much different. Condo's can and will collapse in price, as it is where speculation is most highly concentrated. The rest of the market would likely unwind more slowly as the natural turnover in homeownership sets the marginal price level - job losses, transfers, moving for whatever reason.

However, a 20% decline in housing is HUGE because of the leverage involved. Many of the buyers of the past 3 years are putting little or no money down and using "innovative" mortgages to get into the homes. A 20% decline would wipe out most if not all equity and put many upside down - with no incentive to stick around and pay a mortgage they can't afford anyway. Even with prices at all time highs, home equity is at ALL-TIME lows. This suggests that there are many with little room to spare on the equity side should prices fall.

Again, the bigger impact may be on the job market directly (via mortgage and real estate businesses) and indirectly (via retail). Cylces tend to snow ball and once this one does it will get quite ugly.

California has anti-deficiency statutes which bar lawsuits by lenders against buyers of residential properties of 4 units or less. Without these statutues, lenders in California would be able to sue the borrower for the lender's losses after a foreclosure sale returns less than the amount owed.

In some other states, borrowers do not have these protections but they have been able to avoid the loss of remaining assets and income to the lender by filing a bankruptcy. Now with bankruptcy "reform," I suspect that these other states may respond by enacting, too late, some form of anti-deficiency statutes of their own.

According to the Bureau of Economic Advisors,
Per Capita Personal Income For the San Francisco-Oakland-Fremont MSA FELL from $48,343 in 2000 to
$46,958 in 2003 (-2.9%). For the San Jose-Sunnyvale-Santa Clara MSA , it FELL from $53,415 to $46,072 (- 13.7%).

Looking at total Personal Income for those MSAs, it FELL in San Francisco-Fremont MSA from $200 Billion in 2000 to $195.2 Billion in 2003 (-2.4%) . For the San Jose-Santa Clara MSA it fell from $92.9 Billion in 2000 to $79.8 Billion in 2003. (-14.1%)

Ref: http://www.bea.doc.gov/bea/regional/reis/

Detailed Data by MSA for 2004 is not available yet. However, personal income for California as a whole rose by 6.1% in 2004 and per capita personal income was up by 4.8%. Since the San Francisco area makes up about 29% of California income, I would think the San Francisco area would have roughly similar rates.

This is inline with FDIC data showing a significant drop in San Francisco employment between 2000 and 2003 with some recovery last year:
see http://www2.fdic.gov/recon/linechart.asp?CONCEPT_CODE=E10&GEO_CODE=7360

The fall in employment in the San Jose area has been even more severe since 2000, with weakness even in last year: see http://www2.fdic.gov/recon/linechart.asp?CONCEPT_CODE=E10&GEO_CODE=7400

Note however, that the FDIC report for California indicates that most of the employment growth in the San Francisco area was in housing related work -- which could disappear if interest rates rise and choke the housing boom. See Chart 1 at
http://www.fdic.gov/bank/analytical/stateprofile/SanFrancisco/Ca/CA.xml.html

So what supports the rise in housing prices in San Francisco? Other than ill-founded speculation?

Answer: High housing prices are supported by the incompetence and sloth of the San Francisco Board of Supervisors.

That seems to be a pretty solid foundation -- akin to granite.
See http://www.ci.sf.ca.us/site/bdsupvrs_page.asp?id=17966

TO: All
RE: Kelo

Funny....how things seem to all come together.

Here we were, this morning, talking about a housing bubble and I suggested that maybe the banks and mortgage companies were in cohoots with each other to do some land-grab business.

A few hours later the Supremes do something I thought was literally impossible, overthrow the home-owner for the sake of PROFIT.

Regards,

Chuck(le)
[I believe in 'coincidence'. I just don't trust it.]

TO: Sean Neves
RE: Really?

"Chuck Pelto implied that the evil banks somehow want to own real estate. This is hogwash. Every month the bank owns some dirt or a house represents a massive loss on intitial investment." -- Sean Neves

How about if they can pimp a deal with some developer for a tract of land that is favorable for development? Especially in light of Kelo?

Regards,

Chuck(le)
[Something is rotten in the state of whereveryoulive.]

P.S. Sean...they only want to 'own real estate' in order to sell it and make a 'profit'.

P.P.S. What's your line of business?

I'm in Escrow on a house in San Diego now. I'm not sweating it. Easy credit + high demand + limited supply = ?
In many areas, people just aren't selling their homes because just as their the price of their home has gone up, so have prices of any place they'd buy, meaning higher property taxes for one, and probably the same mortgage payment.
Worse case scenario, I go bankrupt & live in a van down by the river, or stay put for 10 yrs in a nice place in a desirable area.

by the way, I actually laughed out loud AT the person who thinks it's all a Bush plot to get votes. What won't he think of next!!

So what are the implications for those of us who are saving our bucks but not in real estate now? We've missed a big run-up (in my case, couldn't help it - - not enough savings yet). Will we be able to scoop up foreclosures on the cheap?

Excerpt from http://www.fdic.gov/bank/analytical/stateprofile/SanFrancisco/Ca/CA.xml.html
-----------
"According to PMI Mortgage Insurance Company, there is at least a 30 percent probability of home price softening during the next two years in the Southern California, Bay Area, and Sacramento markets. "

The problem with buying a house in the future is if interest rates have gone back up. Currently long term fixed rates are at about the lowest they've been in 30 years. See http://mortgage-x.com/trends.htm and look at the chart "30-Year FRM Rates 1971 - 2005 " near bottom of page.

In San Diego, median house price rose 38% one year, and %20-something the next(last yr). Obviously this can't hold.
If by softening, they mean more realistic raises of 5-10%, it can't be all that bad.
$0.02

Don Wrote:
E.g, If someone has $300,000 equity in a $800,000 home (with a $500,000 mortgage), then the bank may foreclose and sell the home for $500,000 just to get their principal.



The problem with this analysis is that the owner has $300,000 in equity they can sell the house at a discount price of $700k, and take the "loss", or they can refinance and pull some cash out of the property to make some payments, or more likely a little of both on different properties that the investor might own. If the investor is careful enough and plans well enough a 20% hit on his investment should not cause a large problem. However, a 20% loss will cause a lot of problems for a lot of people who are heavily leveraged (which is easy to do in the real estate market).

Actually, if they are laid off, they probably will NOT be able to withdraw equity from their home because to do so they will need to refinance and they probably won't be able to get a new bank loan if they are out of work.

Most people do not think of their home solely as an investment. When times are hard, it's a refuge. Using my example above, they will try to hang on if prices fall --i.e., as the equity in their home drops from $300,000 to $150,000.

If they then are laid off and can't make payments, the bank will foreclose and sell the house cheap --i.e., at $500,000 instead of $650,000 --because (a) the bank wants to get it's $500,000 back quickly and without risk and (b) the bank doesn't get any money over $500,000 so why should it take a risk by haggling over anything offer beyond $500,000?

An investor could actually make some money going around during hard times, looking for problem loans, and urging the bank to foreclose so the investor could buy the house cheap. I don't think I would have the stomach for it, but aren't there some people who do?

If the home is behind on taxes, they can even pay a donation to a local politican to have the politican encourage the sheriff to put the house up for auction.

It's pointless to argue about what choices a person can make when they get laid off, but getting a job at any fast food restaurant would probably allow them to get at their equity, if they don’t have any savings built up in the first place. Baring that they could put the house on the market $50,000 to $100,000 below the market value and probably get it sold in under 30 days. The only ways someone could loose their house is either through inaction or by having no equity built up in their property when prices begin to fall. Now if you just lost your job and sold your house and managed to get $50k to $150k out of it you might just think about moving, in other areas of the country that would be one great down payment, possibly a whole house.

Not only is it the greater fool theory, but a question of survival. Most of the loans being originated right now are interest only ARM. We did the calculations last week on what it would cost to move up the street. In today's market it would take 70% of my household income.

All that I can say is everybody needs to position themselves to take advantage of a lot of short sales when Geenspan starts raising rates.

Regards,

4MySales REALTOR Tools

Hello,

Thank you for your articles which help me in my work

Bye
Andy

A small pullback or reduction would be healthy now. However there are a lot of people who are waiting for a price drop. So this higher priced market could last for awhile. As I am also looking for a house the small price adjustment would benefit me.

We've made a living poking fun at the current real esate trend of taking a sub-average homes and pasting a huge price tag on them. The climate is right for people to sell their homes for ridiculous amounts of money and the climate is also ripe to laugh out loud at ridiculous real estate. Check out what we mean:
http://www.ridiculousrealestate.com

It is quite interesting that with the increase in prices of properties there is also increase increase in purchasing power of people "quite unusual". In my view its all because of less rate of interest which increases the capacity of people but with this more and more people are in debts now.

rajinder.dogra@a1internetdesign.com
http://www.indiarealestateblog.com

Bill,

Great site, thanks for the honest advice. I currently live in San Diego and may be moving up to the Bay Area, probably Palo Alto. Right now I own a condo in Downtown SD in one of the new luxury highrises. I have only lived here for about 8 months, but bought predevelopment (went into contract almost 3 years ago) so I have earned about $150K to $180K in equity. I do have a good rate (5.34%) on an interest only 3 year ARM. I did refinance to get this rate and combine my 1st and 2nd together so I have almost the full 3 years at my current rate.

It seems to me that the Bay Area is even more overinflated than San Diego. I'm thinking that keeping my condo in SD for the tax break, renting it out and renting up there would be better than selling and buying in Palo Alto. What are your thoughts?

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