Tuesday Morning: Irvine Blogger Goes Inside the Mind of the Bubble

Those of you who believe it's a bubble will want to clip and save this item, which comes courtesy of the Irving Housing Blog. As you can see, it's a map of the "Psychology of a Bubble":

"The above graph is an excellent depiction of the psychological stages of a market bubble. It is fairly easy to put time frames to each of these stages as displayed by our local housing market:
    •     Take off: 1998-1999
    •     First Sell Off: 2000
    •     Media Attention: 2001-2002
    •     Enthusiasm: 2003
    •     Greed: 2004-2005
    •     Delusion: 2006
    •     Denial: 2007
    •     Fear: 2008
    •     Capitulation: 2009-2010
    •     Despair: 2011-2013
    •     Return to the Mean: 2014

Obviously, the past is easier to document than the future, so we may reach future stages sooner or later than shown above, but we will reach them."

Where are we now? "Right now, we are in the denial stage. Prices have not dropped enough to cause real fear. Denial is apparent in polls like this one ...  where 85% believe their home will rise in value during the next five years, and 63% believe a house is a good investment. That is serious denial."

What do we think? L.A. Land is in the Greenspan camp, which holds -- in a rather wimpy fashion -- that bubbles reveal themselves only by popping. That is, until it pops, you don't know for sure if it's a bubble.
And -- though it is true we have been accused many times of being a bad listener -- we haven't heard the distinct sound of a pop in L.A.

Your thoughts? Comments? Insights?
Thanks for the link: Patrick.net
Graphic: Hofstra economist Jean-Paul Rodrigue via Irvine Housing Blog

Comments

[Jay Michaels]

"Those of you who believe it's a bubble" Is there still denial??l and isn't that heh heh 2007???? right on schedule. Here North of Boston homes in my neighborhood are still for sale well over a year after being put on the Market and yet still they build financial suicide

[David]

The fundamentals of the housing market are out of whack, especially in California and Florida. I used to live in Florida and the wages there in no way can support the inflated prices. I have never lived in California, but I look at those prices and wonder how anyone can afford mortgages that top a half million dollars. Just roll that around in your head...easily over half a million dollars! I live well outside of Philadelphia and bought my house in 1998 (2500sf, $161,000 in central bucks great schools and good area). My brother in law lives in Pasadena. He bought his house in 2000. 1200 square feet, $749,000.....wtf!

The bubble has/is popping and hopefully it won't drag the economy down with it. That right now is my biggest concern, the impact this will have on the US economy. Housing accounts for somewhere around 25% of the US GDP. There are alot of jobs that are dependant on a strong housing sector.....lumber, steel, home appliances, home depot type retailers etc etc. The domino effect comes to my mind. So far the employment number's are holding strong, but I temper that figure with the fact that we are just enetring the first part of the housing deflation bubble. Usually it takes a little time for the trickle down effect to be seen.

[a]

In response to Jane:

Stay in LA if you are happy, but you should stop saying such hateful things about other parts of the country. I know several Asians who grew up in the "ignorant" states. Most had happy childhoods in safe environments. I'm sure there are some Texans who blame Laotians for bombing Pearl Harbor, but that is not everyone. When you classify every white person from Texas and Iowa as an ignorant, illiterate redneck, full of hate, you are the one who is racist. This is simply not true. There are racists in every group. For some reason, the media allows us to say that only whites are racist.

LA is full of crime and hate crimes. It is not paradise, but it has some good points. Stay there if you can make ends meet and enjoy your life. Austin, Texas (or similiar) is not an endless KKK rally. People of all races live there, and live a good life. Don't assume that there is no racism in LA and the rest of the country is an episode of "hee haw". That is an unfair generlization.

[Dimitri]

Talking about illegals buing after amnesty? They already own now. Lenders don't care. Owning a home is only in someone's head. Check the numbers. Now is not the time to own, period. I am beeing subsidized by my landloard who has to dish out $400 per month for all the house costs above and beyond the rent I pay and he bought the house 16 years ago. In addition, all excess housing will be competing for rentals, thus driving rentals down. Or they will try to sell them which will drive house pricing also down. No win for those who bought lately.

[Louis Hill, MBA]

This graph is right on they money!!!

The real estate bubble is a classic bubble by all accounts, from the meteoric rise of the asset class to the suspension of reality about it, and we are now well past its peak.

We are in for several years of economic and fiscal pain brought on by Alan Greenspan's loose monetary policy.

Even the Bank of International Settlements, the central banker's central bank, warned of a potential bubble burst that might be similar to the Great Depression of the 1920's. You can read more about this at my blog www.myrealestatebubble.com/real_estate_tales.html

Protect yourself now with correct investments and portfolio structures using the eBook "How To Prosper In The Changing Real Estate Market. Protect Yourself From the Bubble Now!" found at www.myrealestatebubble.com.

Louis Hill, MBA
www.myrealestatebubble.com
www.outstandingebooks.com

[Robert]

These are all excellent comments about SCRE. I live in Palm Springs and have been shopping for a new house for 18 months. Asking prices have dropped about 20% (at least) during that time.

The real problem is that the houses still are NOT worth it. Percentages don't really matter; what matters is that whatever you buy is worth the price. The second factor is whether the buyer is willing AND able to pay the price either in cash or by being financed.

Credit is going to continue to contract. The pool of potential buyers will continue to contract. Prices WILL fall. How far and how fast, no one really knows.

As a real estate agent in Florida up until last year, I saw the collapse coming in 2005. There were simply too much inventory being built AND too many people buying for the wrong reasons. I know because I did it and, fortunately, got out in time.

So now, as a buyer, I plan to wait AT LEAST a year before buying. My rent is less than half I would be paying for a mortgage and the value of my "investment" would be decreasing as opposed to the difference earning at least 5% in a money market.

The capitulation will come when the stock market capitulates later this year. The Bear Sterns warning is the real deal. There will much more to follow and the WORLDWIDE credit bubble will collapse. It has been leaking for a year but no one is really paying attention. As long as consumers keep spending their home equity, the facade of prosperity continues. With a negative net savings rate for the country, this is simply not sustainable.

All these things are interrelated. The SCRE market is but a small part, but it is a part and will be affected by the larger dynamics. Hang on to your hat and your money!

[bill]

i may be wrong, but i haven't seen any stories or comments about how high-price housing could impact california's economy. there's something wrong with that. as mentioned, california is experiencing net outmigration. the population is rising only because of the influx of low-wage immigrants. if young, well-educated people are leaving because they feel that they'll never be able to buy a house, that would be a problem. companies go where they can find a well-educated (and hopefully cheaper) labor pool, and california doesn't have a monopoly on that. nissan has already moved its U.S. headquarters from L.A. to tennessee to cut costs. How many other companies have done the same or are thinking of doing so? Also, I know people from out of state who have turned down jobs here due to the high cost of living. The media (especially the OC Register) until recently seemed to carry only stories that extolled ever-rising home prices. But is there a point at which it becomes detrimental to the state's economy?

[chopdodger]

Martin Kane sure know how to mix a metaphor: Chicken Little, "fire is hot", "window of opportunity". It sounds like some of the desperate craigslist adds you read these days.

[Geoff]

If you think things are out of hand in L.A. you should see what is happening to Vancouver, Canada. We here are in the midst of a major speculative bubble in my opinion. Our downtown core is now littered with construction towers that have just finished or are finishing Condo projects (many of these appartments are under 500 sq Feet and are selling for over 300K!!!)

Now how can it be that property value is going up almost everywhere in the world at the SAME time. I understand that when a community or area is prospectively/economically doing well, then that region has money to spend, thus increasing inflation, through mortgages, loans, etc. But it seems beyond reason that almost every region has had their 5 year window of Triple gains and beyond.

A major Factor for Us in vancouver that is fueling the Bubble we are experiencing is that we will be hosting the 2010 winter Olympics. Up in Vancouver we have the blinders on that most of the world really cares about this event.

It would seem that 2 major ongoing problems that is fueling this housing problem (as I would call it) is that interest rates are still historically very low, thus people are still borrowing, and providing jobs for real estate agents, construction workers, and the circle that all of those people spend their money. Secondfold, the construction costs have escalated beyond any reason because of the mega-projects being constructed.

I don't know how this will end, but it can't be good for the world economy. Now that everybody is linked globally, then it stand to reason that what follows a global boom cycle (of which has been a great run, and continues...) in a global period of recession. As the world has never seen the likes that we have seen, globally of this bull run on such a wide scale, there has to be some fear of what looms beyond.

The biggest problem with the system in place, is that credit is so easily available. Remove the value of what backs our loans (our housing), or of the valuation of the stock market (our retirement savings), and we have a colossal problem.

[jason]

What happened to our traditional warning signal: the drop in condo prices? Condo prices have always been like the canary in the coal mine: they would drop first and furthest. I checked mls today and there is very little distress. There are only a few vacancies among the units for sale and no foreclosures or short sales. Why is this different this time?

[Scott]

I buy and live in income property in West LA. I have profited ten fold from my down payment investment in 1999. I live rent free, and my tenants are paying my mortgages. My newfound equity allowed me to purchase another six unit property as an investment, and I have positive cash flow from that building also. I used seller financing to finance the new purchase, and borrowed from my equity for the down payment, essentially using 100% financing. That property has went up in value about $500k since 2004. I easily re-rent any vacancies for hundreds more in rent. I will eventually develop that property into a new condominium complex.

I remain very positive about the real estate market in West LA. I see quite a bit of new construction, teardowns, and remodels in the area. We will benefit from the Expo light rail line in a few years. My new tenants have told me they would rather pay more to live close to work, and not commute.

The housing stock of this area is very dated. There are thousands of properties that are very old, and sitting on large lots. As these properties are redeveloped in the future, I believe you will see prices continue to rise over time. It is true that it takes two people with good jobs to buy a house, but it continues to happen. You at least control your own destiny when owning.

Renting and waiting is like saying you can predict the future. If you are concerned about values, look into income property. Buy and hold for the long term, and you will gain in net worth.

[imua kulia]

Your assumption of $40,000 holds true if you take the population at Panorama City and Sunland and include their kids who are college students above the age of 21. The income in West Los angeles and Santa Monica averages $95,000 per person. Rather than taking a single income, you should use an average family income in the entire Los Angeles region, which, as you know, as per census data in 2006, averages $92,000. This allows families to easily afford a home of $500,000 in the valley or suburban Los Angeles.

[AnnS]

Hi Paul

I used the 5% as a cautious number. Traditionally real estate hasn’t appreciated more than 3-5% a year so going only about 5% of the rental cost could be justified if the market is coming up or it is a great buy at anytime or you have to buy for tax reasons. Whether you want to go a little it higher on purchase costs over rent depends a lot on extra factors – how long you plan to stay, maybe the location is too perfect and houses there rarely come up for sale, you are addicted to having huge dogs (like me) and can’t find a place to rent that will take them ……

You are absolutely right to rent and not buy the place. Your numbers are correct. Too many people get caught up in the idea fixee of “oh wow –it will appreciate and I won’t be throwing money out on rent and have nothing to show for it.” They don’t take into account all of these costs:

(1) regular maintenance – just the routine painting and repairs add up.
(2) major maintenance – a pipe bursts and floods the basement or the laundry room, the furnace dies, the A/C dies, or the roofing needs replaced (and that alone can be the equivalent of the property tax bill for the year.) It really is true that a house is a hole in the ground with walls into which you pour money.
(3) the local government passes a special one-time property assessment to redo the sewer and water….

They also do not consider that a house is not exactly a liquid asset. It doesn’t matter how much equity in it they have if they can’t get it out – and equity loans don’t always solve the problem if the money is needed because of a job loss or other events that disrupt income and make lenders nervous about lending. Additionally, they have to live somewhere and if their house appreciates, so does everything else they could buy.

When the adjusted after-tax cost of the mortgage, taxes and insurance come out to be so much more as in your case, you are correct that it is better to invest the amount you save and wait. Before the bubble and nutty prices, it was the accepted practice to rent and save the difference for a down-payment to eventually buy what you wanted.

The thing to think about when you buy a house is if something happened and you had to move for a job or some reason and if you couldn’t sell it as fast as you needed, could you rent it and cover your costs? If the answer is yes, then you are safe. If the answer is no, proceed very very cautiously based on how much you would be in the hole every month. Things happen with jobs, illness and the need to relocate.

By the way, I follow my own advice. We retired early, sold the house and traveled for a few years. When we decided to settle back down, I took one look at the prices versus the cost of renting and laughed. I have no intention of paying 40% more to buy the same house that I could rent on a ½ acre 3 blocks from the beach. And I’m watching sellers around here slash their prices 20% but still not get an offer - they will get the price right eventually.

Interest-only are the height of insanity for anyone who is not a contractor building a spec house that has buyers eagerly waiting. That is throwing the dice and hoping they come up 7s. No one knows what will happen in their lives in 1,2 or 3 years – and betting on an out-of-control, out-of-touch with reality market to make the deal work is almost as silly than believing that you will win the lottery so you can retire.

ARMS are flat scary unless you have planned that you really can handle the worst possible rate increase even if your income does not go up.

I have always approached the amount of a mortgage payment with great caution. There is what lenders happily announce they can lend you based upon income and then there is what the budget really can handle. A ‘safe’ number is to figure on not spending more than 28% of gross on the mortgage, taxes and insurance at maximum. A better number is to calculate your monthly budget and expenses and see what you can comfortably spend on housing. Then it becomes a lifestyle choice – do you go for the maximum house you can handle while still being able to put a nice chunk of change in savings and forego Venice (Italy) or do you content yourself with a smaller house, put the same amount or more money in savings and go to Europe (or whatever your chosen indulgence maybe.) If you go smaller, you can always remodel and add more house (consistent with the zoning code.) It is always wise to have at least 6 months of living expenses (including the mortgage) in the bank before you buy and 12 is even better. You never know what can happen.

“Assuming that the projections are correct, and median house should cost 4 times the median income plus-minus,and today in so-cal it is 10. So either our wages are due to increase 2.5 times for median $60K to $150k or house prices would need to go down at least 1/2.”

I think the odds of wages increasing 250% is somewhere between Slim and None and Slim just rode out of town. That leaves prices coming down. The ratio of price to income has changed over the years. In the early 80s it was more 2.5 times income.

Yes – lower prices may mean higher interest rates but proportionately, there is more interest to deduct out of a payment so you come out the same or ahead – and that etra money goes to savings.

Sorry for the length – I spent too many years micro-managing my clients and their business affairs.

PS: For all those who say 'who cares - everyone wants to live here' , be careful. The data is already showing that employers are having atttracting employees - even professionals- because of the housing costs. The employers don't want to raise the wages offerred, they need the employees so they move their business - classic shift in employment patterns. A business can only go so far in increasing its labor costs without having to increase prices which in turn makes in uncompetitive with a competitor who is not located in the high cost area.

[Randall Unruh]

Who said condo prices are not dropping? Outside of high end projects that the rich and famous will buy, in West L.A. they are already down at least three percent or more for existing condos.

[Steve]

Over the long term RE will never go down in LA, simply look at Europe and Asia where the average cost of RE is 20 to 30 times the annual wage. If you cannot afford RE now in SoCal you never will by paying rent. The solution is get out now and there so many better options. To summarize LA is the most over rated hell hole in the US.

[RIA]

I don't want to spend 40-50% of my monthly income on a mortgage nut plus all the other ancillary costs associated with existence, like food, healthcare, etc., I don't care how open-minded people are in LA, I don't care how many creative shops and restaurants are there, I don't care who's the celebrity de jour of the month, I don't care if my alternative lifestyle neighbors are hosting another wrap party, I don't care about driving a Range Rover to collect my groceries from Whole Foods Market - because I don't want to live in a city breathing a toxic blend of ozone and fine particulate week in and week out that finally drives my immune system into a hospital bed prematurely. Find a good oncologist just in case. I am so o-v-e-r the LA experience, and I have "been there, done that" fellow posters.

[Jackmac]

The graph is a reasonable academic snapshot at how typical bubbles have burst.

However - I don't think the graph is applicable here.
What will prevent this extremely steep fast decline in LA are:
1. continued dynamic economic conditions.
2. continued influx of affluent and/or educated skilled immigrants with positive financial prospects
3. continued exit of Californians who by choice or by necessity out to less expensive areas within or out of California

As long as California acts as a port and entry point for Pacific Rim economic trade activity to the West and trade from South American nations to the South, we will continue to have a better economic outlook even in down cycles.

Will a $500,000 home today be priced at $250,000 in 2014?
I bet it won't. My educated guess is that while the meteoric rise phase is over, I do not believe a catastrophic decline is in the works.
Homes will, at worst, keep up with the rate of inflation for owners to build equity, not investment returns. That is the normalization I expect to see.

With the disappearance of speculative investors in the RE market and more families who want a home, the value of homes will be less unpredictable. Prices will be more reflective of the supply and demand conditions and the overall economic health and inherent desirability of a given market region.

[Sam]

Just wait and see. All these arguments for bubble and against bubble means nothing. WE will know what happens in 2 years. Relax...do what you are supposed to do...I am not going to sell my house or buy another one by reading your opinion here.

[Mark]

Imua Kulla, where do you get the idea that the typical family is making $92,000 per year? First of all, you shouldn't look at the average, you should look at the median. There is a difference, as I'm sure you know.

This URL below is directly from the Census Bureau, and it states that in 2003, the median household income in LA County was $44,674. Maybe it's up to $46K or $47 now, but it's nowhere near $92,000.

http://www.census.gov/acs/www/Products/Ranking/2003/R07T050.htm

[Raul Garcia]

I don't what your smoking to come up with the $92.000 yearly average income, but whatever it is me and 90% of my friends would like some.

[Steve]

You people have no idea how bad your quality of life is. I just bought a 4000sq ft McMansion on a Golf Course for $420K. As I write this I have a clear view of the Rockies and can see 20 miles with no pollution or ICE Helicpoters over my house. I am totally safe, no gang bangers, low life, road rage. I drive 10 minutes traffic free to a low pressure job. My kids go to public schools where you feel like it is Leave it to Beaver. I used to make $120K in the hell hole, I now make $70K and live three times the quality of life and save 3 times the money (look at Yahoo comparison). It has come to a point in LA where the negatives far out way the positives and again the cold reality is if you are not paying down a house you are going no where financially. For those who are waiting for the bust stop kidding yourself and it is this simple move out of CA and live happily ever after.

[Don]

Good information and professional opionins here. To quote Robert Kirosaki, "Remember that the term real estate comes from Royal Estate." Meaning you never actually own the land but it's leased from Royalty. These days banks.
Also, the new building has not slowed at all in my neighborhood. I can see at least 1000 new condos coming on the market next year, which I'm hoping will make this graph reality!

[cochon.name]

san diego recently aksed it's residents to cut water usage from the average 180 gallons per resident per day to 20 due to the colorado river's continuing drought and annual sierra snowfall being 60% below normal. just wait until the problems with getting water to southern california's millions get really bad. then you will see prices drop substantially and serious panic that could spell trouble for the entire american economy.

[JLingk]

There is a lot of truth in that post Steve. Been doing some comparisons myself to west L.A and Colorado. This differences are staggering.

In terms of the collapse of housing, that just isn't going to happen west of the 405 in my opinion. Demand is still high and it's going to take a complete drop off of people coming here or wanting to move to the safer side of L.A. for any price destruction to happen.

The largest decrease in home costs that has ever occurred here is 20% in the 90's and that was the direct result of economic events related to jobs. There simply is no sign of that and no catalyst for a correction.

Because 95% of the people can't afford the median house means nothing. Enough people are not leaving or defaulting.

[Yscracker]

Someone earlier mentioned water supply as risk to SCRE. There is a far greater risk than water - OIL. I spent 25 years in the oil biz before mergers and high cost moved my job and my paycheck to Houston.

The US now produces 5.1 million barrels of oil per day compared to 9.6 million back in 1970 at the peak. We now consume 22.5 million barrels of oil. In the late 70's here was a price scare that ended when global spare capacity undermined prices. Domestice production is declining by 2% per year (net decline plus new production) while US population driven by immigration increases by 1.2% annually. These conficting trends cannot be sustained and the probelmes they portend have not yet surfaced because up till now the world has had extra oil to sell to the US.

THERE IS NO MORE SPARE CAPACITY TODAY and there never will be again unless some major population decrease occurs. The world is at or near its peak oil production capacity just like the US was back in 1970 and when the world produces less oil year after year a vicious game of musical chairs will commence. While we have constructed an economy that totally depends on cheap oil for survival, China combs the world locking up long term supplies.

There will be major economic upheavals as oil prices trend higher and higher. Socal beach cities have the advantage of being low on the energy intensity scale since very little heating or cooling is required. This may be supportive of prices here relative to other parts of the US but it will not eliminate exposure to the economic difficulties caused by the end of the era of cheap and plentiful energy.

Take a look at the website peakoil.com. And my suggestion is to buy some oil company stock instead of a home or condo.