Retracing the housing bubble: 1997

As promised, the blog is retracing the housing bubble in hopes of better understanding where we are today and how we got here. This is not meant to be a definitive history, but a rough outline for discussion. I'll likely add to these posts with more information, anecdotes, and statistics, partly at your suggestion.

1997: The housing bubble begins to take shape in Southern California as median home prices slowly begin their long rise. In celebrity news, the L.A. Times' Hot Property reports that Brad Pitt (pictured) has bought a two-bedroom, 2,200-square-foot house in the Hollywood Hills for about $400,000.

According to DataQuick's tracking of median sales prices in Southern California, prices bottomed at $146,000 in January of 1996 and again in February 1997, ending a five-year slide. Prices across the region then began a historic, 10-year rise, peaking at $505,000 in March of 2007, a rise of 246%. Had prices over that period only matched inflation, as measured by the consumer price index, median home prices would have peaked at about $189,000 in 2007.

1997 at a glance: Median sales prices rose $12,500, or 9.8%; inflation that year, as measured by the CPI, was 1.7%.

Month   SoCal median sales price     % change y/y     %change from bottom
Jan.              $147,500                                  1.0%                      1.0%
Feb.              $146,000                                -1.0%                       0.0%
March           $152,500                                 1.6%                       4.4%
April              $152,000                                 1.3%                       4.1%
May               $155,000                                 2.6%                       5.5%
June             $156,500                                 2.0%                       7.2%
July               $155,000                                 2.0%                       5.5%
Aug.              $159,500                                 4.6%                       9.2%
Sept.             $160,000                                 5.3%                       9.6%
Oct.               $158,500                                  5.7%                      8.6%
Nov.              $160,000                                  6.7%                      9.6%
Dec.              $162,000                                  8.0%                    11.0%

Your thoughts? Suggestions? Insights? E-mail story tips to peter.viles@latimes.com.

More on Brat Pitt: The home Pitt bought in early 1997, fresh from proposing to Gwyneth Paltrow in Argentina, was the third he had purchased in the same gated enclave.

Photo Credit: CP.

Comments

[puckhead]

I think Brad Pitt has aged remarkably well

[lak]

Brad looks like a chick in this photo. Deadringer for Sharon Stone, just about.

[lac]

So does PItt still own the property? How much is it worth? Was it a good purchase. in your opinion?

[SoCalRealEstateNews.com]

I've been selling homes since 1980, and agree that we can benefit from reviewing how we got here.

We probably use the bottom as our base for projecting. At that point So Cal homes were extremely undervalued for two reasons:

1. Tens of thousands of jobs had left the state over the previous five years, putting so cal in the deepest recession in modern local history, even as the rest of the country was doing fairly well. Remember all those see-through buildings in downtown and all the vacancies in the former defense buildings throughout So Cal?

2. As with any market correction, the market over-corrected, fed by the negativity. I remember buying decent "B" apartment buildings for 4x GRM around 1995--and people thought I was crazy to do it! Everybody thought real estate was toxic.

I'd say a good place to start would be the middle of the 1991 - 1996 decline, maybe wherever they were mid 1993. The bottom is just too low a base.

My other comment is that another phenomena took place since that bottom--our coastal plain became virtually built out. As that occurred, not only did resale prices soar, but builders turned to increasingly large, upscale homes to get the most money from their dirt. I think of Rancho Cucamonga, where builders went from one story starter homes to two story McMansions.

And many homeowners added on, upgraded, or tore down & rebuilt. Areas like Rossmoor on the LA/OC line come to mind.

Given that upgrading of housing stock and the increase of supply over demand on the coastal plain, it's only natural that home appreciation would exceed inflation significantly.

[Cal]

I love going back and looking at history to get context, looking at todays sales, prices, inventory in the context of only MoM, YoY sales really doesn't give you much information unless you already know what has been going on.

I highly recommend people read the DQ archives:
http://archive.dqnews.com/AAMain.shtm

[save your ammo]

Peter:

NOT TO PRESS THE POINT... but could you
please give us a side-by-side chart from 1997
through to today with the yearly bubble mediums
next to what the annual CPI mediums would have
been.

This is the clearest way to view how far off
normal inflation prices we actually are. It
eliminates so much of the chatter that surrounds
this issue here. Many thanks.

[John]

So, what's the point? It was a bubble. Of course, people in the real estate industry and most sellers are delusional and want to pretend otherwise, but what else is new? Prices will continue to slide until homes are once again affordable. Granted, some properties in prime areas will always command a higher price. I'd say to look for a further reduction. Another 50% would be about right.

[Valley Observer]

"1. Tens of thousands of jobs had left the state over the previous five years, putting so cal in the deepest recession in modern local history, even as the rest of the country was doing fairly well. Remember all those see-through buildings in downtown and all the vacancies in the former defense buildings throughout So Cal?"

It's ironic that Countrywide's HQ is Calabasas was formerly Lockheed's HQ. It still has the underground super-secret vault meeting room suspended on springs. The irony continues at Countrywide's software group in Agoura Hills, which occupies the former HQ of Litton Data Systems (since absorbed by Northrop Grumman), where they made artillery and air defense systems.

[save your ammo]

Sorry, Peter. I decided not to wait for you.
I went to the Federal Reserve Bank's site and used the CPI Index calculator.

Here's what inflation would have added to our medium
home prices between June 2000 and (projected)
June 2008.

Bubble Expansion
Month/Year Med. home $ (LA) CPI Index $
June 2000 $203,000 $203,000
June 2001 $228,000 $209,000
June 2002 $269,000 $213,000
June 2003 $313,000 $217,000
June 2004 $414,000 $223,000
June 2005 $475,000 $230,000
June 2006 $517,000 $238,000
June 2007 $545,000 $244,000
Feb. 2008 $460,000 $254,000

Some will argue that a higher 4% return for housing
is more accurate but even that figure pales in
comparison with bubble top prices.

This chart says that if we're offering 2002 prices,
today, we're probably being too generous.

Suggest your readers go to patrick.net for a
link to a NY Times story on what's behind
a seller's slow, painful acceptance of the fact
that his or her home is worth maybe half of what
they think it's worth.

[Truth2Pwr]

For two extensive and data rich reports that have greatly informed my understanding and analysis of the situation:

http://www.cbp.org/pdfs/2008/080212_
LockedoutReport.pdf

and

http://www.homesforworkingfamilies.org/resources.
dyn/Analyzing_Affordability_1.30.08_FINAL.pdf

[sfvrealestate]

Also, it wasn't easy to get a loan in 1997. You still needed to have at least 10% down plus 3% in closing costs plus 2 months' reserves, unless you were getting an FHA loan, which was 3% down and 3% closing costs. And good credit. And, if I recall correctly, interest rates were still hovering around 7% plus points.

[Hugh Jorgan]

So I'm not imagining things...I've been saying for years that prices started going up the day after I made my bid on my home (June 30, 1997). I'm not far off.

[AJ]

Hi Peter,
I have faithfully been following your blog for months. It is great! Thanks for everything. Could you please check out Phil Vassar This is My Life video . I have no affiliation. You can look it up on youtube. It to me represents what this whole mess is all about. The corporate fat cats versus the middle man. Alot just said in that sentence for sure. Again, this is just a simple woman from New England that wants to get the good word out.
Best regards, Ann

[jbunniii]

Nice chart - however, keep in mind that in a correction, house prices generally overshoot on the way down, so therefore we should expect them to dip below the trendline indicated by the CPI. This occurred in the early-mid 1990s bust, check it out. Another good indicator, also observed in the 1990s, is that at some point it becomes cheaper to buy (using a standard fixed-rate mortgage and conventional 20% downpayment) than to rent the equivalent property. This is both a good indicator that the market is reaching a bottom and an excellent buying opportunity.

[anonymous]

This is not your father's bust. This is the perfect storm. Prices will come down to 1996 levels. Anyone who buys before then will be paying interest and losing principle.

[puckhead]

I agree with sfvrealestate regarding interest rates. Rates are low now which allows people to buy “more” house compared to the mid 90’s. This supports higher prices vs the CPI. With the credit squeeze and recession, I don’t see the FED raising rates anytime soon. I also don’t see the dollar falling much even with more rate cuts. The weak dollar at some point will hurt European and Asian imports and will cause too much of an imbalance vs other currencies. If the dollar continues to fall, I would not be surprise to see Euro and Asian central banks start buying more dollars to support the currency. As much as Americans are hated around the world, world markets need a healthy US economy because if it’s one thing we know how to do……………….it’s spend mucho money.

[bottom line]

By all means, let's keep our principles intact, lol.

[ray]

Housing prices are still way up relative to affordability, inflation adjustments, median income levels, or whatever good or services you want to compare it to.. building materials, food prices, price of gasoline..blah, blah blah.

Those who argue for these high housing prices, realtors especially, expect the inventory of homes to increase and the length of time the home is on the market to be prolonged. Expect more yourselves to be out of a job, expect to live on bread and water.

Cases on point.
http://bubbletracking.blogspot.com/search/label/
Silly%20REALTORS%C2%AE

[anon]

It seems to me it's crucial to know the avg lending rate at the time to compare housing prices over the years. For example, a $400,000 loan at 6% is $2,398/month; a $233,000 loan at 12% is the same (and I know rates in the 80's were sometimes even higher than 12%). There should be a way to incorporate this rate *along with* the CPI to truly compare housing prices equally.

[puckhead]

Ray,

I agree with everyone that prices will fall, but not as much as some perma-bears contend. All of the factors you mentioned are fallacies when it comes to valuing real estate prices.

1) The median income theory that median prices of houses should be attainable to median income households. SoCal has always had large number of households as renters. I believe that % is currently at 50%. This implies that if you are at the median income household, then you are probably renting. The median price of houses should be selling to approximately the 75% level of household incomes.

2) That housing prices should track the CPI or inflation. This is such a simplified statement that it’s absurd. Prices are set when the demand and supply curve intersect. The demand curve was artificially steepened the last few years via voodoo loans. However, if you look at the population of Socal in 1997 and the population as of today, I’m pretty sure that you’ll see that the population growth has far exceeded the number of new houses and condos that have been built during the same timespan. More households chasing fewer houses/condos (especially in centrally located, safe neighborhoods) will equal higher prices.

3) That housing prices have any relation to building commodity prices. The land that the house sits on is way more valuable than the house.

The economy in 2008 is also much more favorable than 1997. Unemployment is still relatively low and growth in high salaried jobs is very good. Interest rates are low and the FED will not be raising rates any time soon. Things are not as bleak as the perma-bears think.

[Flaaash]

When people talk about the market over correcting itself and what not, this reminds me of Rational Expectation that I learned in business class. One cavaet is that if people expects something, then it may not come true because other forces in business are going to try and profit off that expectation. So for example, if the popular expectation is for the market to come down to say 1999 level, then people who have been holding off to buy a house may pay 5% above that level, thus we may never reach that level. Likewise, when other people hear about Rational Expectation, they may try and outthink those buyers willing to pay above 5% by going with 10% above. So my warning for people who talks about expectations is that it may alter the future. If there was no expectation, then the market may freely correct itself. I hope people understands this concept. Look up Keysian and Rational Epectation on Wiki.

[Cal]

I do believe the market will overcorrect on the way down but I think many are underestimating how much financing has fundamentally changed. This is not a tight money market, it is only more restrictive relative to the incredibly loose underwriting standards of the past few years. With FHA (Mortgage Insurance) + Fannie/Freddie (secondary market), combo especially with increased limits I think it puts an effective floor under the market.

And I think that floor is higher than it was in times past.

[Richard]

Father of the great housing bubble

[First time listener . . .]

Puckhead, your analysis is a bit skewed. Most commentators/analysts don't strictly compare median income to median sales price and say that prices are unaffordable because the median income family cannot afford the median priced home. What they do is look at historical trends, and those historical trends for any given area show fairly constant (ups and downs accounted for) multiples of median income to median price. During the last downturn in the 90's, prices dipped all the way to below 4x median income. During the present boom, they rose to double digit multiples of median income. Looking at this way accounts for your valid point that most of LA doesn't own (because in most parts of the country the ratio is 2.5x median income), but the historical ratio of salaries to median prices does accurately reflect when sales prices in this area will be back in line with historical levels of affordability in LA.

[Laker]

as Save your ammo mentioned, offering and paying more than 2002 price is basically over paying.
This 100% supports my theory that prices are heading to 2001 levels. Now since indeed interest rates are lower than in the 90's, that will fight against the overshoot in correction so instead of going to 1999 prices, we will end up in 2001 prices.
The dear RE agent here forgets to mention that in the 90s people needed down payments and all the foreclosures back then were from people that ACTUALLY had SKIN in the game...that was a fact that somewhat limited the number of foreclosures...
This time, people that bought in 2003-2007 have ZERO skin in the game. This is HUGE difference and basically suggests or i should say guarantee, that the foreclosures this time will be 10 fold, and hence the over correction will be much greater!!!
After extensive research and reading a lot of facts and analysis, i begin to wonder if my 2001 price level is too optimistic number now....maybe rollback prices prior to 2000 are actually going to happen....wow...