The L.A. housing bubble: a snapshot in time

Calculated Risk, the reliably insightful economics blog, posted the above chart today as part of its coverage of the Harvard Joint Center for Housing Studies report. It's not up to date -- as you can see it does not include 2007 and 2008 data; but it's a powerful illustration of why the Los Angeles housing market really is different.  What happened here did not happen in most of America.  What happens next? That's why the blog publishes comments.

Your thoughts? Comments? E-mail story tips to peter.viles@latimes.com
Hat Tip: Uncle Billy Reads Calculated Risk.

Comments

[l.a.guy]

The extreme, and unwarranted, up turn in prices seems to coincide with the explosion of Option ARM's popularity. When the postmortem on this debacle is written I think Option ARM's will have been the single most poisonous ingredient in the toxic real estate concoction. If you think about it, even under the "conservative" lending requirements you are essentially buying real estate on the margin. 10 or 20% down let's you leverage your money enormously, not unlike buying a stock for 10 or 20 cents on the dollar. With zero down Option ARMS people were able to play the lottery without even paying for the ticket.

I honestly don't understand why Option ARM's are even available for the purchase of single family residences.

In any case I suspect the LA portion of the graph will resemble a panoramic view of the Mount Everest skyline if you look at it in a couple of years.

[CD]

CLIFF DIVING !!!!! BIG TIME !!!! FOR A LONG TIME!!!!!!

[Ace]

That is a wild ride Mr. Toad.

[Laker]

Peter,
I disagree. If you look at the national (dashed line) you see same shape just different magnitude....
Look at the denver line, I think we can infer from it that there was some income ratio that slowed down the rise. You can see that instead of concaving up, it started to concave down. LA concaved up all the way. I think this has a lot to do with fraud. The up trend was as a result of easy cheap financing but you still need demand and appreisals. LA has some much fraud in the RE valuation - that it is hard to believe.

The best part however, is that if someone had just landed from the moon and is looking at this graph. Shockg and lefty could sell him the 600 sf shack in Compton for $800,000 EASY!
But if you add the data up until june 2008....watch down below....slippery slope..

[toby]

10x over medium income...I mean wow. In Macroeconomics class, you'd be laugh out of the room to suggest such a thing.

Cause without fraud (giving a McDs employee a 500,000 mortgage, knowing there's NO WAY they can pay it back, just to collect the fee) it's just not possible.

And Macroeconomic classes hate talking about scenarios regarding rampant fraud.

[Cal]

Los Angeles was so different because of the tremendously low level of home ownership. When subprime came along it unleashed a wave of new (temporary) homeowners on the market. There was an additional layer of speculation to add into the mix.

We are now seeing that there is a tremendous difference between qualifying for a mortgage and actually affording it. Now we see the lenders even getting in the ballpark of affordability qualification (not even close to traditional guidelines though) and you get the NAR saying they tightened credit too much. If the NAR was so studied up on underwriting loans where were they during the boom?

[tew]

The graph overstates the case. Two things have trended in LA during the past three decades:
1) Unreported income as a percentage of total income has almost certainly risen sharply. (This is the underground economy.)
2) Wealth - rather than income - is increasingly at play. When this data series began whole segments of our current population hadn't even arrived. Whether it's an Iranian 30 years ago or a Chinese businessman today, they arrived with suitcases full of cash and real estate is a great place to make it "legitimate".

Trends in Price/Income are only valid if everyone is pretty much a W-2 paycheck collector. When a meaninful portion of the population have trust funds, offshore accounts, and unreported businesses the trend data become less helpful.

Put it this way: Who can better afford a $1 million house - a couple with household income of $200k or somebody with taxable income of $30k but with an offshore account containing $10 million?

[Politicus Finch]

Realistically, what happens is that LA home prices go back down to about 4.5x income. Even 6x income is an historical peak according to this graph, and 4x income an historical low. So the question is, what is the median income in LA right now? Anybody know? I don't. Multiply it by 4.5 and see what you get. There's your median house price at the end of all of this. Oh, and is this graph medians or averages??

[fezco]

Tew hit the nail on the head. At least here in the San Gabriel valley, there is a huge underground economy and it is easy to spot. Just show up at a college some time at the beginning of a semester. Kids show up in their mercedes and get tons o' financial aid because their 'stated income' is at poverty level.

Another reason for the spike is a change in demographics. In the SGV, there has been a shift from the nuclear family owning a home to multi-generations all piling in. Of course grandma, granpa, mom, dad, uncles, aunts, all contribute to the mortgage on their 4br stucco mcmansion. Most locally raised California natives who work for a living would rather live in tough-sheds down by the overpass than bunk with their parents again.

[WhereWasIWhenTheyGaveAwayFreeMoney]

Often overlooked is the fact that this mighty bubble equated to a huge transfer of wealth. Where did the billions of $ go that are now being written off? Whoever sold real estate from 2003 on out got a HUGE windfall. If you were lucky and had capital, you could very easily take home a few million $. Sure, some leveraged further and lost. But many just got lucky. That's why Santa Monica, PacPal, MB, etc. will remain unafforable for anyone earning a normal "very good" salary. That's because you compete in the RE market with people who got an easy $3m in capital gain for free. The thing that can make you mad is that, after faceless investors were caught holding the bag, got wise, and won't get caught again, Dodd & Co. are now out to make the taxpayer transfer even more money to people who really should have no business receiving any.

[dontmatta]

Politicus Finch said:
"Realistically, what happens is that LA home prices go back down to about 4.5x income. Even 6x income is an historical peak according to this graph, and 4x income an historical low. So the question is, what is the median income in LA right now? Anybody know? I don't. Multiply it by 4.5 and see what you get. There's your median house price at the end of all of this. Oh, and is this graph medians or averages??"

According to the "Los Angeles Alliance for a New Economy" website,
http://www.laane.org/research/los_angeles_economy_
2007.html
the median household income for the county Los Angeles in 2006 was $51,316.

This 4.5 x that figure = $230,922. Currently HousingTracker's numbers (not updated today yet) says the median listing price in LA is $439,999, so looks like we still have a long way to go.

[dontmatta]

Tew, do you have any sources to back up your 1st theory? There has always been unreported income, and what would make Los Angeles that much different?

For your 2nd theory, there have always been wealthy people in Los Angeles. An influx of wealthy people into Los Angeles isn't what caused prices to skyrocket. It was maily due to historically low interest rates and bad lending practices. If it indeed was wealth that caused these prices to skyrocket, there's no reason the bubble would have ever burst, because they would have been able to afford and sustain these prices.

[formerlahomeowner]

tew,

How many people have trust funds or offshore accounts worth millions? Using your example, if I have that kind of money, I'd be living in Hawaii, not LA. And how many houses are bought in cash?

[shockg]

Peter, thanks for the outdated data. You could always make up the future on the trend line like Laker attempts to do on his biased bubble blog. LOL. We all know about Lakers motives as a housing speculator.

[l.a.guy]

"So the question is, what is the median income in LA right now? Anybody know? I don't. Multiply it by 4.5 and see what you get. There's your median house price at the end of all of this."

It's an article of faith by most readers of this blog that the median house price has to be in line with the median household income. It may well be true, but I'm wondering if we're aiming to low because the median income numbers are based upon 100% of the population. According to an earlier post home ownership is at 67.8 right now. For the sake of argument let's say the market for selling single family residences is only 70% of the population. I don't think it's a big leap to assume that, GENERALLY SPEAKING, the 30% who aren't participating are at the lower end of the income spectrum. So if you just looked at the median income for the top 70% percent of wage earners in Los Angeles what would the median number be? I'm guessing it's considerably higher than the number based on all workers, and might suggest that the median home prices may not be falling as far as widely assumed.

Of course that's just my opinion, I could be wrong.

[S.Y.]

10X average household income is just plain ridiculous. However, I don't see Socal house prices coming down to 4X either (due to more wealth from Asia, construction costs, and more demand for housing than average US cities). I doubt Nocal and NYC are even close to 4X either. At the moment, the price has come down to about 8X. I look for price to settle around 6X (which would make the LA area median prices to be about 300-350K).

[keith]

Compare graph to the following quote -

"Velocity of the downward plunge...bringing terrifying new meaning to the term "negative gravity." But the towering thriller isn't finished with you yet. There's still another heart-pounding wallop as riders rebound...back up the tower before a final landing below."

Now - where are we?

[Laker]

WhereWasIWhenTheyGaveAwayFreeMoney:
Where did the billions of $ go that are now being written off?

Pretty much yes. Money cannot disappear unless you take it literally and burn it (burn the cash).
Obviously all the writeoffs are basically money that is sitting now in many big pockets of regular Joe's that sold in time, a lot of it is in the pockets of people like Mozillo and co, and a lot is in the pockets of Dodd and his pals. However, i doubt how many regular Joe's actually sold at peak and went renting...I mean most people need to live somewhere and these sold their home even at peak, and went on to buy even bigger and better house for more money as they still bought at peak. At the end of the day, now they super duper expensive houses are crashing proportionally to their cost, and they may end up forfeiting all their "profits" at best case, and go in to foreclosure and losing everything at worse cost...The only winners were those who sold and did not buy, those who were NOT greedy. How many people you know like that??? Enough to buy all LA inventory...
Speaking of which according to housing tracker just go boosted to almost 46,000 a 3000 increase in one week....
Shockg, so the median price is stabilizing? Or did it already finished stabilizing? oh....wait there's more...high end just gave $20,000 after holding steady for month.....

[Grateful Renter]

"Talk about your plenty, talk about your ills,
One man gathers what another man spills."

-Garcia/Hunter

[Laker]

shock foolG,
Peter does not need to make up future data. The graph is outdated, and peter apologized for that on the post. One smart man told me that if you don't have anything smart to say, you better shut up, only bad thing will come out. An you fell to your own trap here. This graph is missing data from the past that is data from 2007 through june 2008. That is 18 months of you know what type of trend....This is not a prediction but more of not depicting the past. We could however try and predict what will happen after june 2008, but there is really no need or a problem to do that...Every fool knows where the bottom is....if something is in a free fall, you wait to hear the big boom...then you know it is the bottom. So far the bleeding only started but the streets are very quite....no big boom yet.

[yourkillingmelarry]

"If it indeed was wealth that caused these prices to skyrocket, there's no reason the bubble would have ever burst, because they would have been able to afford and sustain these prices."

Bingo, Tew's argument is very subjective. Underground economies exist on large scales in places like Russia and old eastern bloc countries where up to 30% to 40% of the economy is driven by organized crime. Developed countries do have underground economies and yes there is one in LA but a much much smaller scale of somewhere in the area of less than 5%.

Home prices in LA were not driven by wealth, they were driven by bad loans.

[Ace]

'Whoever sold real estate from 2003 on out got a HUGE windfall. If you were lucky and had capital, you could very easily take home a few million $. Sure, some leveraged further and lost.'

Nah, very few people got out. Real estate is like Vegas... sure you are up $500 now but your plane doesn't leave for another 36 hours.

Speculators rolled their easy money into another speculation. Joe Six Pack rolled his easy money into a McMansion. They are just paper profits. Kinda like when my childhood baseball collection was worth millions.

[tew]

dontmatta, formerlahomeowner,

Let me be clear - I said that the graph "overstates the case". I would not want the factors I cited to be interpreted as explaining all or even most of the meteoric rise above historical norms during the past few decades. Prices were and remain way out of proportion to fundamentals.

As far as sources, I have searched and searched and it is difficult to get estimates of the underground economy. Many economists have used several techniques to try to estimate this. IMO, having good street instincts and looking around with eyes wide open - no PC police in your head - is probably better than all their studies put together.

Also, a key insight into how prices are set in the marketplace is that the margins matter. Among a few million people if a few hundred thousand people move in with wealth, they take supply off the market long term. Even if nobody you know has wealth and nobody in your neighborhood is "rich" or thriving with unreported income, if the neighborhood up the hill is full of folks like that, it impacts the prices for you, because the next income tier is forced off the hill.

As for rich people either a) having always been here or b) opting for other locales, you're right and wrong. Recent trends (see LA Business Journal and some other articles) show that there has been a huge increase in foreign wealth buying in the LA area. The buzz in those circles has become that LA is now "world class". You may not agree, but it's a trend, no doubt.

Now add in Prop 13 (long held estates never sell), the weaker dollar (we look like a bargain compared to, say, upscale parts of Mumbai (Bombay) - somebody earning 500k euros in 2000 was making $400k, but now that translates to ~$780k), and a hyper-celebrity culture (yes, stars have always made lots of money, but the ratio of B-list celebs/athletes/"personalities" to "regular folks" has shot into the stratosphere in the past decade (*).

* Don't forget that just because somebody lives in LA doesn't mean all of their income is counted in LA numbers. An official residence in Incline Village (NV - no income tax; overseas works too - lots of choices) and a house in Beverly Hills) is a winner.

[RO]

Where is the controversy here, we've already lost close to 40% on the median in the last 12m. I don't have precise numbers at hand, but Peter posted a zipcode-based lookup that showed statistically impressive declines. The real mystery here is why the "nice" neighborhoods haven't budged.

[shockg]

Inventory increases by 3000 homes at the peak of summer after 6 months of flat inventory and Laker is jumping for joy. I can see how you need something to cling on to at this point. The other speculators are now out there buying and you keep on waiting for your 50% off. LOL. Why dont you look at the other side of the equation....demand. UP UP UP.