California Housing Forecast/Fidelity Pacific Real Estate

I hate to say it, but I do not see that much value in historical comparisons such as those shown in the last chart. We have never had such a big part of the economy disconnected geographically from its customers. This is possibly through technology and gives people choice where to work and live. Some places are winners and I do not see how that will change any time soon.

RadT:

Unfortunately, the "winner" areas are the one where household incomes have been higher than the norm historically. Home prices are determined by household income, together with interest rates on standard loan vehicles. To spell this out for you, take the median *household* income, which has nothing to do with the location of the job, or the source of the income, but the location of the *house* in which the employee lives, and spend 1/3 of said income on mortgage payments using traditional loan instruments at prevailing interest rates. Said computation accurately tracks and has tracked home prices. So, ignoring your notion of "winners", the fact is that homes are priced to what people can afford to pay, not what they wish they could afford to pay. The charts on this site explain how, with incomes roughly flat in the "winner" areas, the prices of homes have risen, namely by a collection of toxic loans that allow people to buy an more expensive house while maintaining the same monthly payment, at least briefly enough to cause a little mania. In Japan, they were even offering 100 year loans to be passed on to grandchildren, at the height of the bubble. In any case, the sustainable monthly payment amount is not measured by job location or desirability, but by how much you can afford to pay. In terms "not seeing" when this will end, this will end when the monthly payment rates reset, when the credit cards are maxed out, and when family is no longer willing to lend money to support the higher monthly payments.

Nothing new to see here -- feel free to revisit this issue when household incomes in san diego or phoenix double, and then you can argue that the doubling of home prices has been justified.

RadT, your theory would make sense if the people living in those expensive cities earn a very high salary by working for an employer in another city. I don't know anyone in San Diego who works for an employer in another city. Do you have any examples?

I deleted the spam post.

Your data appears to be confusing the Bay Area with San Francisco.

The people in every area took their income into account and went equally overboard. Now everyone is proportionately over their head. Of course it is true that whichever area was most wrong about their future economic state will be the most screwed, but everyone is over-extended on average.

The historical rental P/E is still important. The Bay Area does have a price premium attached to it. Historically it was 24x while the nation was at 16x. Now the nation is at 26x and SF is at 42x. So yes, there is a premium to living in SF, but we're well outside of "premium" territory and we're in "insane" territory.

As an analogy, Japanese cars cost a premium in this country due to import taxes, etc. and that premium is reflected in the price. But what if japanese cars DOUBLED in price in five years? Would you still say the 100% additional cost is due to the import taxes? Of course not, because those taxes were already factored in the old premium price and didn't change in proportion to the amount the price went up.

Point is, and always was, there's nothing in the fundamentals that explains prices now. Not interest rates, wages, building costs, availability of land, rents, etc. Nothing. The only thing that is keeping the prices where they are right now is speculation.

I agree that price rise is insane but what if its the result of inflation that is brewing. Central bank printing money like crazy lately and as dollar value falls so more foreign buyers can afford land here even at crazy prices as it is.
If inflation will kick in who says that rent will not go up?

Cheer.

Oh, another geography faux pas. Thanks for the correction. The error is in the report too, and that's how I got confused. Exhibit 117 labels one of the regions as "San Francisco Bay Area".

The Bay Area includes San Jose (the largest city), Oakland, and San Francisco, according to Wikipedia.

I've read people like Rich Toscano, and economists, talk about the effect of inflation on housing, but they all forget that inflation can only keep prices high if that inflation leads to wage increases. Very important!

Historically, wages rise with inflation, but in the last few years they have not. Between insourcing and outsourcing, our wage increases will lag inflation for decades. This is a global economy, and we are headed to being on par with our competitors in emerging economies.

So I don't buy the theory that "rising inflation will cause high house prices to make sense".

We may have a few foreigners buying a beach house here or there, but foreigners are not what caused this bubble. All around me in my city of San Diego, it is Americans who got 100% financing on overpriced homes.

Aesot,
I love when the home bubble cheerleaders start to scream that rent is rising. It's not. We are at the beginning of a long decline. All that matters is median income to median price ratio. Eventually the chickens come home and the party is over.
The thing that everyone should be worried about is the recent rumblings by the goverment to get involved. They will just make the situation worse by creating a bail out plan and going over board on regulations. Then there will be no demand for homes at all and the prices will sink lower than they should.
If you want to save housing as an investment at all then write your Senator today and stop the bail out.

While I believe a bubble exists, I believe it is more than that on the Coasts. In LA and SF, I believe the immigrant population has has a profound impact at all reaches of the market.

At the lower end, easy credit enticed first-time Latino buyers to bid on new development in desert regions. They are now getting hit with their mortgages, and prices will sag in this portion of the market.

At the higher end, the off-spring of new immigrants from Asia and other parts of the world, having graduated from good universities, are bidding on pricey condominiums and houses. Also, there are many, many wealthy young people that move here from South America and Europe. They do not help matters.

My point: Demand IS up. Way up. How many people are now in CA? No one really even knows. Is demand for housing elastic? No. It's inelastic, just like fuel costs. You get a stress in the supply/demand dynamic, prices will get crazy.

The one safety valve is people leaving. And natives are fleeing California at a fast clip.

I want the bubble to burst and am hopeful. Still, I think it is possible LA and SF are undergoing a transformation that will make living expenses closes to NYC than to Kansas City.

spom in Venice

Demand is WAY DOWN. Sales are down 20% or so from last year. Our sales are the lowest in over a decade. We have a glut of homes, and record vacancies. We have never had so many vacant SFR in the Census Bureau history: 2.7% of all homes. We have never had so many vacant rentals.

We increased homeownership from 65% to 69% of population, due to practically eliminating lending standards. This process is reversing.

This is the most important question, if I can distill my entire forecast into one sentence: how much mortgage can a buyer afford when credit standards return to normal?

Let me ask again. How much can a buyer pay for a house when down payments are again required, when you have to prove your income and ability to repay? And don't think this lax lending is here to stay. It is contracting, and in a few years we will be back to normal lending again. Investors don't like losing money, and this entire MBS gambling hall is going to shut down.

Then, people can borrow only 2.5x their income. Not 10x their pretend income. But 2.5x their proven income. How low will house prices have to fall, when buyers can only pay 2.5x their proven income. Oh, and that's on 90-95% of the house, because they need 5-10% down.

Now that investors figured out they can't buy real estate for appreciation, they will only buy when it "cash flows", ie the rent covers the mortgage. How low will prices have to drop before investors get back into the market?

That puts house prices at half of today's levels, maybe even less.

I was worried about inflation too, that it might bring support under these crazy prices. But then I realized that there are all kinds of inflation, and income inflation isn't the kind we're seeing. No we're seeing the kind where our money just gets worth less on the world stage. Things that you compete for on a global scale (like energy) will become more dear, and things you compete locally for (like housing) will adjust to long term norms.

I am not sure how the 42x was derived for San Francisco Bay Area but I do have one data point. I just came back from looking at a house for rent. The rent price was $2600.00. They were trying to sell it for $799,000.00. That makes the ratio about 25.6x.

While I would like to believe the 42x (because that would mean bubble might burst to the point where I can buy instead of rent), it doesn't look like the "PE Ratio" is that out of whack.

Just want to make sure we are not "cheerleading" the other side of the argument too much.

For San Diego, my price/rent ratio is typically 12-16 and we are at 26 now. I don't know how they calculated theirs.. But from my calculations, we need a drop to 12 or 13 to return to historic bottoms, which means the median home price has to drop in half. Some areas will drop much more than others.

I'm currently doing a study for the subscriber area, on how much houses on the water fell. People will be shocked, as they think houses on the water (ocean front) are immune to price drops. They crashed seriously, Luxury homes seriously crashed in the mid 90's. People had to sell, and there were short sales on the water! Stay tuned.

Not sure about the rent PE multiples, but there's an alternative way to get at what one might consider a correct multiple. (I live in LA, currently renting, having sold my SFR in late 04)

For Example: take your rent and determine what your comfort level for payment would be. For example, if you pay $2000 in rent, would you be comfortable buying the same place for $3000 (1.5x)?

Next back that number ($3000) into a mortgage calculation in reverse.(use the link I provide to play with some numbers (for LA) or other on-line calculators.)

Assuming the $3000 is what you're willing to pay after taking tax benefits into consideration, in LA you end up with a house equivalent price of approx $625,000

Divide that by the original $2000 = personalized rent multiple of 26x

Next determine what the property you're living in appraises for.In my example, the house I'm renting is probably worth about $800K to $850,000 (even in the current market) and thus has a multiple of 33x to 36x

If your willingness to spend more than the $3000 indicated in this example to 'own' a home, that's fine, and it will shift you personal rent multiplier number higher.

I also think that the broader numbers indicated above are probably distorted on the low end more than on the high end. (And thus explain partially why the high-end resale market is stronger than the low end.) For example, at the height of the bubble, properties in South Central LA started to go for the mid 400s where as rents in that are much much lower, thus inflating the rent PE.

Because of this distortion, you have to go back to the old maxmum, 'location','location','location'. and figure out what your own personal variables are for your particular neighborhood of interest

It seems to me that you are just writing the basic stuff I learned in real estate school back in the eighties. The idea that these formulas are controversial are new to me. I suppose if people had invested in bonds, then standard bond formulas would start coming into question too.

Filmo, rent multipliers on the lower end are distorted too. A 1000 sq ft house rents for $1600, while a 2100 sq ft house rents for $2100. So the lower end house has a higher multiple for price/rent than the bigger house.

These multiples are basic real estate valuation tools. You calculate them not by assuming how much more someone would be willing to pay to own, because then you're getting back into that ponzi scheme stuff. You calculate based on whether a rental income stream will cover the mortgage. Your $3000 vs. $2000 will not cover it, so there's a bubble.

The basics for calculating a house value are price/rent and price/wages. This is just fundamental analysis. A fair price is based on the cash that asset can generate.