How To Forecast the Real Estate Bottom

J

jamis359

It's easy. You need only a few things: the median family income, the median single family home price and an online mortgage calculator. The underlying theory is simple: incomes and available lending leverage drives home prices.

Let's do Las Vegas for example.

1. Find the median family income. It varies depending on source, but $56,000/yr came up, and I ran with that number.

2. Assume that by 2008 that traditional 10% down 30-yr financing is the only thing that lenders will touch. Forget ARMs, no doc, no downs.

3. Plug $56k and 10% down into an online mortgage calculator. Max home price at those terms = $210,000.

4. Compare affordability to current real estate median price. Currently for Las Vegas it's about $295,000.

5. Market price has to fall to meet the bid. Therefore, the median home will need to drop from $295,000 to $210,000 for the market to function normally again. That's about a 28% drop from today.
 
Quote from jamis359:

It's easy. You need only a few things: the median family income, the median single family home price and an online mortgage calculator. The underlying theory is simple: incomes and available lending leverage drives home prices.

Let's do Las Vegas for example.

1. Find the median family income. It varies depending on source, but $56,000/yr came up, and I ran with that number.

2. Assume that by 2008 that traditional 10% down 30-yr financing is the only thing that lenders will touch. Forget ARMs, no doc, no downs.

3. Plug $56k and 10% down into an online mortgage calculator. Max home price at those terms = $210,000.

4. Compare affordability to current real estate median price. Currently for Las Vegas it's about $295,000.

5. Market price has to fall to meet the bid. Therefore, the median home will need to drop from $295,000 to $210,000 for the market to function normally again. That's about a 28% drop from today.
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Thats nice in theory, but its like saying a bear market in stocks will end when the PE of this Index or that one reaches X. It might be in the neighborhood, but likely on the very edge and close to the next one. Each market has its own economics, your never going to find, for example, NYC, Boston or SF on average to be affordable again for the average person UNLESS they remove growth restrictions, which is HIGHLY UNLIKELY. Each market is "real estate" and will have commonalities as such, but you also must understand that each market is its own small economy, and as such will have its own drivers and catalysts which will determine a bottom or top.

Brandon
 
Quote from Brandonf:

Thats nice in theory, but
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That's kind of what I thought. People who start off with "It's easy... are usually people who do not understand the market rules, including real estate. You cannot plug in median incomes, and ignore dozens of other variables, such as renting, flippers/investors, growth rate of population, projected supply, job market growth/supply, etc. etc.
 
Quote from jamis359:

It's easy. Compare affordability to current real estate median price. Currently for Las Vegas it's about $295,000.

Market price has to fall to meet the bid. Therefore, the median home will need to drop from $295,000 to $210,000 for the market to function normally again. That's about a 28% drop from today.
More...
If the average's not the ceiling it probably ain't gonna be the floor either.
 
There's one major problem with this approach - it assumes that a price decline will stop at "fair value". Often when boom turns to bust, the price bottom is not reached at fair value, but at a significant discount to it. You are effectively playing a guessing game - great if you happen to be right, but bad news if you are wrong and get in too early.

There's a much simpler, almost foolproof way for knowing when to re-enter a real estate market after a bust. Simply wait for the first year on year increase in prices before buying anything. Real estate has far less "noise" than stocks or other liquid financial markets, trends tend to be one-way and reverse a bit like an oil tanker i.e. slowly. This way you will not get the exact bottom, but you will be buying into a recovering market. The odds are very good that you will be buying after the bottom, rather than before it.

This method helped pick the bottom in the Japanese and German real estate markets a few years ago, and worked well for other real estate busts in the last decade e.g. Bombay, Buenos Aires, Hong Kong, SE Asia etc. It's very rare to get a slump which goes down for a year or two, then has one up year, and then moves back down to new lows.
 
Instead of looking for a year over year increase in home prices, look at local rental prices. When they increase, generally about 6 mo. later, local housing prices will start to increase.
 
Quote from Cutten:

There's one major problem with this approach - it assumes that a price decline will stop at "fair value". Often when boom turns to bust, the price bottom is not reached at fair value, but at a significant discount to it.
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In those other real estate busts where prices undershot fair value, was the driver of the bust lending or unemployment? That's what is unique about the current RE market, it's happening during a period of full employment. As long as employment holds up then the bottom should be determined by lending terms as I described because there will be many bidders eager to buy once they can qualify.
 
As a person who just sold property in NYC, I assure you there are still plenty of people looking to buy. The difference is that a lot of people want a bargain and are waiting for the realtor to find that ever elusive condo that had been put on the market very recently by a widow who just wants to get rid of it and consequently will accept 30% less than the market price.
Then again NYC being an island is unique and since it can only expand upward, prices will remain high (always have). Factor in inflation and demand from foreign individual investors and the bigger picture will look bright and expensive.

I think the prices will continue to slide except for the hot cities where there is just too much demand nd too many people making decent coin to dent the market the other way.

I also think that as years go buy homes will increase in price and what once was available for a regular joe will only be available to the upper middle class and higher.
 
Quote from jamis359:

In those other real estate busts where prices undershot fair value, was the driver of the bust lending or unemployment? That's what is unique about the current RE market, it's happening during a period of full employment. As long as employment holds up then the bottom should be determined by lending terms as I described because there will be many bidders eager to buy once they can qualify.
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Most really bad busts have also had hits to employment and correlated with recessions. However there have been some that had no such problems - it was just excess speculation, and oversupply, which caused the problem. A good example is the Florida bubble and crash in the 1920s during a booming economy.

Recently you had lending standards far more lax than normal, even for boom times. People with no job or income were able to acquire multi-million dollar portfolios, with no money down. In some cases they actually got *cash back* for buying properties. That is a huge number of forthcoming foreclosures that will be dumped onto the market en masse by panicky lenders. Add to this the record numbers of new condos in the pipeline, way in excess of the market's natural year on year demand for new properties. Supply is high and will go on getting higher in 2008, 2009, 2010 until all the current projects get built out and every flipper has ditched his property portfolio.

The kicker is that the real estate industry is a large proportion of GDP. In recent years every Tom, Dick & Harry has set up as a realtor, developer, or condo flipper. Many of them are going to be unemployed by this time next year. Their discretionary spending will disappear, and in many cases if they refinanced their home equity they are going to end up homeless too. Think of all the money these RE related people spent on luxury goods, real estate, restaurants, nightlife, big ticket consumer items etc. If they feel the pinch, which looks likely, this will affect a huge chunk of the economy - knock on effects could cause a recession with rising unemployment.
 
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