Real Estate is dying? Investment-wise what is the next Asset Class Du Jour?

>Anyone with more than 66% of the current value of his house in debt and no other assets would be bankrupt if the value of his house fell by a third. I have no statistics, but with all the stories of zero-down mortgages and home equity loans, I bet there are a lot of Americans in this precarious situation. Especially in California and other hot RE areas.

*** I don't know about that. Have ya'll looked at the size of the payments that people are making versus the size of house you can buy? Although prices on houses have gone up, you can still buy more house (square footage) now than you could a 3 or 4 years ago for the same $1500 (or whatever) payment. In fact, I've figured out that housing would have to rise another 5 to 10% just for the size house you can buy to go back to where it was.

The people who are locked into fixed rates who can ride out a housing price crash are still going to be better off unless they timed it absolutely perfect. If the market crashes, it will be for one reason...because rates went up. The price of housing would need to drop a long way to justify temporarily renting and waiting for a crash. Take my situation for example. I bought my house before this price run. Over the last 5 years, it doubled in value. I refinanced at the bottom (got a 5.25% fixed note). My payment is so low that my tenants are paying just 25% less for a townhouse half the size. If the market crashes because of high interest rates, I'll be able to charge even more for rent because it will be hard for people to buy a place. My cash flow will go up. Meanwhile, my house payment will stay the same. So will I go bankrupt? Heck no, I won't move, and inflation will make my housepayment laughably small.

Bear in mind, that if the market crashed because high interest rates make houses less affordable, yes...there would be a lot of dopes who didn't buy fixed mortgages when the rates were at record lows because they wanted to save an extra 15%. However, those of us that did, who could potentially wind up upside-down in our houses would just not move. Right now, if you wanted to buy my house, I'd consider it. If I was upside-down, I would not consider it at all, and I'd just keep my small payment. My point is that if rates rise, and this causes a bursting bubble, there are many, many people like me who will not add to the supply side of the supply-demand equation. The supply of houses for sale will shrink considerably, and this will act as a shock absorber.

So the bottom line for everyone here is that if you're in an overpriced area, and you *know* that you're going to stay there, or at least you know that you could rent your place out, then just finance into a fixed note and stop worrying. Home prices may go down a lot, but payments and rent will go down little, if any, and may likely go up.

SM
 
Quote from darkhorse:

And yet, if you look at the weekly for a big picture perspective, you see higher highs and higher lows: http://tinyurl.com/58ud6

Not only that, but the upswings have a disconcerting bit of vertical feel to them. Appropriate for the situation we're in.

Sometimes charts say a lot, sometimes they don't say much at all. Often the context really helps. For example, we did the lombada thing with rates already. You have to stop when the back of your head brushes the ground. We got to what, 40 year lows? 50?

Not to mention that average US consumer saving, proportionate to income, is down to $1.50 per week. The keg's tapped out. We drank all the beer. We're drinking more to try and avoid the hangover.

The maestro himself is talking down the dollar (or at least he was last month). Lowering rates now would be like pouring salt in our creditors' wounds. The only way we go back to falling yields is if the economy stumbles and falls again, which brings recession and potential stagflation to the party. Not the most bullish scenario.

Macro just ain't in RE's corner in any way, shape or form. If you want to be bullish no matter what, better to ignore and hope than try to rationalize.

Let me stress again that I still think "muddle through" (as John Mauldin calls it) is a reasonable possibility, and not one to be counted out. But the truly ugly scenario is still 1 in 5, and maybe 1 in 3.

p.s. actually there is another scenario that could bring about lower rates on the 10 year - an inverted yield curve. But once again, this would not be pretty... in fact it would probably be a nightmare...
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p.s. I took out the stuff about ignoring and hoping. Easy to let the sarcasm go too far without realizing it, probably because it's more glaring on a board than among friends. Still just agreeing to disagree here.
 
Quote from OldTrader:

Just thought I'd post another link. Alot of folks forecasting higher interest rates. Yet the 10 Year Note for instance has a distinct look of heading lower, not higher. You be the judge.

http://www.ttrader.com/mycharts/display.php?p=29227&u=oldtrader&a=OldTrader's Charts&id=1300

OldTrader
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I really like your posts, OldTrader. Food for thought: Look at it over a 3 to 5 year period and you might get a different answer. I'm not a chartist, but I've found that you can get different answers depending on what duration you're looking at.
 
Alarm over price of homes

Kathleen Pender

Remember how the price-earnings ratio for stocks soared before the market crashed?

Well, the price-earnings ratio for homes in the Bay Area and greater Los Angeles is also skyrocketing, according to a forthcoming report from UCLA economist Ed Leamer. He says homes are so overvalued that prices are likely to fall when the Federal Reserve raises interest rates.

A P/E ratio shows how much investors are willing to pay for a dollar of earnings. It is one way to measure the public's enthusiasm for a particular asset class. The higher the ratio, the greater the zeal.

In the stock market, you calculate P/E by dividing a company's share price by its annual earnings per share.

In the housing market, you divide the price of a house by the annual rent it could fetch.

Leamer calculated the average P/E for homes in several California metro areas by dividing the median price for a single family home by the average annual rent for a 2,000- square-foot apartment in each region. (You can get more and better data for apartments than rental homes, and the two tend to track each other.)

His findings: In the Bay Area, the average P/E for a house shot up to 13. 8 in the first quarter of 2004, compared with 7.2 in 1999 and 2000. Today's ratio is more than a third higher than it was 1989, just before housing prices started a multi-year descent.

In Santa Clara County, the average P/E is 15.8 today, compared with 10.3 in 1989.

"We are in a situation that is more extreme than it was in 1989," says Leamer, director of the UCLA Anderson forecast.

In the Bay Area, P/E ratios are skyrocketing because rents are falling while home prices are escalating, Leamer says.

In San Francisco, the average rent has skidded to $22.01 per square foot from $31 per square foot in 2000, while the median home price has risen to $606,000 from $450,755.

In Southern California, where the economy is stronger and more diverse, rents are rising, but housing prices are rising even faster. As a result, P/Es are also rising, though not quite as far as in Northern California.

In Los Angeles, the price of a median home rose to $399,000 in the first quarter of 2004 from $215,652 in 2000. Rents rose to $19.35 per square foot from $18.07.

When the economy is booming, investors are willing to pay higher prices for stocks and houses because they think the earnings from these assets will grow faster than normal. Occasionally, they throw common sense out the window and start believing that earnings will continue upward in a never-ending spiral, untouched by forces like competition and economic equilibrium.

That is what happened to the stock market and tech stocks in particular in the late 1990s and early 2000. In March 2000, Cisco was trading at 192 times earnings. Today, it is trading at 35 times earnings.

When the economy cooled in 2000, stock prices started coming down, but housing prices continued to go up because falling mortgage rates had made homes more affordable.

"The elevated P/E ratio didn't come from the strength of the economy. It came from low mortgage rates. That's great if it is a permanent new condition. We know it's not true," Leamer says.

In a 2002 paper, Leamer warned about rising P/E ratios for homes, but did not see the bubble bursting "in the immediate future." But, he warned, "this could turn around rapidly if Mr. Greenspan decides to increase short-term interest rates."

In closing, he wrote, "Stay tuned. I promise to keep you informed of any breaking developments in this regard."

With the Fed likely to raise short-term interest rates this summer, Leamer says now is the time to worry about a bursting bubble.

On Tuesday, Federal Reserve Chairman Alan Greenspan downplayed the bubble theory, but told senators, "We perceive that the very strong expansion in new and existing home sales is now flattening out. And the really quite unexpected boom in home sales over the recent years is unlikely to be continued. Our forecast is generally flat, not in prices but in aggregate volumes. Where house prices go, I'm not sure, but I would be quite surprised if they showed continued acceleration on the upside."

Leamer says the best-case scenario for housing is that price appreciation slows or stops. This would require the economy to grow rapidly with relatively little inflation so people could still afford homes, even with a modest increase in interest rates.

In the worst-case scenario, "inflation starts becoming more apparent, and long-term interest rates elevate much more rapidly or substantially."

In this case, higher interest rates not only make mortgages more expensive, but also choke off the economy, leaving fewer people able to afford homes. Higher rates also make bonds and money market funds relatively more attractive than real-estate investments. As a result, housing prices fall substantially.

The most likely scenario, in Leamer's view, is that "we have another recession in 2006, with significant problems in the housing sector."

At a home-building conference in San Francisco Wednesday, Ken Rosen, chairman of UC Berkeley's Fisher Center for Real Estate and Urban Economics, called the current P/E ratio for Bay Area housing unsustainable.

He predicts that gradually rising rates will make purchasing a home less attractive than renting for many people. That will lower house prices, increase rental prices and bring the P/E ratio more in line with long-term averages.
 
Quote from darkhorse:

And yet, if you look at the weekly for a big picture perspective, you see higher highs and higher lows: http://tinyurl.com/58ud6

Not only that, but the upswings have a disconcerting bit of vertical feel to them. Appropriate for the situation we're in.

Sometimes charts say a lot, sometimes they don't say much at all. Often the context really helps. For example, we did the lombada thing with rates already. You have to stop when the back of your head brushes the ground. We got to what, 40 year lows? 50?

Not to mention that average US consumer saving, proportionate to income, is down to $1.50 per week. The keg's tapped out. We drank all the beer. We're drinking more to try and avoid the hangover.

The maestro himself is talking down the dollar (or at least he was last month). Lowering rates now would be like pouring salt in our creditors' wounds. The only way we go back to falling yields is if the economy stumbles and falls again, which brings recession and potential stagflation to the party. Not the most bullish scenario.

Macro just ain't in RE's corner in any way, shape or form. Let me stress again that I still think "muddle through" (as John Mauldin calls it) is a reasonable possibility, and not one to be counted out. But the truly ugly scenario is still 1 in 5, and maybe 1 in 3.

p.s. actually there is another scenario that could bring about lower rates on the 10 year - an inverted yield curve. But once again, this would not be pretty... in fact it would probably be a nightmare...
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Sorry about that. Hit the wrong button.

I don't know a soul...not one....who expects anything other than higher rates. If you look back through just this thread you will find that everyone "assumes" a higher rate. Yet, for the moment, the yield is under the 20, 50, and 200 day averages. Even broke out recently and failed. Why?

Again, I have no problem with the idea that real estate moves lower. I've said that. I've said it has likely already peaked in my area.

But again, houses are not stocks. People need to live somewhere, either a rental or their own home. The house is the last thing to go. It's a priority. The idea of houses moving on the downside like nasdaq stocks is simply a flight of fancy. Stagnation. Yes. A drop of some moderate type. Yes.

But back to the chart, if the yield curve is flattening, this may foreshadow a coming economic slowdown. In this scenario real estate may not do well, but the interest rate structure may lend some support to it.

By the way, I'm not talking about anyone "lowering rates". I'm talking about the plausible idea that higher rates, higher oil prices, may cause a slow down which rates are now potentially reflecting.

Frankly, this idea that rates go sky high and real estate crashes is a mighty popular idea...and has been for some time. If it works out that way it will be the first time I've seen so may forecast correctly.

The US has been muddling through as you put it for years. The first time I heard a doomsday scenario for real estate was back in the early 80's. And if there was ever a reason for it to happen that was the time.....20% interest. Yet it didn't.

I don't know about you guys but I won't be selling my house. :D I have no desire to rent an apartment. I don't count on my house as an investment. It's something I consume, just like my car, or anything else. Likewise, I won't be selling any of my investment property other than through the normal course of business. You know, rents have been under pressure for a while. Mainly through giveaways because of the fact that people are all out buying houses. If this is to swing the other way the way you guys forecast, people are going to need places to rent.

OldTrader
 
Quote from onewaypockets:

Alarm over price of homes



He predicts that gradually rising rates will make purchasing a home less attractive than renting for many people. That will lower house prices, increase rental prices and bring the P/E ratio more in line with long-term averages.
More...

Just thought I'd point out that this article is an old article. Patterned after a book which assigned PE ratios to houses! :D :D

In any case, rates peaked last summer just for the record.

OldTrader
 
I hesitate posting my letter by chopping it up. But it is just too long. But very important, IMO. Traderbal got the hint early. We are near a currency war. I'm not a trader. I read macro stuff. So here it is and hope it isn't too dry. This is the big war going on IMO Moo. QUOTE:

The problem is not solved by dollar devaluation; it is solved by the U.S. restraining its profligacy and returning to a net national savings rate that is both its national and the global historic norm.
It is hard for people to understand that, when savings propensities are so disparate, a large current account deficit can be the reigning market equilibrium even if it is unsustainable in the long run. Let me try to illustrate.
Is the dollar overvalued? Against what? Europe and Japan? The depreciation in the dollar against the euro and yen has had little impact on the U.S. current account so far (though some impact is due, given the lags in trade). Most models suggest something like 70 yen/dollar and 1.80 dollar euro are needed to shave perhaps 1% or 2% off the U.S. current account deficit. Does that make sense? Will a cup of coffee in Milan have to go to $16 for the U.S. to correct its external imbalance?
Now think about this from the point of disparities in savings propensities. Assume a U.S. with a historically normal saving rate. Poof. The current account deficit shrinks, and by a lot. Let the ECB ease and stimulate domestic demand. Poof. The current account deficit shrinks further. Then we don’t need an exchange rate equilibrium with $16 cups of coffee in Milan.
Well, that is basically the problem with the U.S. current account deficit. Except the U.S. - won’t accept the cold turkey adjustment of recession.
The U.S. has a recession sized fiscal deficit and zero household savings. That never happened before. In the early 1980’s the household saving rate was 9% when the fiscal deficit was this size. The financial surpluses/deficits of the four economic sectors – households, governments, corporations and rest of the world (current account) – must sum to zero. It’s a waterbed world – push down one sector balance and another will have to go up. How are you going to create a new low U. S. current account deficit if you don’t increase the savings of households and government? Reduce the current account deficit via exchange rate depreciation and thereby add to the rate of corporate free cash flow? It’s already at record levels. The labor share of income is already record low. The current account deficit is not an imbalance that requires $16 cups of coffee in Milan to correct – it requires changes in savings propensities in the U.S. and abroad.
Of course, U.S. dissaving is only one side of the problem. The other is that Asia saves and invests too much. These are simply same coin, two sides. Once investment ratios are so high and the capital stock is export oriented, you can’t adjust costlessly. This is China’s problem. Europe and Japan’s currencies are all right. Given their weak demand patterns they might be overvalued against the dollar. Yes, China and the emerging world must eventually revalue. In the past emerging Asia did it by inflating higher than the U.S. But not now. Because the Chinese investment ratio is crazy high even relative to emerging Asia, she cannot take a large revaluation. The crazy high investment ratio would then no longer be validated and growth would have to go negative.
The U.S. current account deficit is not the global imbalance. It is the outcome of deeper global imbalances – dissaving in the U.S. and overinvestment and over saving in China and elsewhere. Correct those and the U.S. current account deficit falls to a level that is consistent with a non explosive external U.S. debt path. Without $16 cups of coffee in Milan.
When one looks at it this way one can see that as long as the U.S. is Miss Profligacy and Europe and Japan and the emerging world are Miss Thrifty the dollar market equilibrium is higher than the current dollar level and it is only huge speculative shorting that has pushed the dollar down.
This is all economic argumentation about a hugely complex subject. I recognize this and do not want to be dogmatic. But, to look at this more simply, the dollar has declined now for eleven weeks in a row. Measures of sentiment and positioning show it extraordinarly oversold. On the long term chart the dollar is at a multi decade low with multiple touch points.
I have never seen a two way market in which virtually every participant thought it was one way. The dollar can only go down. For most markets, when psychology reaches this extreme, everyone is on one side of the boat and the boat is ready to tip. I am not alone in this view.
But even if the dollar is overdue for a bounce, what would precipitate it?
The European and Japanese policy makers, fearful that dollar weakness will throw their weak economies back into recession, have been pushing the U.S. to engage in coordinated intervention to reverse the speculative positions of the dollar bears. The U.S. has refused. As a consequence anger is rising among these policy makers and it is spreading to encompass the likes of China and other emerging economies. We are hearing strong and angry language on this issue from the U.S.’s trading partners like we have not heard for many many years. Efforts are now being made by these countries toward a very broad coordinated intervention that may exclude the U.S. but may encompass China and many others.
Will such intervention work? The speculators who are short the dollar say no. But the historical record says otherwise. When speculation and the dollar are at extremes intervention works. It turned the dollar down on March 1st, 1985 – the day of the dollar high. It turned the yen down against the dollar on the yen high in 1995. It set in motion the big dollar rally in 1996.
Why does intervention sometimes work? Because speculative bandwagons displace currencies from their short run economically determined equilibria. Speculators are trend followers. If their positions are extreme, intervention, by changing the price trend, can cause speculators to unwind positions en masse.
Speculators in today’s markets are more short term momentum oriented than in the past. Hedge funds are judged by monthly returns. That is why we see so many charts in which prices follow a trend in a very narrow channel. But, once that trend is broken a crash ensues.
If intervention in the currency markets comes and it is successful, even for a while, the odds are that the dollar, which is itself in such a narrow channel, will break hard. This should not be hard to imagine, as it happened a mere eight months ago.
Conclusion
There is a growing body of evidence – both technical and fundamental – that the equities are rolling over and that the dollar may correct. The latter will, of course, pull down the former.
The key is the now disappearing dollar. Today there is a universal consensus that is bearish the dollar.
But careful analysis suggests that, whatever the long run outcome for the dollar, it could have a significant rally off multi decade chart support. Even famous dollar bears concede this.
We are not dogmatic on this point, however. We understand the potential for a greater dollar decline…….. If the dollar index breaks long term chart support at 80, that could occur. If we judge that will be the case we will increase our dollar short exposure This is all about probabilities, and the probability of a significant perfectly typical correction in the long term bull market that we envision is also significant, so we must exercise some caution and be willing to hedge. END. Dry but real important to the world. And that translates to being careful in all investments, IMO. The BIG PLAYERS are deciding now I think. Could be real a volatile period. I'm not a daytrader. I'm looking for big events. Like China having to unpeg the yuan. Maybe no choice.
 
Bill, that was an excellent letter. I mostly agree. Whenever extreme terms, such as "currency war", are used, the market in question is close to a turning point. Also the recent Economist cover was an excellent buy signal for the dollar.

And it's not only the currency market that's near an extreme. As the Elliott Wave newsletter (Dec 3) wrote:

"This deflationary scenario calls for a dollar rally to coincide roughly with a downturn in stocks, precious metals, oil, commodities, real estate and junk bonds. What's truly exciting is that in addition to all of these markets moving more or less in sync, bullish psychology in all of them is reaching record high extremes at nearly the same time. Stocks just hit a record DSI; gold and silver have a record DSI and record open interest; oil recently had a record DSI; junk bonds are on track for a record number of new issues this year; and the dollar and the euro have a record DSI and record open interest. Speculators are buying and selling everything and with a coordinated psychological fervor that may be truly unprecedented in history." (DSI = daily sentiment index)

Since this forecast oil has already crashed, gold and silver are in the process of doing so, and I'd be surprised if stocks and junk bonds would come far behind. Real estate will probably be the last piece to fall, but eventually it will too.

OldTrader, much for the same logic as above, I agree that long-term interest rates are unlikely to go up in the near term.

In fact they could go down boosted by more foreign buying. Namely IF, though that's a big if, the European and Japanese central banks knew what they should know, they would intervene heavily in the currency markets RIGHT NOW. Just like with the yen last spring, massive intervention would hit the amateur speculators hard and knock the yen and euro down swiftly. And this intervention means more need for the foreigners to buy something (i.e. bonds) with their dollars.


Getting back to the topic of real estate, the Piggington site is really an excellent resource. It should be compulsory reading for EVERY American homebuyer and -owner. As should be its fellow site from the Bay Area.
http://piggington.com/mania.php
http://patrick.net/housing/crash.html
 
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