Every market trend will over time gravitate toward the mean.
Every trend.
Fight it. "It's different this time" they'll say.
It's not. It never is.
Good article on this in the Realty Times - highlights here:
In his November, 2005 edition, Campbell writes, "Creative financing can be very dangerous when the price of the asset loses significance. People start believing that it doesn't matter whether a home sells for $200,000 or $400,000 because the monthly payment is the same. Sorry, but when mortgage loans are based on fictional values as opposed to true values that are supported by economic fundamentals, financial bubbles can develop that eventually implode."
Markets are mean-reverting, which he says explains why booms are followed by busts
In September 2005, the median price of a CA home was $544,000 and the median household income was $60,300. This puts the P/E ratio at 9.4, which is a level of extreme overvaluation based on 26-year norms. From 1996 to 2005, CA home prices rose by $366,000, a phenomenal 305 percent rise, while CA incomes rose by $17,000, a 40 percent rise."
To calculate how housing prices would fall if they were to revert back to the 26-year average for the P/E ratio, Campbell multiplies $60,300 by the average P/E ratio of 5.2. If the market reverts to the mean, housing in California should cost about $314,000, which makes it susceptible to a stomach-lurching 42 percent drop.
California homes have always sold for a significant premium compared to other U.S. homes -- 63 percent more since 1968. In Sept. 2005, the median U.S. home was $212,000. The same home in California should cost $346,000 (212,000 x 63 percent, add result to 212,000.) If the median home in CA is $544,000, the market is overpriced by $199,000.
January 03, 2006
Just do the math: If the market reverts to the mean, housing in California susceptible to a stomach-lurching 42% drop
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Other factors to throw in the pot are as follows: California's economy is VERY resiliant and very diverse. It is weathering the march to globalization very well. For example, the port business from the China imports is staggering. More than 90% of all venture capital goes to California. It has the most manufacturing, the most successful agriculture, it is the leading dairy state (sorry Wisconsin), it has the large entertainment industry, silicon valley even with its problems, tourism AND best of all it has the MIRACLE OF HOWARD JARVIS!
Jarvis's famous Prop. 13 allows a person or a business to have very low property taxes even with boom prices! But you say its income tax is high or its sales tax is high. Well you can "manipulate" those if you are smart with tax planning but if you are stuck with high real estate taxes as you are in other states like Illinois there is very little that you can do but PAY PAY PAY.
For example the Tax Foundation says that a state like New Hampshire has LOW taxes because of its lack of a sales tax and an income tax. BUT BUT BUT if you look closer it does have a high dividends and interest tax AND a business profits tax AND AND AND some of the highest real estate taxes in the country not to mention a near artic climate. In New Hampshire it is said that there are only two seasons... July, August and WINTER.
But you say that there are earthquakes in California..... but earthquakes are good for business WHY.... massive rebuilding aid comes in like a Marshall Plan and STIMULATES the economy in a HUGE way! Places like Gary or Detroit or Buffalo should be sooo lucky as they and many cities like them sink into an economic abyss!
So as bad as California is.... it still has unique redeeming features that help keep its property values up over other states.
Can someone please confim the data from this article for me. This is the first time I have seen the P/E ratio defined as the ratio between house price and household income. Usually I see it expressed as the ratio between house price and what the house would earn if rented. In other words, the asset price vs. the potential asset earning, like a stock P/E ratio.
So is this house price to household income ratio worthwhile? Can anyone confirm that this has historically been an average of 5.2? Because 5.2 seems like it is high to me. Follow this:
If, historically, households purchase homes that are priced 5.2 times their median income, then these households have 39% of their monthly income tied to mortgage+taxes+insurance. What happened to the 28% rule? I know that 28% has been thrown out the window with the recent exuberence, but we are talking historical averages.
Please check my math. Example:
Household income: $60,000
House price: $312,000 (5.2x)
Downpayment: $62,400 (20%)
Loan amount: $249,600
P+I: $1,496 (30yr, 6%)
Taxes: $390 (1.5% / 12mo)
Insurance: $65 (0.25% / 12mo)
Total mo pmt: $1,951
Total mo income: $5,000
Pct of income: 39%
This is an example, but start with any yearly income amount and it returns the same 39%.
So is the 26 year P/E really 5.2 and the 28% barrier is really a myth, or is the P/E of 5.2 not correct and it is really something lower? If 28% is the true historical barrier, then the historical P/E ratio should be something less than 3.75.
Anonymous(first post): As they say in California-speak, "You're in denial." Sounds like you've got a lot of excuses lined up to try to paint a better picture of CA. I lived there for 25 years and recently moved out (so obviously I have a biased opinion). For me the housing situation in CA is at the core of the cost-of-living/quality-of-life balance--which is very bad, not to mention it's many other problems: bad government, sprawl, racial and ethnic division, bad educational system... etc. etc. Maybe Dr. Phil will solve it on one of his shows...
Regards, Kalifornia. It isn't like other places. Yes, housing bubble, yes lots of negative, but yes lots of positives. Anon 12:17 makes several good points and one really bad claim. "Broken Windows" are not economically stimulative. His conclusion is correct:
So as bad as California is.... it still has unique redeeming features that help keep its property values up over other states.
It will pop, pop bad -but- it won't go anywhere near the national averages in prices. Criminally bad government, social dissonance, bad primary schools, suspiciously high prices for certain products, collusion in entire markets, single party state politics (doesn't matter which party), burgeoning underclass, loss of the most productive segment of society,... I could go on for paragraphs. That said there is opportunity, mobility, enterprise, vitality, variety, again I could wax poetic for hours.
Kalifornia -is- different. Anyone who says otherwise is the one in denial. Housing prices are at the highest they'll be for at least a decade but we'll just find something else to be stupid about, probably alternative energy, biotech and modernizing agriculture.
A couple more points. Price is only a barrier to entry. after that equity gets transfered such that it is concievable that the purchaser of a $600,000 will end up paying less per month than when they were in a house they bought for $200k and sold for $450k. Doesn't matter whether their income s rising to keep pace dose it? The other is how many people are houseprisoners. Prop 13 and the other costs of relocating -within the State- are keeping people in one place. Again, the teoretical price to income ratio is dostorted in comparison with other States. It isn't the median house price and the median houshold income that operates. it is that ratio at the time of purchase.
in response to 1st post (ie., california's economy is resiliant)...
keep in mind that a bubble doesn't necessarily mean that fundamentals are bad, it just means that prices have become detached from fundamentals. A corporation can have a wonderful business plan and excellent prospects for growth - but does that justify a huge PE ratio? Keep in mind that many of the tech companies that lost 97% of their market value in 2000 are now small and moderately profitable. They were fine companies - they just had unrealistic valuations.
You can ask the same questions about real estate. California should be more expensive than the rest of the country... but how much more expensive? 2x? 4x? 8x? Almost every indicator would suggest that it makes perfectly good sense for property in San Francisco to be pricey - the question is how pricey. I recently read a study that controlled for a number of factors - average income, scarcity of buildable land, population pressures, historical growth, etc... and it concluded that the median price in SF should exceed 550K. While that's far more expensive than many other regions, the fundamentals seem to justify much higher prices... problem is, the median price in SF is close to 800K. Even with all the reasons to believe SF property should be expensive, this is looking very dangerous to me.
The moral of the story is: you don't need to be a pessimist to be concerned about these prices. Even an optimist can become cautious in a sea of irrational exuberance.
Anon 11:52 gets it; "...you don't need to be a pessimist to be concerned about these prices. Even an optimist can become cautious in a sea of irrational exuberance.
California is resilient. That's a good word to use. Part of the RE rush is itself a rebound in response to the aerospace collapse, dotcomm bubble, fires, earthquakes, floods, etc.
Besides, where would you rather be "trapped?" Buffalo or Burbank? San Diego is a bit more exposed to future problems. Other places, Bakersfield, Fresno, Sacto, Inland Empire. The Bay Area and SoCal coast are significant nations unto themselves by most measures. P/E and other indicators surely point to unsustainable home prices but that's all. The fallout will be swift, severe and will spill over to the general economy but the run up was swift, severe and spilt over to the general economy. California will remain desireable and that won't change this time anymore than it changed the last 10 times.
"California will remain desireable and that won't change this time anymore than it changed the last 10 times."
If it were up to me, CA would be very desirable: a private island in the middle of the Pacific ocean after cutting it off from the mainland.
Bear with me here; everything bad in this country originates in CA. Let's explore it:
1. BLING BLING - 'nuff said, you don't see Cribs looking in DC or Cincy
2. SUV's - trucks were only popular in Texas before every city yuppie had to be seen driving a SUV in Hollywood, then the whole country suddenly needed a 4x4 Suburban to drive back and forth to work.
3. McMansions - CA has the largest homes in the country. Started the McMansion craze that conincided with the dot com boom/bust.
4. Immigration - lots of problems with illegal immigration in CA is spilling over to other states.
5. Housing bubble - CA has been in a bubble since the early 90s and it's only gotten worse.
The positives:
1. Economy - CA's economy is the 6th biggest in the world and is likely bigger than all rust best states combined.
2. Tourism - CA is a beautiful state. A perfect mix of oceans/mountains and warm/cool weather provides a weather nirvana.
I know many people who have moved to CA only to return due to high prices and the different lifestyle. I love prime rib, but I don't want to eat it everyday. When I was in CA last, I didn't want to leave, but thankfully I did and saw the folly in my longing to move out west.
I'm the guy who responded to the first guy by saying he was in denial. (don't mean to be anonymous, but I'm too lazy to register). Anyway, yes California is different. Yes California has a diverse and resiliant economy. California undoubtedly has allure the world over. Last I knew, California would rank 9th in the world in GDP (above Canada) if it were a country. To me it sounded like he was saying that high real estate prices were somewhat justified or offset by how awesome California is--the price for paradise.
It should be obvious to anyone that California is leading the way (as with many things) in the real estate bubble. And in a way the allure you describe fuels that. If you like California, then live there. But I've been seeing a lot of individuals, families and businesses moving out of California with the specific intention of getting away from it's problems.
We need a Congressional hearing on housing to perpetuate the walfare state and subsidize housing for the median income through higher taxes.
By doing this we can wipe out the wealth of the average worker. This will cause him to produce and recover, generating taxes and perpetuating the welafare state.
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