Monday, January 22, 2018

Quantifying the Real Estate Market, the Easy Way!

How do you tell if housing is overpriced?  Turns out, it ain't hard to do!  Just one simple test!

An article in Bloomberg this morning says a "rare bear" who spotted the housing crises in 2005 is saying that housing is again overpriced.  The fellow has mountains of data to show that housing is overheated, from the share prices of home builders to sales prices to whatnot.   And I am sure that his analysis is sound, particularly in selected markets (and you know which ones I am talking about). 

But the article falls down on two counts.   First of all, it wasn't a "rare" person who saw the housing market collapse coming.   I saw it, and I'm a blithering idiot.   What's more, many other people saw it, too.  There were a plethora of articles at the time questioning whether the housing market was overheated.   Our own head of the Federal Reserve talked about "froth".   People knew, deep down, that their hovels weren't worth millions, they just chose to look the other way, because they wanted to believe they were rich.

Hey, it was fun!   Back in the day, we had two condos in Pompano Beach.  We'd fly down on $30 post-9/11 airfares and pickup our BMW convertible that we left in long-term airport parking.  We'd spend a week going to bars and restaurants - often by boat - or just lounging out by the pool, enjoying the Florida sun.   At night, we'd go to cocktail parties with other real estate agents, mortgage brokers, appraisers, home inspectors, and other hangers-on in the real estate business.   And the topic of conversation was always, "how long will this last, and when it crashes, will it crash hard or crash soft?"  Because anyone in the real estate business for any length of time remembers the previous crashes.

That evening, the weather would cool down, and we'd put the top down on the BMW and cruise up A1A and admire all the mansions on the beach - and the mega-yachts parked on the Intracoastal.   I was quite a heady time and every one was pretty drunk and having fun.   But we saw the party ending, and when people offered us a ton of money for our condos - we sold out.

So how did we figure this out?   We don't have the smarts of this guy from Montana in the Bloomberg article.  We don't have the numbers to crunch, the charts, the figures, the vaults of newspaper clippings, the time to research and figure this out.   How did we know when to leave the party?

Simple.   When it was cheaper to rent a property than to own it, the properties were overpriced.   Very simple test, very easy to calculate.   When it costs nearly double to own as it does to rent, well, you've got a bubble on your hands.

Again, we made money in real estate not through wild speculation but through hard work.  We bought properties that needed work and did most of the work ourselves.  We rented them out at modest, market-based rents, and made modest profits each month.   We never thought we would get rich, but we would make some money and get a good tax deduction from depreciation.  When housing prices went berserk, we weren't euphoric, we were nervous.

We sold one duplex and bought two condos in Florida.  The market was heating up, but even at the prices we bought at, we were able to have a positive cash flow by fixing up the places and renting them, not by the month to local Florida trash ("Florida Man!") but to vacationers and Canadian snowbirds who wanted to rent by the week or the season.  At the prices we paid, we made a little money and it all made sense.

Then others started buying in  - and offering us nearly double the money for the same condo.   We sold.   At the prices they paid, there was no way they could ever make a positive cash-flow every month - even renting at seasonal rates year-round.   And as I related before, they didn't bother to even do that - instead installing Florida white trash meth-head tenants who never paid any rent whatsoever.   The whole thing fell part in short order - Statewide - as all these condo high rises topped out all at once and flooded the market with luxury condos that cost more to own than to rent.

You know the rest - or you should, unless you've forgotten it already.  Human economic memory is 18 months, tops, from what I can see.

Now note that I didn't make any calculations as to whether housing is affordable or not.   That is a much tougher test for the average person to calculate, and I am not sure it even is quantifiable.   No matter how much or how little anyone pays in rent or mortgage, everyone says it is too much.  No one complains their rent is too low or their mortgage too small.   So I take the "housing is unaffordable!" cries with a grain of salt.   All my life, I have struggled with housing costs - it is the nature of the beast.   Some folks want a free ride, is all, so they posit they are victims.

But a funny thing, everyone ends up finding a place to live - maybe not their first choice, but a place.   Folks living at the poverty line think they have a "right" to live in a trendy downtown neighborhood, instead of some cheaper location away from the city.   I am sorry, but I just don't get that - no one subsidized my choices in housing - I had to move to shitty places that I could afford (and still do - just that my level of shitty has improved.  They still won't let me live on real rich people's island as there is no "affordable housing units" there for middle-class schmucks.  We should have a protest march!).

So I would leave that other data alone.   If it costs more to buy than rent, you may be overpriced.  When it costs substantially more to buy than rent, you should really think long and hard before buying.   When the costs are double, or even triple, as they were in Pompano when we left, well, hello bubble-time!

The other thing to think about is future trends.  One thing that has driven real estate bubbles is interest rates and the availability of credit.   In 1980, with mortgage rates at 14%, home prices were depressed.  I remember my boss shaking his head because some friends of his bought a townhouse, and the mortgage payment as "over $1000 a month!  Can you believe that?"   Times have changed since then, of course.

By the late 1980's, rates started to drop and prices started to rise - and then over-correct.   It all fell apart in 1989.   By the mid-1990's, prices were down and interest rates started to fall, and lending practices got, well, sloppy.  Zip-code appraisals, liar's loans - I know because I used both myself!  Prices skyrocketed and, well, 2007 happened.

Since then, mortgage rates are at record lows, and housing prices once again are skyrocketing - perhaps not as bad as in 2007, but still pretty bad, particularly in places where there are high-paying jobs or people with a lot of money to spend.   But interest rates are on the rise, and as I have noted before and the Bloomberg article notes, "A rate rise from 4 to 5 percent for a 30-year loan would drive up monthly mortgage costs by 12 percent."

Think about that for a moment.  If mortgage rates go up even a percentage point, the cost of housing, as a monthly expense, can go up by over 10%.   If rates go up a couple of points - as they appear to be poised to do - housing could increase by 20%.   And people buy houses based on monthly costs, not overall costs.   Do the math on this and see what answer you get.

And although people buy houses based on monthly carrying costs, they sell them based on overall gain or loss.   If you buy a house based on a $3000 a month mortgage cost, that's fine and all.   But if mortgage rates rise a couple of points, $3000 buys a lot less house.   Your resale value may remain flat, or even go negative.  Again, do the math and see where it goes.

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