The “Housing Bubble,” is everywhere mentioned and speculated about, and in a few spots, it has begun, but slowly. A bubble it is, and as a classic example, a friend of mine owns a 1800 square foot home in the LA area, which he paid a bit over $340,000 for, eight years ago admittedly a high price even then. Today, it is worth $1,200,000. Tripled in price in eight years, and of course he isn’t going to sell. Why sell? He has a great job, and his equity is close to 100%. It’s like having gold or silver in one’s safe, as opposed to having futures contracts or paper gold and silver. If it’s yours, and free and clear, what difference does it make, if it goes up or down? Anything not denominated in dollars, on which nothing is owed, is security of the first magnitude.
Further, in California, my state, and most others I suspect, one’s property taxes are based on the purchase price. If Nick sold his house for $1,200,000, and bought another for the same price, his property taxes would be triple or better. Certain locations, and especially the east coast, have enormous property taxes, and it might be a good idea to copy Lou, a client of mine, who upon retiring, sold his small home with $11,000 a year property taxes in he had lived in for 40 years. Lou and his wife are now out here in the west, and will probably settle down in a home with a tenth of those taxes. Not only a tenth of the taxes, but low humidity and crime, plus lots of sun. Taxes are an important consideration when selling or buying a home. But we are discussing the “bubble,”
There is one in housing, and perhaps 50%, or even more of Americans know it, but either refuse, or can’t figure out how to deal with it. The housing bubble, is nothing like the stock market bubble we also predicted would burst, but few listened. As far as a stock market bubble, the basic problem, is when to bail out. The same is true with a housing bubble as well, but with major differences. First of all, is the move. They say three moves is equal to one fire. Ever move, after living in the same place for many years? Not fun. Not cheap, and fraught with problems. I last moved in 1991, from a 2100 square foot home built in the 1970’s, to a 3350 square foot home, built in 1887. The distance moved was but a hundred miles, but over three mountain passes. I elected to do it myself with my two small trucks. Ugh. I am going to die in my current house, because I’ll never move again. Never. The prices of both houses were the same, but I love old stuff, so we moved. The 1887 home, which we simply love to pieces, has gone up in value at least by 500%, but the taxes are based on the purchase price, and are a bit over $1,000 per year. If we sold for the $750,000 and bought another for $750,000, maybe in a different location, the new property taxes would probably be four or five times as high. Why do it? Besides, the 1887 (photo below) is probably the greatest Queen Anne Victorian between Denver and San Francisco, and to me is priceless. When considering escaping the bubble, one MUST consider whether the home which has gone up so much, is loved, is conveniently located, and has decent property taxes.
For escaping the housing bubble, there are at least two reasons for doing so, and they are (1) to make a profit by selling and renting, till prices go down, and then re-buying, at a much lower price. (2) Because of so little equity, its price could go down to below what is owed, and therefore to escape an intolerable debt. One might want to ignore the bubble, and as it deflates, sit buy and pity those who are suffering from it. The question then, is when will it lose its air? I don’t know, but I do believe there will be signs of it, and one can get out if necessary, before disaster hits. Because the housing collapse will not be anything like the dot com collapse was, even though a lot of “experts” seem to think it will go quickly. Here’s why it won’t.
The reasons for a bubble to pop or deflate, is because of (1) over-priced goods, (2) an over-supply of them, or (3) a mass inability to pay for them, regardless of price or desirability. Housing is desirable. Housing is necessary. Housing rental rates today, do not reflect the high prices of housing. A normal house rent will give the property owner, a ten percent return on his investment, after taxes, advertising, repairs, insurance, and a vacancy rate. Probably a home rent should be about 12% of the home’s value each year, for it to be a wise investment for income. In other words, a million dollar home, should bring in $120,000 a year in rent, or $10,000 per month, for it to be a decent investment. The actual facts are, that million dollar homes, at least in California, are bringing in landlords, if they are lucky, perhaps a 2% return. Not a 2% return on their investment, because they undoubtedly paid a lot less than the million dollar current value, but a 2% return on the current value. In other words, “sell the damned thing and get your money out, before it all comes crashing down,” might be a good idea, if one owns rental property not giving a decent return on invested capital.
If one thinks real estate prices will go down, and taxes, location, or love for a home, plus the agony of moving, is of no concern, then by all means sell, take your profit, and find a cheap rental. Wait till prices come down, and then re-buy a home for a lot less than you sold your previous one for. The NASDAQ bubble burst within a few days, for all practical purposes. The crash of 1929 happened quickly too, as did the one in 1987. Why did they go down so fast? Because millions of people owned stocks, and even millions owned the same stock. When profits lag, or panic sets in, they all sell at once, crashing the market. All sellers and no buyers, always crashes markets in anything. Absolutely anything. LP records are for sale everywhere for a few quarters each. Why? Because everyone has CD’s and LP’s are not as easy to play, they get scratched easily, are large and bulky, and each side is only good for about 20 minutes. When everyone gets disgusted or afraid of the stock market, there seems to be some period when everyone tries to sell all at once, and the prices crash. No one knows why.
Housing is the same, only it works much slower, and unlike LP’s, are far more expensive and immovable. A home can last a hundred years, but in the last three or four years, many homes have increased in price by several hundred percent. Why? Because, like other bubbles, when prices begin to escalate quickly, fools rush in, believing the prices will go up forever. Nick’s house, and Lou’s ex-house, could undoubtedly be built for a fraction of their selling price. Why do they go up? For the most part, it is speculation. Like the futures market, when an item is “hot,” its price goes up rapidly. New York, California, Boston, and Washington DC are “hot” real estate areas, and prices have gone through the roof. Traders in stocks, futures and yes, even homes, can manipulate prices. Homes can go up because of fake or exaggerated appraisals given to sales people for bribes or favors. It happens every day! “Well Bill, that place isn’t worth $350,000, but since you need it and have given me a lot of business, I’ll appraise it for that.” That goes on all the time. It’s just like a stock broker being pushed to sell a big profit item by his boss, and especially for a bigger commission. The appraisal tells the mortgage broker how much it is worth, and consequently, how much he will loan.
Houses have gone up to the stratosphere because of cheap interest, fraudulent appraisals, high pressure sales, bad neighborhoods to be moved from, and several other reasons, none of which are sufficient to keep them at such high prices. More next week.