The Housing Bubble - For the Record

10-13-2013 Update:

 This is actually a bit old now but he’s calling it like I see it. - Darren

http://business.time.com/2013/01/22/what-ever-happened-to-the-big-bad-shadow-inventory-of-homes/

Nice summary, and I agree with it as far as it goes.

The question now is, how are all these investors going to have time to drive around and enjoy their new homes?

The reality is, these “properties” have simply moved from one set of file cabinets to another.  Sure a few of the small local investors have rehabbed and flipped or rented, but the bulk remain empty.  So the question not asked (nor answered) by that post is, where do the butts come from that will sit in those approximately five million houses?  I’ve got one freshly painted and yet setting empty for the last year right next door – no sale, no tenant.

This “housing recovery” is simply the “ringing” caused by investors I’ve talked about before.  This too shall pass, and I fear in the process find a new bottom for the housing market sometime in the next 36 months.

First posted 06-17-06:

Those who know me, know I've been talking about the housing bubble for the last couple of years. I've done everything except beg some of my friends to sell their homes so they'd be sitting on a profit when this thing pops. I'm afraid I've been a bit of a pest.

It's impossible to call the top of a market, let alone a bubble. No matter. I've been calling the top of this one for the last two years and now it's finally happening. So I think it's time to document my predictions, before history starts to be rewritten. It's time to go on the record.

My anti-home ownership campaign started with a bit of sticker shock. I've owned one home after another since I was 21. Well, at least until I got divorced in 2003. Since then I've been renting - here's why.

When I went to buy a new house, I couldn't believe how much prices had run up. And it just kept getting worse. The longer I waited, the crazier it got. If I'd known how stupid this market was going to get, I would have flipped a couple myself while I was waiting. Hindsight is 20/20. Like I said, you can't predict market timing, so I didn't. I sat it out.

I've sat out every bubble I've ever discovered. I sat out gold in the 80s. I sat out the internet in the 90s (even while working in the middle of the tech world). And I've had my ass firmly planted in a rental for the last three years - tax advantage be damned! I just can't help it. The prices never make sense.

Here's how I know housing is in a bubble. You can use this tool to spot the next one. The key is fundamental value. That's what something's worth when no one's looking - when there's no speculation. It's the value that reflects the property's ability to produce income compared to other available investments.

An old rule of thumb is, a property is worth 100 times what it will return each month. That's a capitalization rate (rate of return) of around 12%. Again, that's just an estimate. There are always expenses to deduct and capital markets do vary some. Net return after costs in the 8% range for real estate is reasonable. When these cap rates fall below comparable investments, the ONLY reason to buy is speculation - THAT is when it becomes a bubble.

So ask yourself, how much rent would you pay for any given house? Now add two zeros. See what I mean? You will only find THOSE price in Kansas (something to do with whirling wind and unlimited vistas). Here in Reno you can rent a 2000 square foot house for $2000 per month. Therefore, it should be worth $200,000 as an investment.

But hold on... There's the sign out front! It's listed for $480,000 and sold a year ago for $395,000. If you bought it as a rental, it would only return 2% after expenses. That's also about $200 per square foot to buy or build.

Your mileage may vary depending on where you live and the quality of the building. But no matter how you rationalize it, houses have sold for twice (or more) what they are "worth" in a reasonable investment market.

Now, It's true rents are a bit depressed because of all the spec homes still sitting empty, but not depressed by THAT much. And this is just an average example. Much worse can be found. Just look around. Check it out yourself.

I've heard of new construction at Lake Tahoe being built and sold for over $700 a square foot. That (and growth in China) is why steel, concrete and other building materials have also had such a run up in the last few years.

But that's about to change.

Right along with the price of houses.

And it's WAY past time. The bigger a bubble gets, the worse the pain, when it pops. This one got pretty big in scale but not in value ratio.

Here's a comparison. The internet bubble created about four trillion dollars worth of new "value" in the economy but the value ratio was more than ten to one. So far housing has added TEN trillion dollars worth of "value", BUT has only doubled to do it. That's an important "BUT". We don't have as far to fall. It could have been worse. It can ALWAYS be worse when it comes to bubbles.

Some even better news is that it probably won't collapse as quickly or as far as the internet bubble. At the bottom, many internet prices actually went below their true investment value. That's not likely to happen with homes because people live in them. Living in them creates a lot of financial inertia.

Another way to look at it is, there was almost no real value in the internet prices. Many companies had no profit at all, so they had farther to fall. Housing has only doubled (or tripled in some cases) and those who can still afford the payments will likely stay in them. This will soften the crash.

We'll see a 15 percent drop in the next few months. This drop combined with variable rate mortgages and increasing interest rates will be enough to put a lot of marginal new buyers into forclosure. These bank properties will likely get in line with all the spec homes headed for the exit. This will just make things worse. For a while.

I believe house prices will fall for the next 18 months. They will bounce off the bottom at 20 to 40 percent below their peak of November 2005.

If you've owned your home more than three years and haven't refinanced in that time, you're probably OK. If not, batten down the hatches.

It's about to get ugly.

So there!

I'm on the record.

Let's see what happens.

You can watch it all at The Housing Bubble.

I just hope you're not watching it from a new home.

Sudden Disruption