House Valuation Workshop

Does the drop in home prices we have seen so far make the current real estate market affordable? Do prices that have dropped ten percent represent a great buying opportunity? Long-time Seattle Bubble regular Eleua takes on these questions and more with his “House Valuation Workshop,” using his native Bainbridge Island as a working example. Follow along by using home prices, rents, and incomes for your own neighborhood.

by Guest Poster Eleua
Original posted at Clearcut Bainbridge

At the Institute For Economic Reality, we are always trying to help people out of their self-imposed, colo-cranial economic impairments. Judging by the volume of chatter on how the real estate market is suddenly “affordable,” it would appear that we have our work cut out for us.

When home prices have gone up 150-200% in a decade, a 15% rollback isn’t exactly a buying opportunity. Keep in mind that during the run up, the “experts” all predicted that prices would not decline, but would level-off and allow incomes to catch up. When confronted with a slowdown, these same experts said that a 10-15% rollback would represent the “worst-case” scenario.

The delusion is understandable. Bainbridge Island is populated with Babyboomers, and Boomers have seen property prices increase for the bulk of their life. In fact, real estate is the one “investment” that Mouseketeers think they know well. The prospectus for a Boomer’s investment in real estate goes something like this:

Property prices have gone up, so they will continue. My real estate agent said this is the “bottom,” and I had better buy now or be priced out forever (they would never tell me something that is self-serving and against my interests).

Is there an objective metric to value a home? Should you jump all over a home that has been reduced in price $10,000, or wait for a better value?

(Click below to read the rest…)

As we like to say at the Institute For Economic Reality, the difference between a good home and a good investment is the price you pay for it. There are many good houses on the market, but we have yet to find a good investment.

For example, if we have a house that represents the median home and is located in a neighborhood where the median household income is around $75K (the Bainbridge median), what would the value be? Let’s say that it rents for $2,100/mo, with property taxes of $3,600/yr.

Why is the rental rate important? Given that all but the truly clueless believe we have been in a credit bubble, and that bubble distorted the prices of things purchased with credit (homes), we should expect to see a difference between the bubble value (price), and the non-bubble value (rental value). This is because rents do not move up and down in a credit bubble, as easy credit terms are not available to renters like they are to home owners. Put in another way, you never heard advertisements on the radio, or TV that told renters that they could reduce their payments and get more house, with cash back, and no credit checks. These programs were only available to people that were buying or refinancing homes. Renters had to rely on good, old-fashioned income ratios to qualify for their leases, and the rates they pay reflect the true value of the property.

After all, the only “dividend” the mortgage throws off is not having to “throw your money away on rent.”

The difference between the rental value and the price is the speculative premium. That is the amount of money that you are committing to attempt to capture a rising sales price of the home. Given the recent national obsession with the concept, it should be no wonder to people that people have committed lots and lots of money to chasing higher resale values.

$2,100/mo equates to $25,200/yr in gross income. That’s all you get. That is the absolute maximum amount of cash the home can generate. That also presumes that you keep all of it, which is of course not true.

  • The county assessor still gets her chunk.
  • The property manager gets her chunk (unless you do your own management).
  • The property still needs maintenance, and that comes out of the owner’s pocket.
  • The house will likely be vacant from time to time.
  • If this is your biggest “investment,” then you need insurance.

If taxes consume $3,600/yr, and property managers get 10% (likely 15%), the house is vacant 10% of the time, while you are dumping $500/yr into maintenance (optimistic), and your insurance is $900/yr, then your net cash generation before income taxes is $15,160/yr. This presumes you paid cash for your house and there is no mortgage.

That is your return on investment. What yield are you seeking? Are you going to accept a yield that is below that of US Treasury debt? If so, why are you risking so much for an investment that yields less than the safest investment on earth? You have to command a higher interest rate than that of a T-Bill, or CD at your local bank.

How much of a premium do you need? That varies by individual, but given that real estate is actually somewhat risky (vacancy rates, tax hikes, bad tenants, unforeseen maintenance expenses), you should ask for a few hundred basis points above Treasury debt. If the 10 year T-Bill is yielding 4%, and a bank CD is yielding 5%, one would think that an 8% ROI would not be unreasonable. If I am only going to get 5%, why would I even bother with all the fuss and hassle of putting up with renters and a home that needs maintenance, when I can take my money to the bank and spend my time golfing?

At 8%, your yield goal multiplies your net cash by 12.5 to arrive at the value of your “investment.” $15,160 / .08 = $189,500.

YIKES! Can anyone find a Bainbridge home for this price? If so, does it rent for $2,100/mo?

If we raised the rent to $2,200/mo, did our own property management, and lowered our yield to 6%, we still arrive at $312,667. This presumes that with the orgy of building that has taken place, the amount of rentals on the market would command such a price. Keep in mind that $2,200/mo is 35% of the median income for Bainbridge Island. Home costs have historically capped-out around 28%, and the renter will normally carry his own insurance.

If that house has a current market value of $650,000, then the speculative premium is $460,500 (or 71% of the price) for the realistic example, and $337,333 (or 52% of the price) for the delusional “investor” that is content to take large risks and expend a lot of effort to barely beat the local bank’s CD.

In order for the rental value to equal the speculative/market value of the property, the “investor” would have to be content with a 2.3% ROI in the managed property, or 2.9% ROI in the unmanaged property. Just for perspective, a 120 day CD at American Marine Bank goes out at 2.45%, and I’m guessing you don’t have to worry about fixing a roof, replacing a water heater, or scramble to find tenants when September comes around.

The above example is EBIT (earnings before income taxes and interest), but the overwhelming majority of “investors” will carry a mortgage. This begs the question, “Does it cash flow?”

Let’s see. If we have a 6.5% mortgage and a 15% down payment, then our payments on a 30 year-fixed run $41,944/yr. That’s an annual cash-flow loss of $26,784, assuming there are no further hikes in taxes, maintenance, or any prolonged vacancy period. Remember, our rental assumptions were fairly optimistic.

At the end of 10 years, the total cash outlay was $267,840 in direct cash-flow losses, plus the original 15% down payment of $97,500 for a grand total of $365,340, or $3,044/mo (average).

You should have $182,144 in equity, but you still have to pay approximately 7% in closing costs and real estate fees to get at that money, which reduces your equity to $136,644, assuming you broke even on your house price (sold it for what you paid). Remember, we are not calculating speculative premium, but are merely looking at the value of the investment without the idea that home prices will perpetually escalate. Prices can go either way.

So… our “investment” cost us $228,696 over 10 years. That is money that we flushed away. It would be more if that original $365,340 was earning 5% in a CD, but for our comparison, we assumed the “investor” kept his cash in his mattress.

In order to beat the 5%, our home price would have to appreciate to offset the amount our negative cash-flow would have grown to at 5%, which is $508,619. That is the amount the owner would pocket at the closing. If the “investor” owes the bank $467,856 at the 10 year mark, then the property needs to sell for $976,474 AFTER REAL ESTATE FEES AND CLOSING COSTS! In order to pay Cookie and Candi, we need to sell our “investment” for $1,049,972.

Good luck with that.

Is this scenario reasonable? Look at the price/income ratio.

Currently, the median household income for Bainbridge Island is $75K/yr, which puts our $650K median house at 8.67X income. If we assume an above-trend line income growth for Bainbridge of 3%, then in 10 years the median income will be $100,700, which puts our price/income ratio at 10.4X income. You would have to assume that we would get an above-average income growth (after a spectacular 25 year bull market), and that future buyers would wish to buy your tired rental for an 10.4X ratio, when you only paid 8.67X.

Keep in mind that prior to the credit bubble, a 4X income ratio was considered very exotic and the normal range is from 2.5-4X income. Sub-2X incomes are not unheard of in some parts of the country with high incomes.

What would the value of the median Bainbridge home be if ratios were in historic norms?

$187,500 to $300,000. (Didn’t we see $189K earlier in this example?)

What if we overshoot in the correction to 1.75X? After all, we have lots of new inventory with a population that can’t even keep schools open. If a major Seattle employer gets wiped-out in the credit crunch for writing zany loans and playing fast-and-loose with their accounting, that will be a gut-punch for Bainbridge incomes. What Might that business be called?

Also, how many new Bainbridge residents have been selling real estate for a living? How many write loans, do appraisals, home repairs, additions, and speculative building?

Had enough? I have not. Let’s look at sustainable lending, as the unsustainable lending is what got us in trouble in the first place.

If we assume that the only debt our prospective home buyer has is the mortgage on his house, and that historical, sustainable mortgage debt loads have topped-out at 28% of gross income, then how much house can we buy at 6.5% and $75K/yr gross income? They can afford $21,000 for principal, interest, taxes, and insurance (we will assume no HOA), which equates to $217,343 if we still have the taxes and insurance listed above. If we drop the taxes to 1.5% of purchase price, then the house value goes up to $221,136.

Remember, other debt (student, plastic, auto, personal) will start to weigh on a bank’s ability to fund your mortgage. Our example was a “debt-free” person seeking a mortgage. How many of those people in the median income range do you know?

All the above examples presumed that we are not in a massive economic downturn and that interest rates remained at 6.5%. Both of these assumptions are not realistic. Run the numbers with mortgage rates at 9% to 14% and you will likely get a feel for what the next 10 years will look like.

I hope you enjoyed our workshop. The Institute For Economic Reality seeks to push back the frontiers of economic cluelessness. By now, you should be familiar with the amount of speculative premium that exists in Bainbridge Island real estate. Your homework assignment is to calculate the value of a second/third/vacation home with people laboring to make their payments under the above mentioned conditions. Remember, the latest “bailout” from Hank Paulson removes the tax write off for the “2 in the last 5” provision of a secondary home.

Stay solvent.

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232 comments:

  1. 1
    Sniglet says:

    Renters had to rely on good, old-fashioned income ratios to qualify for their leases, and the rates they pay reflect the true value of the property.

    I am not so sure that rents correlate so smoothly to income ratios. The confidence level potential renters have for their personal economic prosepects can have a major impact too. For example, we have recently been seeing more articles about how people are deciding to double-up, live with parents, or find other shared housing situations to reduce their expenditures EVEN thought their incomes haven’t fallen.

    If people become concerned about their future job prospects they might decide to cut spending to the bone (including their housing needs) even though they hadn’t been laid off. You can even have situations where some people continue to rent, but decide they can do nicely in a smaller home (e.g. having kids double-up in rooms, etc) in order to save money.

  2. 2
    TheHulk says:

    Wow, I am speechless. I never ran the numbers myself. Like I said, speechless.

    Mikal and Harley, I would still like to see how you run the numbers against this, and justify someone buying a house TODAY as an “investment” property where you generate “positive” cash flow out of it. Houses bought before 2000 in Seattle don’t count since they have seen tremendous increases in paper values (which are coming down as we speak).

  3. 3
    Jon says:

    Now, can you account for the benefits of the tax write offs, please?

  4. 4
    vboring says:

    don’t forget rising lending standards.

    with ALT-A basically gone and lenders actually using lending standards again, it’ll be a lot harder for speculators to get loans for houses they could never afford, even if they are crazy enough to want to.

  5. 5
    Eleua says:

    Jon,

    If you think the tax bennies can offset this kind of capital loss, you are very special.

    Unless your income is very high, the tax writeoffs on real estate don’t have nearly the benefit that most people think.

  6. 6
    Cheapseats says:

    I would suspect that as all things tighten, 10% for a property management, or paying someone else to manage at all would be a fat target.

  7. 7
    Eleua says:

    Cheap,

    If you live locally and have the time, you can do your own management. Many of the Island rental properties are owned by Californians or people from the Eastside, and there is no real way for them to do their own managment.

    Yes, if you manage your own properties, your value goes up, but that is extracted from your own efforts.

  8. 8
    Eleua says:

    Property management goes for 15% in most of the cases that I am familiar.

  9. 9
    Eleua says:

    On my CCB blog, Ardell reminded me of the “1% rule of thumb.”

    Monthly rents are typically 1% of the value of the property, which means that the house in my example needs to rent for $6500/mo, which is 104% of gross income, or the price of the property needs to come down to the low $200K range, which happens to be right where all the other metrics are pointing.

  10. 10
    vboring says:

    if rent is historically 28% median income and houses historically cost 100x the rental rate, that comes to houses historically costing (.28/12*100) 2.3x median income.

    that sounds low for all but the cheapest areas to buy. one of those rules of thumb has a problem. my guess is that the 1% rule of thumb is the victim of a rounding error.

  11. 11
    Eleua says:

    I think 2.3 is low for today, but not without precedent. I am predicting a total paradigm shift away from speculation in real estate, and 2.3X income is going to be about right when you calculate in a higher interest rate, and economic recession/depression.

    People are not going to have the appetite for speculation like they used to.

    Highland Village, Texas – about 30mins north of Dallas. Median income is $105K with home prices just over $200K.

    Bainbridge Island, Washington – Median income is $75K with home prices in the high $700s to low $800s.

    People are not speculating in HV, but they are in BI. That is the difference.

  12. 12
    vboring says:

    glad to see you back, Eleua.

    you bring a much-needed sense of unmitigated doom to the blog.

    yes, even for those of us who chose to stay away from RE. if half of what Eleua says is true, we’re in for a deep and prolonged international depression as unwinding financial systems bring every modern economy to a near standstill.

    we should all just be glad we’re in the US, where lenient bankruptcy and lien laws allow us to shed our bad debts rapidly, go through a few tough years, then get on with things.

    imagine being underwater and incapable of making payments on a house in the UK, where personal bankruptcy is the only way out. and sometimes you get stuck with bad debts for life.

  13. 13

    As a former landlord, I’m very familiar with the 1% rule, and never gave it any thought, but my rents were usually about 1% of the value of the property.
    taking the median BI house valued at 650k, I’m guessing the typical rent right now would be about 2700 dollars per month…Maybe there’s a little room for increase, but it’s not going to go more than another 20% anytime soon, because people won’t spend all their income on rent ( or mortgage), so either home prices will continue to come down, or incomes will rise substantially. If you go with the hyperinflation scenario, that’s a possibility, but I’m a Pollyanna: I’m guessing we’ll see home prices continue to fall, rents continue to rise, and incomes go up a bit, but home prices continuing to fall seems the most probable.

  14. 14
    Sniglet says:

    To play devil’s advocate for a minute: aren’t there regions where prices are PERMANENTLY higher than median incomes? Regions that have a high appeal to the wealthy can sustain higher prices just because people WANT to own homes there. Retirees with huge nest-eggs can move in, for example, (who may have low incomes currently since they no longer work). You can also have rich people decide to buy second homes (e.g. because the LOVE the Bainbridge Island ambiance), but never actually “live” there, and rent the properties out for most of the time. Lastly, if there are lots of restrictions on building then this could also lead to prices that exceed the median (i.e. because there is little supply).

    In short, isn’t there a case to be made that prices can remain higher than medians justify due to the desirability of a given area and restrictions on building new supply?

    One possible retort to this argument is that if it truly was the case that a given region justified higher home prices than median incomes allowed, then the rental rates should ALSO be high (i.e. because there is high demand for rentals). I might be able to understand a situation where BOTH rents and home prices were above what one could expect the median wage to afford.

  15. 15
    Eleua says:

    Ira,

    The median price on Bainbridge is about $100K over what I used in my example, and I assumed that the median income was going to live in a sub-median house, just to skew the numbers TOWARD increasing values.

    At $2100/mo, the median income is going to strain to meet that obligation, and the rentals for median homes on Bainbridge reflect this.

    I don’t see incomes rising over the next few years as the credit crunch gains steam. With that, rents will also drop on the income and rental supply issues. This will weigh on home prices.

    We had too much building and the job base was more phantom than reality. The REIC and credit community were the growth areas, and they will lead the charge down hill.

  16. 16
    Eleua says:

    Sniglet,

    IMAO, I dismiss the “special” areas argument. If prices are higher, it is because incomes are higher. Yes, in a few examples, people can buy-down their mortgage with a large down payment, but if we are truly getting a deflationary credit contraction, then that phenomenon will become even more of a rarity.

    Second homes are a luxury that people are not going to afford for some time. You are proposing that “rich” people will be glad to rent out properties at a loss. I reject that in all but the most rare of circumstances. The nicer the house, the less you can recover on rent and the less likely somone would be willing to rent it out. Do you know of any rentals on Rockaway Beach with 120′ of waterfrontage?

    I will be the first to admit that the further you go above the median, the larger amount of income that can be applied to luxury housing, as other costs of living are fixed, regardless of income, so studies at the upper end need to take that into consideration.

    For the median, which is more representative of “normal” than the upper end, prices of housing (rent or owner-occ) needs to be what they can afford. If the prices are well above that level, we find it to be unsustainable (as is our current situation). The only reason it was possible was an ever-expanding, irresponsible credit bubble that temporarily confused debt obligations with genuine income.

    In fact, the aftermath of such unsustainability is likely a prolonged overshoot of normal, sustainable income ratios.

  17. 17
    Sorin says:

    Seems pretty well reasoned to me. I have a friend that bought a house about 4.5 years ago partly because it only cost him about 10% a month more than renting. You can’t come close to doing that today in most areas around Seattle. It’s difficult to imagine how the economics of housing wouldn’t revert back to very close to parity.

    Even if you compare median income to entry level house prices (rather than median), the numbers are still way out of whack.

  18. 18
    Cheapseats says:

    Sniglet,

    I think that your argument is valid. I also think that more people believe this to be the case for their hood than is realistic.

  19. 19
    B&W Nikes says:

    Awesome run down Eluea, really eye opening. There are a few elements or variables that seemed to be missing in the ten year forward time machine. I’m not suggesting any crystal ball or fantasy what if’s, but am curious if or how they could be accounted for. In general terms how does CPI inflation, or real inflation, or the purchase power of the US dollar influence the picture over time? Looking backward $100 had very different purchasing power 20 years ago compared to now, even more so for $100,000. Not all of that change is accountable in product or service demand or value.

    Also, there is also the location and demand thing that makes averaging difficult. One also has to ask themselves why a place like Bainbridge is and has always been so much pricier than nearby Suquamish or Poulsbo. Something else along with baseline numbers is seasoning the stew over there. Maybe the fertilizer from golf courses is getting into the water supply?

  20. 20
    Lake Hills Landlord says:

    Ugh. I feel nauseous. Anyone want to buy a Bellevue rambler with tenants in it that (negative) cashflows -$750 / month?

  21. 21
    Eleua says:

    B&W,

    If by “inflation” you mean a general monatary inflation (the ratio of dollars to the underlying economy rises), then home prices could get a lifting component, but it is uncertain if the boost would outgun the post-bubble effects.

    I would say that kind of inflation has about a zero chance of becoming reality. We will likely get the opposite.

    If by “inflation” you mean that certain commodities will rise in price due to supply issues or input costs (oil based war), then that is decidedly DEFLATIONARY for home prices, as money for that has to come from somewhere.

    Why is Bainbridge pricier than Poulsbo or Suquamish?

    The people and what they do.

    Suquamish is largely tribal, who without the state granted gaming monopoly, would be a basket case if they could produce a basket. Crime, drugs, meth, and a failed culture make this so.

    Poulsbo is just a blue-collar navy suburb, which has many of the same problems as Suquamish, but no casino or legacy of entitlement.

    Bainbridge has always had the better schools. This was the case when my mother attended schools here in the 1950s, and that has survived the years. People tend to have a higher education level, and they don’t want to live on the Kitsap Peninsula. Also, on Bainbridge, you don’t have the risk of having a full-service meth lab open up in your neighbor’s house. Not so with North Kitsap.

    That being said, Bainbridge is still WAY overpriced. Poulsbo and Suquamish are even worse.

  22. 22
    Jon says:

    Eluea,

    You still haven’t taken into account the fact that you do get some write offs. Care to share that with us…

    Let’s take me for example:

    Single Guy, one income, making $225k a year.
    I own my home, but I need a tax shelter. I invest the maximum I can into my 401k.
    I then invest into stocks and bonds, but I am paying taxes on that.

    Now, let’s say I purchase a property that I can now reasonably pick up fro $450k, and get $2200 a month in rent. I can put down 20%.

    I pay a point on my mortgage, and I have typical closing costs of about 6% on the purchase side. My monthly costs are close to $2800 a month, inclusive of taxes, insurance, and maintenance.

    I find a tenant that leases the property for a one year lease, but I screen quite a few and make sure that I am picking a great tenant that wants to be there for a long time, maybe even a bubblehead.

    What are the benefits of the following:

    The tax write off that year?

    The fact that I lower myself into a completely different tax bracket? (Let’s say 33% to 28%)

    The neg cash flow is $600 a month, which is a deductible.

    The taxes are all deductible, and let’s assume they are near $4k a year.

    Am I better off? I would argue, that in my particular case, I am.

    Also, I don’t buy that rents are going down… I think that is a crock statement that has no merit.

  23. 23
    NotaBull says:

    “IMAO, I dismiss the “special” areas argument. If prices are higher, it is because incomes are higher. ”

    You yourself gave an example of an area with incomes at $100K but median house price at about $200K. Shouldn’t the house price there be much higher? Why isn’t it?

    Why is the median house price in Mercer Island higher than the median house price in Sammamish, but the median income in Sammamish is higher?

    I don’t disagree that prices will keep going down for a while, but I think your argument is missing something. What that “something” is, I’m not sure, but it seems to be missing it.

    Data from city-data.com:
    http://www.city-data.com/city/Mercer-Island-Washington.html
    http://www.city-data.com/city/Sammamish-Washington.html

    Mercer Island was in 2005 at about 8X median income.
    Sammamish was at about 5X.

    Sammamish median income is actually *higher* than Mercer Island. So shouldn’t the house prices be higher if it’s all about income? Obviously there are other factors at work here.

  24. 24
    Sniglet says:

    I don’t buy that rents are going down… I think that is a crock statement that has no merit.

    Every region that is experiencing significant price declines and large numbers of foreclosures is also seeing a drop in rental rates.

    We’ve been talking about this in the forums (notice the links to articles about declining rents).

    http://seattlebubble.com/forum/viewtopic.php?f=2&t=1321&start=15

    You could claim that the Seattle area has already hit bottom, and that foreclosures won’t increase any more than they already have, but that’s an altogether different debate. If you believe Seattle area home prices will decline significantly, then it only follows that rents will likewise decline.

  25. 25
    Jon says:

    Again, no merit.

    Rents decline, purchases go up… it’s a cyclical market that we are seeing an anomole to.

    Of course, I don’t expect that 100 years of previous data would convince you otherwise, so I will leave it alone and let the dead dog lie.

  26. 26
    Eleua says:

    Jon,

    Your example seems to be cherry-picked. As I said in post #5, absent an unusually high income, the tax bennies are not that significant.

    Your example is 300% of the median household income. It is certainly doable, but not representitive of the typical “investor.”

    You are also saying that you are picking up a home for just over half the median price, which is the point of my entire article. In order to get the numbers to work, you need dramatically lower prices.

    Yes, you do get some tax write offs, if your income is high enough, and in your Mr. $225K who buys a house at $450K with $90K down, it would have some advantages. These advantages don’t offset the risk of entering into a $650K house with an joint income in the low 6 figure range, which is the current reality.

  27. 27
    Sniglet says:

    Rents decline, purchases go up…

    Huh? Sales have been plumetting in many cities at the SAME time that rents have been falling (e.g. San Diego, Miami, Las Vegas, etc). It is absolutely possible for over-all demand for housing to decline (both rental and purchased dwellings), even without population declines.

  28. 28
    Jon says:

    So you have eliminated the speculators… which is a good thing.

    Let’s focus our conversation on speculation – Wheat, Corn, Oil buyers… they are the real issue at this time.

  29. 29
    jon says:

    Mercer Island was built out several decades ago and now is home to a lot of retirees. I don’t know how they report the income for someone who is living off of savings, but the main factor is those people just don’t want to leave their friends of 30+ years. The fact that younger people having driven up price of homes to high levels doesn’t matter to them. I suspect the same is true of Bainbridge Is, where many long term residents are not interested in the cash value of the family home.

    For some people, a rented house is an equivalent product to a owned houses, but for many people, I suspect most, they really are different. Over recent decades people haven’t even been tempted to consider what ownership is worth in comparison to renting. Clearly that may be changing, but it does affect the calculation. To me, knowing that you won’t be forced out of the home you or your kids grew up in to meet the changing preferences of a landlord is worth a lot to one’s long term quality of life.

  30. 30
    Eleua says:

    Jon,

    What do you mean by this statement?

    Rents decline, purchases go up… it’s a cyclical market that we are seeing an anomole to.

    Rents are capped by income, as renters don’t have the ability to “exotically finance” their leases. With the credit contraction, we are seeing joblessness rise, and the number of vacant homes rise. Remember, the entire supply of housing units expanded in the bubble.

    Rents are going down, just like every other part of the country that has busted.

  31. 31
    TJ_98370 says:

    Hey Eleua,
    .
    Bainbridge real estate values made the local news today –
    .
    Skyrocketing Housing Costs Islanders’ Top Social Concern
    .
    ………The lack of affordable housing ranks as the island’s largest social dilemma, according to a recent human services survey. The community’s efforts and ability to tackle the issue of shrinking housing options for middle- and low-income renters and would-be buyers also scored rock bottom marks……
    .
    ……..According to the HHHS, the median home value on Bainbridge has doubled in the last eight years to almost $700,000, which is three times higher than Kitsap County’s median……

    .

  32. 32
    Sniglet says:

    Rents are going down, just like every other part of the country that has busted.

    A slight correction… Rents will be going down. Rents have definitely been rising in the Puget Sound area over the last year or so (my landlord has certainly been raising mine). That said, this is almost certainly a short-term phenomena, as has been extensively covered in our forum discussions. Many other regions saw their rents rise JUST as their market was turning the corner at the peak, only to come crashing down as the local real-estate market really began to tank (which hasn’t happened here yet, although we are on course for it).

    http://seattlebubble.com/forum/viewtopic.php?f=2&t=1321&start=15

  33. 33
    Eleua says:

    Notabull,

    Yes. The price of homes is a complicated one, but it is manifestly about income and the ability to pay.

    Trees and water are nice, but if the incomes are not there to drive prices, then all the trees and water in the world won’t bouy home prices.

    Detroit once had the highest incomes and most expensive homes in the country. Today, it has among the lowest. The same can be said for Pittsburgh.

    San Jose, Seattle, and New York are not special. They are just where a hot (and highly speculative) job market exists.

    Seattle was the Cleveland of the West Coast until the Microsoft experience.

  34. 34
    Civil Servant says:

    I love this post and I am glad to have learned the great term “speculative premium” and to have been reminded about the 1% principle. More Eleua please.

    With respect to another kind of premium, here are two condos for sale in my neighborhood.

    6557 4th Ave NE #9, a one-bedroom at $300K and $453/sf that was built in 1974: http://www.redfin.com/WA/Seattle/6557-4th-Ave-NE-98115/unit-9/home/74000

    … and 413 NE 70th #212, a brand-new studio at $340K and $588/sf (also with HOA dues that are 60% higher): http://www.redfin.com/WA/Seattle/413-NE-70th-98115/unit-212/home/17165032

    How many renters would pay 23% more per month for zero bedrooms and less space in exchange for living in a fancy new building with even shinier granite? I am sure someone somewhere could be talked into it, but that’s a hard sell. I have often been flabbergasted at the premium people are willing to pay for new and prestigey and tricked out vs. older but solid. I just don’t think that is most renters’ priority.

  35. 35
    Eleua says:

    TJ,

    Thanks. I might have to do an entire blog entry on that. I just need to get in a snarky mood to write it.

  36. 36
    Garth says:

    It seems like a lot of people here believe that every property is overpriced if you can’t rent it on craigslist the day after you purchased it for the same price as your mortgage.

    Apartments have to be converted into condos before they are sold, and mansions have to be converted to rentals to get a decent cap rate (4-6% in Seattle zips right now, not really a good return for individuals as mentioned above, but perfectly acceptable to REITS and trusts and such with a larger portfolio that provide dividends), because they are different products appealing to different groups and the amenities demanded by purchasers are not cost efficient for property managers.

    Most multifamily property owners use median class A (in Seattle zip codes this basically means above ~$1200 a month) apartment rental prices and compare that to the median house payment using normal financing to calculate a rent / buy spread and try and gauge how many of their tenants they will lose each year to buying a home. Many people here seem to be comparing Class B or C apartments or month to month rentals for single family homes from craigslist to median home prices and expecting there to be a very small spread between the two.

  37. 37
    Sniglet says:

    Most multifamily property owners use median class A (in Seattle zip codes this basically means above ~$1200 a month) apartment rental prices and compare that to the median house payment using normal financing to calculate a rent / buy spread

    Does this “normal” method of determining the rent/buy spread show that buying rental properties in the Seattle area is a good business with today’s prices? Does it require the assumption of some sort of appreciation on the property in order to pencil out?

  38. 38
    Angie says:

    Eleua, that was quite an effort. I hope you feel better now that you got that all out of your system.

    I guess I don’t get the sense that great droves of people are trying to make their fortunes by buying rental properties on Bainbridge. But, you know, party on.

  39. 39
    Sniglet says:

    Garth,

    I would love to see an example of how you work the numbers in a rent/buy calculation. It would be very interesting to see how the variables you think need to be considered differ from Eulea’s suggestions.

  40. 40
    Eleua says:

    Angie,

    Why, thankyou. I do feel better.

    The point of my post was not that people are trying to make money as landlords in the Great 98110, but that there is a tremendous speulative premium that exists in all homes, both owner-occ and rental. If the party is over, then I expect to see that speulative premium vanish, and possibly become an “owner’s discount.”

    The present value points to the median home on Bainbridge hitting around $250K, which is quite a gut-punch for the typical Bainbridge home-debtor. This presumes that incomes remain stable and that we suffer no meaningful economic downturn. Given that this premium is the entirety of the economic wave in both jobs and structure, you need to assum that we will get a declining job base and incomes.

    At the end of the day it is called DE-flation.

    Glad you enjoyed the post

  41. 41
    jon says:

    “The difference between the rental value and the price is the speculative premium. That is the amount of money that you are committing to attempt to capture a rising sales price of the home. ”

    So when I go to the bookstore and buy a book instead of renting it for free from the library, am I speculating on the rising price of the book? Why are the prices off waterfront homes in the millions when anyone can go to one of the large number of fine beaches during any daylight hour?

    We each have a certain amount of money that we can spend as we wish. Some people scrimp on some things to own a great house or condo, and others make do with an older unit and go on great vacations or whatever. It’s much more complicated that just comparing dollars.

    The reasons why a median income cannot buy a median house in an established area are so numerous that I just can’t understand why someone would write a whole article that presupposes that it should.

  42. 42
    Eleua says:

    Jon,

    Honestly, I don’t know where to start.

    Your library analogy is flawed. Libraries lend books for free, whereas rental homes are not freebies. If you moved into government housing and paid nothing, then I guess you analogy would survive.

    Waterfront homes are more expensive because people with more money outbid those with less money. At the end of the day, they are driven by incomes (current or past as represented by savings).

    I’m not saying that one family can’t put a higher premium on housing than another with the same means. I’m saying that the aggregate can’t pay above a sustainable amount for any meaningful time without dire consequences. This is sufficiently represented by the median, as the outliers in income and price are thrown out of the equation.

    Do tell us how home prices can have a sustained dislocation from incomes. It would be best not to use creative financing or irresponsible borrowing in your example. We are seeing how that ended.

  43. 43
    jon says:

    “Do tell us how home prices can have a sustained dislocation from incomes.”

    I buy house and retire.

  44. 44

    rental rates will also be driven down when the foreclosures start hitting the rental market. We have too much inventory which will drive prices down. Downward pressure on prices (among many other factors) will send foreclosures up.

    More foreclosures mean more REOs hitting the market. Banks will have to eventually mark the prices down and take the loss.

    At that time the investors will re-enter the market: When the prices are low enough to make the transaction pencil.

    Lots of choices for renters mean downward pressure on rents.

    How did I do, teacher?

  45. 45
    Cheapseats says:

    Jon,

    Honest question, because I have not seen this addressed elsewhere. The “norm” that is often quoted for median income vs median price is usually around 3 X income. My assumption is/was that this norm, when it was followed factored in retirees, rich people etc… they are not a new phenomena…

    The question being, what has changed today, versus when this norm was in line, that allows for the variance. I could speculate that it is people living longer, more retirees, or other factors…

  46. 46
    Eleua says:

    Jon,

    Great. You retire.

    What portion of the population does that represent in middle to upper-middle income neighborhoods?

    I thought so.

    Also, how do 70% of Boomers think they are going to fund the bulk of their Golden Years?

    Yeah, that McMansion they “own.”

    They still have to pay for Jennifer and Jason to go to college.

    77 million people don’t have a viable exit strategy.

  47. 47
    Eleua says:

    Jillayne,

    Gold star.

    If renters are experiencing pressure on their income while having more options when looking for a place to live, I’m going to go out on a limb and say that rents will be decreasing.

  48. 48
    Eleua says:

    Cheap,

    While you did direct your question to Jon, allow me to take a swipe.

    Cheap, unaccountable credit origination is what did it. This put extra money in the hands of the Great Unwashed and they all went to the REIC casino and let it ride.

    12-15X income was beyond insane.

  49. 49
    fancypants says:

    How about I give you guys a real world example to break down?

    400K in a CD at 3.5 percent (money set aside for downpayment on a house)
    2400 mos rent on 3000 sq foot very fancy house with 1000 sq foot finished basement on 5 acres (Viking appliances, etc. etc.)
    Equivalent Houses for sale: 775k (needs 75k in repairs) – 1 million.

    220k annual income, and I always hit the AMT.

    Likely 6.5% interest rate on a loan.

    If we purchased a house my guesses are:
    Insurance: $1500 a year.
    Repairs costs this year to the rental that I didn’t have to pay for: $2600.
    Property tax: $8000

    Our income is extremely unreliable. Our floor income is 120k. (Self-employed).

    Should we buy or keep renting?

  50. 50

    I read a couple of years ago that the historical average of home prices to monthly rent in the Seattle area was 150x rather than 100, so even if that was true, and even if we put as positive a spin on it as possible, and say that the 650K Bainbridge house currently renting for 2700 goes up about 10% to 3000, and we revert to the 150x, then the house is 450,000. That’s still about a 30% drop, and one that I see as more realistic than the 60 something percent drop that Eleua is envisioning, but I’ve been wrong before.

  51. 51
    Eleua says:

    Ira,

    That $650K house is renting for $2100, and it took 5 months to fill it.

  52. 52
    Garth says:

    Sniglet,

    I know a couple of multifamily unit owners with a couple hundred units each and they use a regular cap rate to pencil cash flow when buying or selling, but when they are calculating their rental increases and projecting tenant loss to home purchases they use the median conventional financing payment – median class A rent number to get a monthly spread.

    It is not a rent to buy calculation so much as an estimate what percentage of their tenants are going to be lost each year to new home purchases. Appreciation in single family homes increases the spread generally and leads them to assume that fewer of their tenants are going to leave to purchase.

  53. 53

    In your 2100 per month rent example, how’s you arrive at that figure? Was it based on BI median income? Or was it an actual home?
    I don’t know, it just strikes me that a 650,000 dollar home would fetch more than 2100 in rent.
    I know a woman in Sammamish who had her house on the market for a few weeks at 480,000 dollars, and it was “fairly” priced, she probably would have gotten close to that had she not pulled it off the market and rented it out. She rents it for 2000 per month, and it was only vacant for a few weeks. who knows? Maybe she just lucked out and found some sucker who loved the cul de sac.

  54. 54
    Flotown says:

    Eleua –

    Great analysis for those who have not seen it before – We had heavy numbers such as this on the blog a year ago so it nice to see a refresher.

    to the “3x income” rule of thumb, however, could some of the rapid rise in prices above “historical” sustinable levels be attributable the population and incomes of people buying homes beiong substantially different from those living in the area as a whole? for example, in Ballard, the neioghborhood asa whole is much older and of more humble means, I would wager, than the average homebuyer. Because only say 10% of stock rolls in a given year, and because the market price is only what the last idiot was willing to pay, the sales value are much higher than what could be supported by the local incomes statistically. Because home prices are sticky, people are not necessarily able or willing to sell immdeiately, so it would take many years of transactions before the incomes catch up to prices in tredny locations. What we really should be looking at is the ratio of incomes of the buyers over x period with the value of the homes sold over the same period, correct?

  55. 55
    Eleua says:

    Ira,

    It is an actual example that I think fairly represents what is happening with homes that are just below the median.

    In Kitsap, if you go over $1500 in rent, your options mushroom as the higher end homes can not command rent that is anywhere near what it costs to carry them. Remember, rents are driven by income and not subject to creative financing.

    People that can throw around $2500/mo are likely to be “owners” of homes and not looking to rent.

  56. 56
    Cheapseats says:

    Eula,

    My point about the median income to house ratio was where the new ratio should be. I do believe that it is artificially high, but I accept that the new normalcy point for it may be higher than say 3x median income. If one considers factors that differ from the previous norm. More retirees, boomers etc would seem to change the dynamic, but I have no proof of that, I just threw that out there as an example.

  57. 57
    jon says:

    “What portion of the population does that represent in middle to upper-middle income neighborhoods?”

    Your article seemed rather focused on Bainbridge Island. In 2003, there were 2850 social security recipients, out of a population of 21000 or so. Of that number 4280 are in school, presumably in their parent’s house, leaving 16720. Take out another 1000 for too young for school and you have 18% on SS. I suspect there are quite a number of people on Bainbridge who have retired, but not yet reached 65 years. To show how significant that number is, it it were to hit 50%, the reported median income would be essentially $0.

    Retirees are the people who have been there the longest, for the most part, and have the best locations, probably. On an island, location has a huge effect on price. So you have a large group with high priced property and no income, which is going to skew the medians.

    A ratio of 3 years income to buy a house is fine for an individual. For a group it has problems, but for a special case, like Bainbridge Island, it is near meaningless.

    You have a large group of people with current income, no mortgage, and a nice house. You have a large group of people who bought their houses before the run-up and have been paying their mortgage with a very low rate of defaults. And you have a small group of people who recently bought at a very high price. Those people probably have an income that is well above the median. (We discussed earlier how the average recent sale price for BI is $200K higher than the average price overall.) If you are waiting for a large number of one of these groups to be forced into distress sales, you may have a very long wait.

  58. 58
    Eleua says:

    Flo,

    You bring up good points. Yes, as a neighborhood is infested with greedy yuppies, the incomes will rise, but probably slower than prices at the margin. The longer term residents will likely have lower incomes, but we are talking about the median, not the average.

    Gentrification is difficult to grasp by looking at the median, for the reasons you state. However, as more yuppies move in, they become the median and you see the price/income ratio come back in. Even if we go to the 75th percentile, my numbers would still show a large contraction. At some point, the yuppie has to live on his income and not his debt, and the income isn’t nearly as high as we might think.

    Ask yourself if the way that yuppies were able to afford their Ballard craftsman was sustainable. If not, then you will likely see a contraction in prices. Those older Norwegians will be able to comfortably undercut the yuppies when they want out.

    The only way for the income ratios to be sustainably high is for the outlying income brackets (who have more disposable income). The median is much more sensitive to those historic ratios. You can see this by the rapid growth in Price/income ratios during the credit bubble.

  59. 59
    jon says:

    “I don’t know, it just strikes me that a 650,000 dollar home would fetch more than 2100 in rent.”

    For a place like Bainbridge Island that sounds about right. Locations like that carry a purchase price premium because of the school system, so you aren’t getting as much house for your money. The rental market at that price is going to skew towards people with no kids, so the school has no value to such renters. So the rental value is going to be a lot less. People who are renting out their houses in places with high value school systems are doing it because they want to hold on to the house for some other reason, and are just bringing in some extra income in the meantime.

  60. 60
    Eleua says:

    Cheapseats,

    I address this on another CCB entry.

    http://clearcutbainbridge.blogspot.com/2008/07/better-living-by-driving-prius.html

    Budgets drive spending on homes. Even if you raise the income, the realities of other spending obligations weigh on home prices. Those historic ratios are historic for a reason. We have had boom/bust periods in our past. The only thing different about today was the size of the boom.

  61. 61
    Eleua says:

    Jon,

    The median income is per household, not per individual.

  62. 62
    John says:

    The grim reality of the credit crisis still hasn’t sunk in for some yet. The collapse of Fannie Mae, Freddie Mac, WaMu, Lehman Brothers (take your pick) will help clear things up. Time is on our side.

  63. 63
    Markor says:

    Great post Eleua.

    In the short run I don’t see anything to disagree with. I think things could be different in the long run (30+ years) though. In the long run I can foresee that the value of a house will not be as correlated to wages as it is today. As the world population continues to increase exponentially, eventually we’ll run out of all sorts of resources, and substitutes will be more expensive. In my lifetime I expect mass starvation, like a billion+ people. The effect on house prices should be that people who inherited them or saved a lot can have one, whereas others can be homeless or living in a scrap-metal shack even if they make the median wage.

  64. 64
    Eleua says:

    Back in the mid-90s, the median price was in the low $300s, which was around 5X income. The mid-90s trough never experienced seller capitulation as interest rates were coming down, and Californians were still able to move up with all their Bongo-bucks. This kept the price/income skewed higher than would be expected without the X-Cal influence.

    Today, that is NOT the case. The lending space is completely broken, and X-Cals are yesterday’s news. Without those two factors to buoy the price, I predict that the ratio will come in much further (and faster) than historical precedent.

    Incomes will also come in, which only compounds the problem.

  65. 65
    Alex says:

    Great writeup, Eleua, thanks!

    I am working through your calculations and this is a line I do not understand:

    ‘At 8%, your yield goal multiplies your net cash by 12.5 to arrive at the value of your “investment.” $15,160 / .08 = $189,500.’

    Could you elaborate how you arrive at the value of the house and explain the formula you use?

  66. 66
    Eleua says:

    Alex,

    To get your yield, you divide by the percentage. If your yield is 1%, then your capital outlay is 100X your EBIT income (which results in 1%). If your yield is 5%, then you need 20X income as a capital outlay. 1 / .08 = 12.5.

  67. 67
    Eleua says:

    Put another way, if I have $250K invested in some vehicle, and my yield is 8%, then I get $20K. 250 / 20 = 12.5.

    Now, do it in reverse. If an investment is yielding $20K/yr, and I need an interest rate of 8% to justify the investment, then I am willing to pay $250K, as $20K / 8% = $250K. If I need a 10% yield, then I am only willing to pay $200K for the same investment. If I need a 20% yield, then I can only pay $100K.

  68. 68
    mikal says:

    My mortgages are $1350 and $1450 for duplexes. I get $2300 and $2450 in rent with water costs already taken out. I bought both ten years ago. I have 20 years and my mortgages will disappear. I have done all the work so their is rarely anything for me to do because I did it right in fixing them up in the first place. One needed alot of work while the other did not. I personally don’t care if things drop in value. It will only be temporary. Nothing goes down forever. Anyone who buys anything now is out of their mind. That said tell me there is no money to be made in real estate. Nice to see Eleau take a break from the apocalypse bunker construction.

  69. 69
    Eleua says:

    Mikal,

    The bunker construction is going well. Thanks for asking. When you have Vlad invading his neighbors, you can’t be too careful.

    Congrats on buying 10 years ago. We are talking about today’s prices. But while we are on the subject, what are the sales value of your properties?

  70. 70
    mikal says:

    What will they be in twenty years or more is what matters.

  71. 71
    Nick says:

    Part-time reader, but wanted to comment specifically wrt the inflation angle. Although I totally agree with the analysis, the wild card is inflation, IMHO. If we see real double-digit inflation in the next 5-10 years (which I consider fairly likely, given the 9% current rate and prospects for accelerated deficit spending at the national level), a fixed-rate long-term loan could start to look like a good idea, even with clearly inflated asset valuations at the time of the loan.

    Now, I wouldn’t buy a house right now either, but I don’t know of any other way normal people can borrow money at a fixed rate for 30+ years, and if we happen to elect socialist leaders who spend our currency into the toilet, and the currency doesn’t spiral into hyper-inflation, and you can make the payments on the loan, it could turn out actually beneficial in the long run. It’s a lot of ‘if’s’, but like I said, it’s the wild card.

  72. 72
    mikal says:

    Well Nick, we have been spending our money into the toilet for the last eight years. That would be one of the causes of the current inflation mess.

  73. 73

    Fancypants needs our help. See comment 49

    “Our income is extremely unreliable. Our floor income is 120k. (Self-employed).”

    In today’s more strict mortgage underwriting climate, self-employed income must all be verified and documented. They’ll take a very close look at cash flow.

    I’m assuming you have excellent credit and will pt lots of money down on your purchase. even so, lenders will look at your debt to income ratios to determine if you’re a worthy credit risk.

    The bigger question to ask is, what happens when home prices continue to fall and you end up having to sell that home? If you’ve put a bunch of cash down, would you be able to accept the risk of home values going down further? If you couldn’t sell, could you put a renter in there and cover your mortgage payment?

    This is what Eleua is getting at. Until mortgage payment and rent are closer together, it’s still very risky to be purchasing a home.

  74. 74
    Eleua says:

    Nick,

    Accelerated deficit spending will cause the cost of US.gov borrowing to increase, which will cause all interest rates to rise. That is deflationary for homes.

    I wonder what will drive inflation in the future of massive credit defaults. I’m not so sure we will see inflation.

  75. 75
    david losh says:

    The comments got me to read the post. The interesting part was the 150 to 200% appreciation in pricing.
    An agent contemporary of mine made a statement to me that home prices doubled every seven years. I looked him square in the eye and said, “no they don’t.”
    We both stood there for a few minutes, it was at a Real Estate meeting, and he agreed. We had the discussion for a few minutes because his claim came out so naturally, as though it was just a fact of life. In the past ten to fourteen years it has been.
    Real Estate prices have been doubling. He and I as older agents knew there was something wrong with it, but it becomes a reality while you’re in it.
    I just want to say that the agent I’m referring to is a good guy. Solid, salt of the earth guy, who cares deeply about the business and his clients. How his perception altered is by being overly involved. I’m beginning to see that in many of the older agents I’m acquainted with.

  76. 76
    david losh says:

    The loans already exsist. Give the lender nothing. Agree to take a nonperforming loan, with an equity position, and make payments.
    If the foreclosure scenario is true, and the Real Estate Owned property inventory is as high as I think it is, the lender’s asset is nonperforming and unsalable.
    In the very near future, as they have in the past, they will quietly make deals to reduce thier holdings.
    We’re not in the business to make the lender feel better about the loans they are making. They are in the catch 22. They have to make loans to make money, they lost money by making loans. What to do, what to do?

  77. 77

    Eleua,

    When will the Institute for Economic Reality be holding classes on the topic of deflation?

  78. 78
    TJ_98370 says:

    Whoa! Reading this thread is like the lightening round with Cramer – only with more reliable info.

  79. 79
    Eleua says:

    Fancypants,

    Here is a link that you may find useful

    http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?_r=2&oref=slogin&oref=slogin#

    That should answer questions regarding your wallet.

    You need to decide what your objectives are. You can afford the house, although affordability doesn’t mean you should buy.

    Are you content to rent? You place sounds pretty sweet.

    Would you put the entire $400K down? If so, why?

    What would you say to someone that offered to pay you $15K/mo for the next three years (tax free) if you continued to rent, rather than buy?

    If we are heading into a deflationary environment, then CASH IS ABSOLUTLEY KING and DEBT IS CERTAIN DEATH. That $400k is going to fetch quite a bit more than 3.5% in that kind of environment. A depression is an environment where people can’t find the money to do what they want. If you have an abundance of it, then you can name your price.

    I’m not giving advice, but if I had your circumstances (and I’m in your ballpark), then I would wait for the price to come in quite a bit. With all the debt out there, you are going to have people throwing large assets after small sums of money in the not-to-distant future.

    It would be one thing if you were living in an intolerable rental. It sounds like that is not the case.

    Food for thought…

  80. 80
    Markor says:

    mikal,

    I personally don’t care if things drop in value.

    I would care if I were you. If prices fall far enough fast enough, even it that’s temporary you could come out ahead by acting on that. Presumably you’re a landlord for the profit. Why leave money on the table?

  81. 81
    Eleua says:

    Fancypants,

    Check out this link. It should answer any questions your wallet might ask.

    http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?_r=2&oref=slogin&oref=slogin#

    Regarding your scenario, you might want to consider the consequences of giving up a large sum of cash and taking on debt for an almost certainly declining leveraged asset at the outset of a deflationary depression.

    If we are headded for a prolonged, economic quagmire, CASH WILL BE KING. People will be scrambling for it and throwing large assets after small sums of money to get it. That $400K would come in handy, as you will be able to name your price. Interest rates will be high (that is what happens when money becomes priceless).

    Your rental does not sound punishing, so why catch a large, falling knife?

    Food for thought.

  82. 82
    TJ_98370 says:

    Jillayne and Nick –

    Won’t increasing interest rates be deflationary with respect to purchase price on all big-ticket items normally purchased on credit?
    .

  83. 83
    Ray Pepper says:

    I liked it. Nice article……..Send it to the News Tribune please. Devona Wells is now gone and I think this article will knock some sense into the Gig Harbor pumpers….

    But, come on…… Kevin Dubrow is dead. Retire the Metal Health Avatar. . I actually met him in the buffet line on top of Harrah’s Lake Tahoe. I noticed his girl friend first and thought wowwwwwwwww. I still didn’t know who he was until he sat down with the bandmates and then I noticed they were playing that night..

  84. 84
    Eleua says:

    TJ,

    ROFL! I don’t know if I want to be compared to Cramer, but it is what it is…

    Jillayne,

    Just a brief outline of the deflationary thesis…

    Money and credit are one in the same. I can use credit and money in the same manner. We live in a credit based economy (not gold based), so the money supply equates to the availability of credit.

    Money is borrowed into existance and is extinguished by repayment or default. When I borrow $200K to build a business, the bank and I have just created $200K.

    As my business flourishes, I am able to pay off my loan. That $200K is gradually destroyed by my repayment, but the asset base has grown (my business). I can then use the equity in my business to borrow more money, and “re-create” that $200K, or even $300K. See, the money supply expands to cover the productive base and assets of the economy. If the ratio of money to the economic base (assets) remains constant, we see no inflation or deflation. A dollar has a value that is denominated in what it represents.

    If we borrow excessively, with ever-declining quality of collateral, we get an expansion of the money supply, but the base remains relatively constant. That 1975 Pinto really isn’t worth the $300K that is loaned against it. We call that IN-flation.

    The best, and most timely, example of this was the recent housing bubble. A home that had $200K loaned against it in 1988 had $800K loaned against it in 2005. It is the same house, but a much higher sum of credit that the house represents – INFLATION. You saw this as people were taking out HELOCs and buying stuff. The credit was on dangerous ground because the asset base couldn’t support it. It only worked if nobody ever defaulted or called a loan.

    Either way, we had a rapidly rising money supply (how many mortgage companies sprung up in that environment?), but a relatively stable asset base.

    Now, if we get defaults, the money supply contracts, but unlike a repayment, it denotes that the underlying asset base is incapable of supporting further borrowing to replace that which was destroyed. The asset base remains relatively stable, but the money supply shrinks rapidly. This is especially so if the massive borrowing is in highly speculative, assets, such as CDOs, mortgages, bond insurance, etc. A cross-contamination of defaults can trigger a chain reaction of defaults, where all of those debt obligations are looking at the same collateral to be made whole.

    DE-flation. Money supply shrinks over a relatively stable asset base.

    Just as our HELOC example was a ready illustration of inflation at work, we can see that in a depression, where people are desparate for work to pay off their debts, they will lower their asking price for their labor or what they are selling. The asset base is fetching less and less money, as money becomes increasingly valuable. Supply is shrinking where demand is increasing.

    Once this starts, it is very difficult to stop. People do not want to originate loans in this environment, because they are fearful of defaults and an asset base that can’t cover the debt, while those that want the money are fearful they will be paying back in stronger dollars. Interest rates rise and volume drops (just the opposite of inflationary – weak dollar – environments.)

    Can the US.gov print our way out of it? No.

    Uncle Sugar goes to the same pool of money for his borrowing that you and I do. He has a better credit rating (he can tax and has a kick-ass military). For him to issue money, he has to first borrow it or tax it. If he were to simply “print” it without a debt obligation attached to it, the bond market would freeze overnight, as the bond traders would hike rates to the moon to cover money that is going to be paid back without it representing a productive asset. After all, why would you want money that does not represent anything? This is what is called “hard currency.” A hard currency represents something, rather than just a slip of paper. This is why small, Third-World currencies tend to blow-up.

    98.5% of the US dollars out in circulation are in the form of contracts and credit arrangements. As these defalut, that money disappears. The US.gov would have to cut down every tree in the Western US to print enough $100s to offset the money that is not currency, but credit obligation. If you are the Icelandic Krona, you could print, as your currency is very small, but the US dollar is FREAKING HUGE! 80%+ of world debt is denominated in US dollars. That is why we call it the world’s “reserve” currency.

    To get inflation, the .gov would have to get all that money into the hands of the people so they could drive inflation from the demand side. Either that, or destroy the asset base without destroying the credit-based currency that represents it. Given that it can’t send out $250K stimulus checks to everyone without crashing the bond market (and driving interest rates to the moon, which makes the economic activity grind to a halt), they have no option in this regard.

    Deflation is what they fear. Japan has been teetering on it for 15 years, but they have been able to originate so much debt, they have pushed it off into the future. It is still coming, but they have lived to fight another day.

    We don’t have the reserves or trade surplus to pull that off.

    I hope that only confused you a little bit.

  85. 85
    Eleua says:

    TJ #81,

    Decidedly so.

  86. 86
    Nick says:

    Sorry, I’ve heard the deflation argument before, but I just don’t buy it. Uncle Sam doesn’t borrow money from the same people I do, and he certainly doesn’t play by the same rules. For a small example, the Fed can set loan rates to the big banks substantially below the market, unless you know where I can borrow money at 2%, or deposit toilet paper for treasuries…

    When the US government wants to print money, it doesn’t borrow, it just prints, as evidenced recently by the $200 billion handout package, the FHA certain default loans, and all the recent negative budgets. It nominally finances the debt by selling long-term treasuries, but as long as we have a functional currency, they can continue to do this forever. Since the US dollar is the trade reserve currency (by agreement made when it was actually strong, not because it’s still strong), a lot of people hold it, but its reserve status can change.

    We certainly don’t have a hard currency any more (since going off the gold standard), so there is nothing backing our currency any more than any other currency. The bond rates would probably increase, but in a recessionary environment, investors flee to treasuries, which keeps their rates low in offset (as we have already seen). Treasuries will still be backed by “full faith and credit”, and they’ll still be safer than most alternatives, so the idea of massive price hikes in the bond markets is unlikely. After all, we’ve recently tested the theory with the “stimulus” monetary creation, and it worked just fine.

    Both current presidential candidates have no credible plan to balance the budget or reduce spending, and no solid public pressure to do so. In fact, the public is clamoring for more government aid and socialist programs in the face of an economic downturn, so much so that the “populist” candidate’s budget has a projected $1+ trillion dollar deficit in an optimistic case. There’s no credible reason to believe the next administration will not set deficit spending records, and create the same sort of long-term government debt obligations as the administration did the last time the country had a major bubble correction (~1930, you all know about Social Security and farm subsidies, right?).

    When the government spends money they don’t have, it devalues the currency. When the government needs to borrow increasing amounts of money, it pays higher rates, which both creates more money and sucks money out of private investment, making borrowing costs for business increase. This increases costs to consumers, which demand higher wages, and so on. In the short term, the decrease in credit will correct asset prices (“deflation” to some), but in the medium to long term, US dollars will have less value (“inflation” to most people).

    Of course, I’m just an engineer, not an economist, so I might see things in too simplistic terms to grasp the whole picture. However, I think being right about many things in the past few years where notable economists were totally wrong (Greenspan, Bernanke, all the perpetual housing bulls, etc.) has emboldened me, so I’m standing by my possibly naive analysis. :)

  87. 87
    Markor says:

    Fancypants,

    Eleua said: If we are headded for a prolonged, economic quagmire, CASH WILL BE KING. People will be scrambling for it and throwing large assets after small sums of money to get it. That $400K would come in handy, as you will be able to name your price. Interest rates will be high (that is what happens when money becomes priceless).

    And note that we are almost certainly headed for a prolonged, economic quagmire (mikal #72 nailed the cause). Don’t keep your CD in one place. I’d use credit unions too, since they use a different gov’t agency for the insurance (NCUA), and probably didn’t gamble as much as the banks did. The FDIC could easily get wiped out, and who knows how fast the gov’t can borrow more to shore them up?

  88. 88
  89. 89
    Garth says:

    The last census for bainbridge was in 2000 and the median was $335,000.

    http://factfinder.census.gov/servlet/SAFFFacts?_event=Search&geo_id=&_geoContext=&_street=&_county=bainbridge+island&_cityTown=bainbridge+island

    I also could not find anywhere that listed the median for bainbridge over $590,000 with redfin showing $560,000, so using medians I can see 100% appreciation or so in the last decade, but I can’t get to the 150-200% you mention at the top of the article.

  90. 90
    Eleua says:

    Nick,

    You would be well served not to put too much faith in those websites that are trying to sell gold. Most of their monatary theory has been thoroughly discredited.

    Show me where the US.gov just “printed” money without a debt obligation attached to it. I’ll be waiting a long time.

    You just said that in a recessionary environment, investors flee to treasuries. What, exactly, is that? That is the US.gov borrowing money by issuing debt. As long as the supply of credit exceeds the demand, then interest rates will be low, reflecting a cheap, easily obtainable dollar.

    The low interest rates represent our massive trade deficit with China and Japan, and how they recycle the dollars we send them back into US debt to keep our interest rates low, thus continuing the spending orgy. If we reduced this to our common understanding, we would call this “vendor financing.” Vendor financing always ends in tears for both parties (especially the vendor).

    Your second to last paragraph goes in the right direction by saying that increased US.gov spending will hike interest rates (because they are crowding out private borrowing), but then fail to understand how this is manifestly deflationary, as economic activity and debt originations in the private economy are choked off. People may “demand” higher wages, but they can’t get them because their productivity is reduced. Deflation.

  91. 91
    Eleua says:

    Garth,

    Median Bainbridge home price in 2007 was $840K.

  92. 92
    Eleua says:

    The median was capped when the Californians quit coming in October of ’07. They were the driver of the top half of the market. Right now, the only inorganic buying on the island is largely King County, as it has been highly resistant to property price deflation. Their equity buyouts are still functioning, but are starting to slip.

  93. 93
    Ray Pepper says:

    I just don’t buy into rents decreasing. With less and less people being able to buy and the pride of home ownership diminishing , more will be forced into and many more freely choosing to rent. With increased demand for rentals, rates will go and have been going up. Our group owns about 70 properties. Upon each and every tenant that moves out we raise rents at least 7%. In the last 2 years we have been raising 12%-15%. They are readily snatched up. We buy next to Universities, densely populated areas, and military bases. We never have paid more then 180k for a property and they all remain cash cows. The best investments thus far have been the single wides on our own land. When you can find these Gems at 50-60k and they easily rent for 750-850 in Thurston, Kitsap, Mason, and Pierce county. Again it always matters what you buy and what you pay for it.

    300k? 250k for a rental? Are you nutts? With high foreclosures you believe rental rates will come down? Where are these people going? I tell you. Craigs List looking for rentals. I know. I field many of the calls. We continue to get 3x as many calls as we used for each and every rental. We own in Tacoma, Albany, Eugene, and Fallon Nevada. All new homes except for the mobiles. All financed on World Savings Cosi Loans(now no longer available). Each month about 150.00 gets tacked onto the principle yet each property cash flows 400-600 per month.

    The doom and gloom for landlords I don’t buy into, unless of course they bought non Gem-like properties and in very poor rental areas. Its all about doing your own DD.

  94. 94
    Markor says:

    Nick,

    Sorry, I’ve heard the deflation argument before, but I just don’t buy it.

    No doubt the next prez is screwed on the economy. The problems cannot be fixed immediately, or without spending hundreds of $billions.

    There can be both inflation and deflation. Consider shoes. Chinese factories are shutting down en masse; their costs are too high now. They’ll shift to Vietnam or wherever, but still the cost of shoes in America is going up. The cost of used shoes, however, should go down. Maybe you don’t want used shoes, but how about used cars, used big screen TVs, and yes, used houses?

    Look on craigslist for dining room tables. You can get a table that costs $3K new, for around $300, in great condition, with a large selection. Two years from now such tables might be $100, in dollars then, and the selection might have doubled in size.

    I advise everyone to stock up on non-perishable goods now, that you will use yourself, as an investment. You could make 10% or more on them. For me, that includes shoes.

  95. 95
    Markor says:

    Eleua,

    http://www.treasurydirect.gov

    CDs seem more convenient, higher paying, and just as protected. I prefer dealing with private businesses to gov’t bureaucracies. What am I missing?

  96. 96
    Joel says:

    Great workshop! Where can I order the DVD set?

  97. 97
    jonness says:

    Harley:

    Home buyers don’t tend to buy based on how much houses cost overall. They instead typically go by how much it will cost them per month. Furthermore, prices are driven by supply and demand. If interest rates go to 18%, prices will adjust down to a level that people can afford to pay per month.

    It doesn’t make sense to pay an extra 100k for a 400k house just to take advantage of low interest rates. Especially if you plan to live in the house less than 20 years. In fact, buying at a point of high interest rates is an excellent time to buy because house prices have been driven to the bottom, and you can refinance when the economy picks up and interest rates drop accordingly.

    Now is a terrible time to buy unless you are a RE agent representing the buyer.

  98. 98
    mikal says:

    Markor, I already did the math. I would have to get more than $150, 000 more than they could have ever valued out and that is max. I could get more in rent than I am currently so am no bind at all. The only potential problem I would have is if rents dropped by half. That isn’t going to happen. I could see house values drop, but not for as much where my units are located (12 blocks from downtown), For you gloom and doom people read Jim Kuntsler. He makes the supposition about gas causing people to leave the suburbs much further than I ever have. That means everything close in is going to only go up in value. Kunstler thinks the suburbs are finished.

  99. 99
    Sniglet says:

    I just don’t buy into rents decreasing. With less and less people being able to buy and the pride of home ownership diminishing , more will be forced into and many more freely choosing to rent.

    This is not proving to be true in regions where real-estate prices are declining significantly (which hasn’t happened in the Puget Sound yet). There are lots of stories coming out about how landlords are struggling from Phoenix and Las Vegas to Miami and Atlanta as increasing numbers of people decide to down-size their housing needs (e.g. get smaller homes than they previously had, move in with parents, or find shared housing arrangements). There is also the factor of growing shadow inventory when home-owners unable to sell their homes decide to rent them out.

    Yes, the Seattle area has been seeing rents rise recently, but we haven’t experienced the mass of REOs and price declines that have been seen elsewhere yet. As soon as these pick pick (i.e. price declines and foreclosures) our rents will go down too. Housing demand is much more elastic than most people think. It’s not as if someone who decides not to buy will necessarily be renting (i.e. they can move in with ma). I already know of colleagues at work who rent homes for their families who are opting to move to cheaper rentals with lower square footage to save money–they are making their kids share rooms and going for fewer bathrooms.

  100. 100
    Sniglet says:

    He makes the supposition about gas causing people to leave the suburbs much further than I ever have.

    Gas, and commodity, prices are simply the last bubble left over from the credit binge that is already starting to pop. As the global recession takes hold in 2009 we will see demand destruction (from Europe and America to China and India) create a glut in oil, steel, and almost everything else.

    Just look at how commodities saw a major pull-back in the last month, into clear bear-market territory. The massive commodity rally of this week just confirms the fact commodities are entering a bear market (i.e. massive, swift, rallies always occur in bear markets).

  101. 101

    ELEUA HAS ADDED MANY INTERESTING OPINIONS AND FACTS

    To add to his treasure trove: I’d assert that the tax advantages of buying a home only exist primarily when the principle interest deduction [with any other other deductions] exceeds the 1040 standard deduction you get when you rent anyway. I have purosely left an approx $80K principle on my house so that I could deduct property tax, charities, etc up until now. Now, with approx 2% after income tax interest on savings CDs it makes much more sense to pay the principle off on get the Title.

    Remember, even 6% house interest loans are payments from your net pay, not your gross pay. To compare the payout of home interest or rent payments, multiply the 6% by your bracket creep increase [approx 1.3 for most of us]. You get the point, by paying off a 6% principle loan its like trading a 8% loan payoff for a measley 3-3.5% CD….pay off your house, it pays much better than the negative mutual fund stock market too.

    Will we have depression deflation or worse yet, recession stagflation; as this debt crisis unfolds?

    My gut feel and its a wild guess at this point is we’ll see both. We’ll see recessionary stagflation in oil and food. We’ll see depressionary deflation in housing, incomes and anything resold used. Will commodity price increases affect the prices of materials to build homes? Yes and no. I see price increase demands on lumber, but a demand decrease on lumber too. This has already affected closing or curtailing lumber mills. In the end, when the holder of assets needed cash during the Great Depression, a can of cash bought an apartment building, because no one had any available cash and bank doors were locked.

  102. 102

    “and X-Cals are yesterday’s news”

    I’ve seen a rise in X-Cals lately. With local buyers less likely to change their current housing circumstance, the % of xCals in the buyer pool is on the rise. Difference is they are not coming with “the sky’s the limit” mentality and they are blending in. A higher % of buyers are relocating from somewhere else, and many of them are relocating from CA.

  103. 103
    david losh says:

    To finish a thought concerning commodities. First the Stock Market doubled, then tripled, between 1994 to 2001. After a brief time Real Estate doubled in pricing. Now oil, in a year, doubled and almost tripled in pricing.
    Not all stocks or Real Estate are the same but there has been a definite homogeneous look to the pricing.
    I very glad Bainbridge Island is the example here. What economic forces drove up prices on Bainbridge Island? The Issaquah Plateu is another place I simply can’t figure out. How did these places command $500K, to $850K pricing? In Issaquah it was less, but I still don’t see the value.
    What was the value base of many areas around Seattle or the country?
    The same was true for the stock market. We even use the term the dot com era because all some one had to do was start a company claiming internet benefits and some one would buy the stock. Honestly there are stocks today that make no sense in terms of the value compared to the pricing.
    When you start talking about corrections, deflation, inflationary dollars, and decreasing rents, I’d suggest you step back for a minute. Just take a minute to look at the houses, housing units, Real Estate, and tell me what the actual value is. Is that a half million dollar house? Would you pay rent to live in a half million dollar house in Lake City? Why would you pay more rent than a place is worth? If you did spend a thousand dollars for rent wouldn’t you want it in top shape? The law says you have rights as a tenent. Wouldn’t you want the very, very best, terms, service, and condition for a thousand dollars? You and I work hard for a thousand dollars and the land lord does nothing. Should his feet be held to the fire?
    Rents are going down as the economy stabilizes. Wake up, stand back, and realize you have been living in a dream of false economic value.

  104. 104
    Sniglet says:

    Why would you pay more rent than a place is worth?

    The true “value” of something is a squishy subject. A decrepit shack on a dusty piece of ground could be worth $20 million if there were sufficient demand. A better question is why someone would pay a high rent for a ex-urb McMansion when they can rent a similar home closer in for the same price.

    A question many renters are increasingly asking themselves around the country is weather it is worth paying $600 extra a month just for the privilege of having an extra bathroom and bedroom: many people are now deciding “no”, and that it would be better just to save the difference for a rainy day considering all the uncertainty in the economy. Or worse, many single people are deciding that they’d rather just room with someone for half-price rather than pay double for an apartment of their own.

    Can a landlord hold a tenant’s feet to the fire and force them to pay for a larger home than they feel they need?

    By the way, I roomed with people for 10 years when I lived in California. I also have MANY colleagues (with high incomes) who have room-mates (and more are deciding to go that route). Shared housing is not such a terrible thing. I became fast friends with EVERY one of the room-mates I had (all of my previous room-mates even came to my wedding).

  105. 105

    Things tend to have their time. Recently, it has been the time for the big house on the small lot in the suburbs, in a development with similar homes. As Mikal pointed out ( and James Kunstler’s rants), rising energy costs and traffic have made living closer to work a priority, so people are choosing to live closer in. And again with rising fuel costs, it’s not making as much sense to live in a 3000 square foot house. Small is beautiful.
    But it’s not always timed well. There are SO many townhomes and condos in the city of Seattle that the supply is way over the demand, not to mention that many of them are just plain hideous.

  106. 106
    Buceri says:

    At this point, I am seeing a WA plate every 3 weeks and 2 CA plates per week here in Tampa, FL.

    And you can be sure they are not “job transfers.”

  107. 107
    EconE says:

    Mikal said
    “My mortgages are $1350 and $1450 for duplexes. I get $2300 and $2450 in rent”.

    then …

    Eleua said

    Congrats on buying 10 years ago. We are talking about today’s prices. But while we are on the subject, what are the sales value of your properties?

    Then Mikal dodged the question, although he had stated in the past that his RE was “worth” 1.6 million at the peak in an old post. Perhaps Tim can find that statement.

    Later…

    Markor said…

    I would care if I were you. If prices fall far enough fast enough, even it that’s temporary you could come out ahead by acting on that. Presumably you’re a landlord for the profit. Why leave money on the table?

    subsequently…

    Mikal said…

    Markor, I already did the math. I would have to get more than $150, 000 more than they could have ever valued out

    Eleua/Markor…you able to do the math on this one?

  108. 108
    deejayoh says:

    E –
    Interesting work but I have to quibble with some of the assumptions on your income side approach.

    – Income growth has been about 4.8% a year for Puget Sound/Seattle MSA for the last 20 years, so 3% is well below trend, not above it. .
    – I keep meaning to look for the “4X” income standard on snopes.com. Maybe that existed as a lending standard for first time buyers versus a specific home – but as a valuation tool – median home price:income ratio has been at that ratio for only 3 out of the last 35 years – 1974-76. 5-6x is a more typical range. We are now over 9 – so I agree something has to give – but find a return to 4x unlikely

    http://img115.imageshack.us/img115/1388/efactshl5.jpg

    Not that I disagree with the conceptual approach, I’m just tempering some of your bearishness

  109. 109
    Nick says:

    I’d guess the 4x number comes from the historical “safe” DTI ratio for a mortgage of around 28%. With a 6.5% mortgage, you’re DTI with a 4x loan is around 30%, and with an 8% loan (more normal historically) it’s around 35% (approaching the upper limit for “safe”).

    By contrast, the FDIC “affordable” DTI number for their new “crime does pay” handout program through IndyMac is 38%, which corresponds almost exactly to a 5x price to income ratio with a 6.5% loan. So even the brain dead, “give taxpayer money to criminals to support housing prices” FDIC doesn’t think the price/income ratio should be higher than 5x.

  110. 110
    fancypants says:

    Markor and Elua,

    Thanks for the advice. I am wondering where I’m going to put this nest egg. I was thinking 100k in my husband’s name in a USAA savings account or CD, and 100k in my name, but i’m not sure what to do with the rest. I was also thinking about putting it all in FTABX, sound smart or dumb?

    I’ll admit I’m really paranoid right now. The rental is fine and we’ll stay here until February when our lease ends. We’re in Seattle now, but I think we’ve settled on Bainbridge long term, so we’ll either switch to a rental or buy there (kid #2 is on the way and I want kid #1 to have the same friends if possible, and have his pediatrician remain consistent).

    If I was conservative, I’d stick to a house around 750k. However, what would be ideal for the need long term is a house that costs 1.2mil right now, and rents for $2800 right now. (We’re going to have the MIL living with us in the near future and a guest house on site would make me very happy).

    Anyway, I’m in a holding pattern. 1.2 mil with a 2800 rent comparison is a stupid buy in my opinion, especially if home values remain flat for the next 10 years (or go down). 1.2 mil is also a risky purchase for us. But if prices go wild again and we waited to buy then we’ll be stuck in a rental or forced to buy much less house. So maybe we should go ahead and get a 750-800k house and trade out when the time comes. Bleh, I’ll think about it harder in December.

    Everyone else on rents:
    I keep a close eye on San Diego since I view it as the bellweather for housing trends. Rents did rise there, but now they are going down because there are a lot of new rentals hitting the market as construction companies convert their inventory. And the high end is finally showing real signs of distress.

  111. 111
    Sniglet says:

    if prices go wild again and we waited to buy then we’ll be stuck in a rental or forced to buy much less house.

    The odds of prices going “wild” in the next several years are slim to none. Even if the more dire predictions of price declines don’t occur (such as the 50%+ price drop predictions I believe in), it is EXCEEDINGLY unlikely that the credit markets are going to re-initiate another real-estate boom for a long while.

    In any event, you will have lots of warning that prices have bottomed when we have gone a year with no increases in inventory, forelocures, or price declines. Real-estate recoveries are always long drawn out affairs, with prices barely appreciating for years before higher appreciation rates really kick in.

    In short: there is NO rush to buy, even if we’ve hit bottom (which I absolutely, positively, do NOT believe is the case).

  112. 112
    deejayoh says:

    By contrast, the FDIC “affordable” DTI number for their new “crime does pay” handout program through IndyMac is 38%, which corresponds almost exactly to a 5x price to income ratio with a 6.5% loan. So even the brain dead, “give taxpayer money to criminals to support housing prices” FDIC doesn’t think the price/income ratio should be higher than 5x.

    That is a lending rule that is intended for a single buyer against a single loan. You cannot take it and peanut butter it as an average to suggest what the
    overall median price:income ratio should be. That ratio at it’s lowest over the past 38 years is 4x. Suggesting that we might overshoot that because of some rule of thumb about what a single borrower can qualify for is just bad math. What about borrowers who want to put 50% down? those that are trading up? Are they limited by income? What about those who are just sitting on a pile of equity because they bought 20 years ago? You just can’t compare the two. they are apples and oranges.

  113. 113
    patient says:

    I think the price/income ratio math is ok. A more precise ratio is of course mortage/income but since that is not easy to track exactly I think a it’s pretty fair to use an estimate of the average price/mortage which I would guess is somewhere around 90%. I.e 10% down. Anyone who has a statistical verifiable number for Seattle, washington or the nation?

  114. 114
    NotaBull says:

    With respect to yield from rental property. Regardless of where rent goes in the next few years in that it might go up a bit, down a bit, or stagnate, there is probably general agreement that rents over time do go up. And they tend to go up with wage inflation. I’m talking 10 or 20 years here which is what any sensible investor (not speculator) would be considering.

    If we assume that wage inflation is in the 3% range, which as DJ points out is actually less than the long term Puget sound average increase, then we can probably safely assume that rents will track that.

    My point in this is not to say BUY NOW, but to temper some of the short term views regarding yields on rental properties. If you are going to look at *current* rental prices vs *current* prices, you’ll be waiting a long time for them to reach parity. They may never reach parity because clever investors realize that longer term yields are higher than current yields.

    The rent payment is higher than the insurance, real-estate tax, and maintenance components combined. So if they all track with “inflation” at the same level, then the yield on a given property increases over time.

    Still, it doesn’t make sense to buy a property to rent out right now. But it will make sense sooner than a no inflation analysis would predict.

  115. 115

    Hi Eleua,

    No, I’m not confused. That was extremely helpful. Thank you. Next question: I’m concerned about all the loan modifications being written.

    Are the banks trying to keep from having to show us the true value of their credit assets?

    If the homeowner goes into foreclosure, then there’s no paper asset. It’s real property that must show up on a different side of their balance sheet (non-performing asset.) Now they have to dispose of it and the true cost does what to the banks?

    So the loan mods are being done to keep the banks afloat, yes?

  116. 116
    mikal says:

    Nobody wanted to do the math all day. I’m making a killing now on a deposit of $20,000. I’m ahead $24,000 a year on a twenty thousand dollar investment. They could be worth nothing, and I am still making $24.000 a year on them. Sorry I’m so late. I have a job.

  117. 117
    Eleua says:

    @Markor #95,

    The only real advantage to the TD accounts is that it will be the last to default.

    When you deposit your money in a bank, CD, bond, etc, you are really loaning your money to that institution, and with that carries the risk of default.

    TD is how you loan money to the US.gov. If a large, Seattle based S&L goes belly-up, the FDIC doesn’t have the money to cover those deposits, so your “insurance” is incapable of making you whole in a timely manner. They may be able to pay you out over time (after the FDIC gets replenished – assuming it does), but that will happen after a significant financial panic, and perfunctory bank run.

    You don’t want your money in that mess.

    At least with TD, you know that as long as the .gov has a credit rating, you will get paid in full and on time, as TD’s solvency is well above that of the FDIC and its subscriber banks.

  118. 118
    Eleua says:

    @Jonness #96

    That is at the core of the issue. As interest rates have fallen over the past quarter century, asset prices have risen to compensate. In the case of bubbles, we saw grotesque appreciation in asset prices, as people misread the situation and thought it would last forever.

    As soon as people realize that as interest rates rise, the opposite will take place.

  119. 119
    Eleua says:

    @Mikal #98,

    For you gloom and doom people read Jim Kuntsler. He makes the supposition about gas causing people to leave the suburbs much further than I ever have. That means everything close in is going to only go up in value. Kunstler thinks the suburbs are finished.

    If Kuntsler’s predictions come to pass, you are not going to have much of an economy in the downtown areas to keep your asset prices anywhere near the valuations they currently command.

    You guys think I’m bearish? Kuntsler makes me look like Meshugy, the Seattle PI, Lizzie Rhodes, and RAL all rolled into one.

    Be careful thinking too highly of your “special” location. It isn’t.

  120. 120
    Eleua says:

    @Ardell #102,

    Thanks for the data point. It would appear that X-Cals carry the same punch that X-Tex does. Without all their Bongo-bucks, they are just another buyer that has to buy homes from their monthly cash-flow.

    As California sinks further into the socialist wasteland and economic morass, their equity buydowns will turn into liabilities.

    No party lasts forever.

  121. 121
    Eleua says:

    @David Losh #103,

    It took you two paragraphs to say what Ihave been trying to say in an entire chapter.

    Thanks.

  122. 122
    mikal says:

    I’m still not interested in building an apocalypse bunker. I’m sure you would say the same thing about me, but your nuts.

  123. 123
    Eleua says:

    @DJO #108,

    As always, I truly appreciate your stats and perspective.

    I will say that a 4.8% appreciation in incomes over the past 20 years is truly surprising to me. Just to put that into perspective, if we assume the median Bainbridge income is 33% above the current value, and back out an average of 4.8% appreciation in that income over the past 20 years, that would have put their income at $39K back in 1988,. This was $7K less than I was offered as a starting construction engineer upon my graduation a year later.

    While anecdotal, I do not believe for a minute that a 22yo engineer would have been offered a salary 17% higher than the Bainbridge median. Even back then, “Old Bainbridge” wasn’t that pervasive.

    I’m just throwing up spitballs here, but I am wondering if that income growth you cite includes items such as stock portfolio and home equity growth, or if it represents actual 1040 data. I do understand that over that 20 years, Microsoft became the largest factor in local employment and that is certainly significant, which gives me reason to believe what you are saying, although I still have a nagging skepticism.

    I did notice that after the internut bubble burst, the growth in local incomes was well below my 3% figure, with notable exceptions of ’04 and ’06, which were nutty years on Wall Street, and the beginning of the super-charged PNW RE bubble.

    I will also agree that the 2.5 – 4X price/income ratio has been skewed in the sexy, coastal regions of the US, particularly where Californians dominate. Anyone that has spent 10 minutes talking to a Californian knows that real estate appreciation is the official religion of the Golden State. It has been my assertion since I arrived on SB that irresponsible lending and buying of real estate has always been liquefied by rising prices, and once that phenomenon stops, it is likely to shift into reverse. Once that happens, only the most prudent will survive the downdraft.

    Banks and borrowers will suddenly look at exotic income ratios with increasing dread, and will impose extremely hawkish and conservative lending standards to protect themselves from declining prices. As anyone in the “enlightened” areas of the nation know, those troglodytes in “Flyover Country” don’t have the home appreciation we do, and I find it interesting that they also have 2.5-4X income ratios.

    It has been my assertion that two generations of mindless appreciation will come out in a rather abrupt fashion, as people realize that the religion of perpetual appreciation is really just a cult.

    As always, I enjoy your posts.

  124. 124
    Eleua says:

    @Jillayne #115,

    Yes, the entirety of the Wall Street saga over the past 13 months is Wall Street, The Banks, and the Treas Dept engaging in a massive conspiracy (yes, it is a conspiracy) to prevent full disclosure of their various assets. This is why the industrial sources of money have been shying away from rolling the comerical paper that banks need to operate.

    Enter the Federal Reserve…

    The FED has been injecting money into the banks so they can continue to operate. This game has a short life, as banks need to be able to lend to live. The banks are now borrowing to meet their operational expenses, not to cover spikes in lending demand.

    The other story is the massive REO that banks are taking and not throwing on the market. This is what will eventually break the backs of those that need home equity to survive. Once the banks realize they won’t get bailed out, their cash flow runs dry, and the FED gets tapped-out, they will have no option other than to throw a massive amount of inventory on the market at one time.

    At some point, the value will appear on the bank’s balance sheet, and it will likely kill off a good chunk of them. As of now, the banks are holding much of their assets in a “mark to myth” valuation, or what is called LEVEL 3 assets.

    I have a kilo of gold. The value of that is easily determined in the market and I mark it as such.

    I have a business. The value of that is determined by modelling my business, its assets, income, customer base, and goodwill. There is no absolute value, but a modeled value

    I have an antique Norwegian potato masher that I inherited from granny. I throw it on eBay, but don’t get any takers. I say it is worth $100K and mark it as such on my personal wealth statement.

    Banks are using that last valuation method more and more as we sink into the morass. Nobody wants their products, but they paid dearly for them. That’s the trouble.

    It is in each bank’s individual interest to sell their REO today, but it is in their collective interest to hold it.

    Prisoner’s Diliema

  125. 125

    I’m touched. You referenced the prisoner’s dilemma. I use this when I teach ethics classes.

    Here’s what’s troubling me tonight: FHA.

    I keep reading about the huge increase in loans FHA is taking on all across the country. 3% down, soon to be 3.5% downpayment and all of it can be in the form of a gift.

    Yes, old fashioned underwriting but still, most of these homebuyers are dangerously close to 100% LTV when values continue to fall.

    WTF are we going to do if FHA fails?

    When the conforming loan limit was raised and there was talk about pushing too much onto the GSEs, I pondered F&F failure thinking it would eventually happen at about 2012, thinking this was way into the future.

    Now you’ve got me thinking about the future of FHA.

  126. 126
    Eleua says:

    Jillayne,

    The .gov is just dealing with the gator that is closest to the boat, and there are a lot of gators. I don’t think there is any planning that goes beyond 6 months.

    Backing up and taking a big picture look at this tells you what you need to know.

    Prices are too high and we need home prices to continue to climb to keep people from defaulting. IOW, we need to continue to drive demand for houses by using stupid loans. We just got done with the private sector doing dumb loans, now we are going to have the public sector try it.

    I know what you are thinking and yes, they are THAT stupid.

    The problem is the only alternative is a massive contraction in home prices, and all of the fuss that brings.

    The entire world economy hinges on J6P making his mortgage payment on an asset that is overpriced by every historical metric.

  127. 127
    Eleua says:

    Why the FHA loans?

    Here is another metric that points to dramatically lower prices.

    DOWN PAYMENTS.

    I know what all of you are thinking. You are all thinking that people will use their equity to get the down payment, so they can drive home prices.

    If Bainbridge lost 15% in the last 12 months, that represents the bulk of the standard 20% down payment. Factor in another 7% in closing costs and you have wiped out the entire down payment. If we get another year like the last one (and I think we will with room to spare), then we have just put another few years of buyers underwater.

    This presumes that everyone was putting 20% of their own money down, which we know is not the case (although to be fair, Bainbridge has a higher than average massive buydown from California equity). The single biggest driver of defaults is the mortgage exceeding the sales price.

    That spells trouble. At the very least, it means that very few people are going to have ANY equity to transport.

    Anyone have stats on the nation-wide savings rate? Last I checked, we have had a negative savings rate since 2005. I’m guessing that in free cash, we have very, very little to show for it. After all, everyone was told to “buy as much house as you could afford.”

    So, with little to no savings, what do we use for a down payment? FHA? Good answer.

    What if the FHA can’t do any more? Thier bond sales are up over 100% in one year, so you know they are straining to meet the demand.

    With no X-Cal equity transportation, how much cash does your typical 40something have sloshing around his bank account? I’m guessing that it isn’t very much. Certainly, I doubt people with median incomes, or even 1.3X median incomes have enough free cash to put 20% down on the median Bainbridge house. They always needed the equity from their previous house, which we know is under serious attack.

    If free cash drops to $40K (and you would be dreaming to think they have that much), what does that buy you if that represents 20%.

    Hmmm…

  128. 128
    Eleua says:

    (Tim, I think something went haywire with this posting. It doesn’t show, but tells me that I have submitted it.)

    Why the FHA loans?

    Here is another metric that points to dramatically lower prices.

    DOWN PAYMENTS.

    I know what all of you are thinking. You are all thinking that people will use their equity to get the down payment, so they can drive home prices.

    If Bainbridge lost 15% in the last 12 months, that represents the bulk of the standard 20% down payment. Factor in another 7% in closing costs and you have wiped out the entire down payment. If we get another year like the last one (and I think we will with room to spare), then we have just put another few years of buyers underwater.

    This presumes that everyone was putting 20% of their own money down, which we know is not the case (although to be fair, Bainbridge has a higher than average massive buydown from California equity). The single biggest driver of defaults is the mortgage exceeding the sales price.

    That spells trouble. At the very least, it means that very few people are going to have ANY equity to transport.

    Anyone have stats on the nation-wide savings rate? Last I checked, we have had a negative savings rate since 2005. I’m guessing that in free cash, we have very, very little to show for it. After all, everyone was told to “buy as much house as you could afford.”

    So, with little to no savings, what do we use for a down payment? FHA? Good answer.

    What if the FHA can’t do any more? Thier bond sales are up over 100% in one year, so you know they are straining to meet the demand.

    With no X-Cal equity transportation, how much cash does your typical 40something have sloshing around his bank account? I’m guessing that it isn’t very much. Certainly, I doubt people with median incomes, or even 1.3X median incomes have enough free cash to put 20% down on the median Bainbridge house. They always needed the equity from their previous house, which we know is under serious attack.

    If free cash drops to $40K (and you would be dreaming to think they have that much), what does that buy you if that represents 20%.

    Hmmm…

  129. 129
    jonness says:

    “I keep reading about the huge increase in loans FHA is taking on all across the country. 3% down, soon to be 3.5% downpayment and all of it can be in the form of a gift.”

    Or better yet, you can offer full price and ask the seller to pay the downpayment. Yes, America truly is the land of opportunity! You need neither money or a brain to buy a new house–even at the height of the bubble collapse. But then again, maybe the people using FHA are actually geniuses. After all, they’ve figured out how to live in luxury while earning tiny salaries, spending their tails off on fancy toys, and forcing 100% of their lifestyle risks onto the guy earning the big bucks who is saving his arse off while living in a tiny shack.

  130. 130
    david losh says:

    This was a fruitful discussion for me.
    In the past few days it’s increasingly clear that most people refuse to see the economy we have today. I run numbers, Comparative Market Analysis on listings I have or had and the pricing stays about the same. People are still buying with a discount in much smaller numbers, but the Real Estate market keeps moving along. People need to buy and sell.
    I thought by now prices for housing would go down. Then again they can’t. All that mortgage money is out there. All those loans have been made based on valuations. There are home purchases, equity lines, refis, and debt consolidation.
    So if people begin selling thier homes for value there is a ripple effect. We don’t want to change our way of life. We don’t want property values to go down the same as we want our stock market to be stable.
    Now wait a minute. Lenders are in business to lend money. Loans are already in place. There is a value associated with those loans that may or may not be true, but they exsist. Churning dollars is what it’s all about. Whether a land lord is getting a 7% cap rate or a bank is getting a 7% interest rate makes no difference. It’s churning dollars. It’s something for nothing.
    There have been many times of hardship in the United States. The room mate solution is one thing. Seller financing is another. Taking over loans from the banks, we already see these Lease Option scams. Blind escrow accounts can spring up, LLCs can take over properties and Real Estate pricing is a function of time.
    I’m just saying that where the Real Estate industry is headed, or where it is today, there are deals that can be done without the bank, or Real Estate agents. There is risk, but feeding a system that I think we are all seeing is broken isn’t going to fix it.
    If you do buy by conventional methods then make offers. Low ball offers in today’s market would be extremely appropriate. The consumer is the only one who can change the market place.

  131. 131
    TJ_98370 says:

    mikal said:
    .
    Nobody wanted to do the math all day. I’m making a killing now on a deposit of $20,000. I’m ahead $24,000 a year on a twenty thousand dollar investment. They could be worth nothing, and I am still making $24.000 a year on them. Sorry I’m so late. I have a job.
    .
    Maybe it’s just me, but I have no idea what you are talking about. I’m glad your investments are working out for you.
    .

  132. 132
    mikal says:

    Markor has been making comments. Read the thread.

  133. 133
    98115renter says:

    I would just like to add to the rental discussion, and bring some people back to earth regarding rental prices.

    We rent a SFH in 98115, and our rent is 0.5% of the most recent purchase price, and 0.25% of the Zillow estimate.

    Reality check….

  134. 134
    Eleua says:

    98115,

    Thanks for the anecdote. If your situation is typical of what the 98115 Zip represents, then you rent would need to double to quadruple to meet the “1%” rule of thumb, which is similar to the example I used in my 98110 application. It would be interesting to see how your situation fits the other metrics I used.

    To me, rents need to come up in a declining economy, or prices need to come down in a declining economy.

    One is realistic and the other is delusional.

    Thanks for stopping by.

  135. 135
    98115renter says:

    I guess my main point is that you cannot get 1% in rent in today’s market. Who the heck is gonna pay $5k/month in rent for a 2 bed/ 1 bath house? Rents will not come up that much (especially with all the empty condos downtown).

    Just more proof that the market is overpriced and there is no incentive to buy.

  136. 136
    TJ_98370 says:

    mikal said:
    .
    Markor has been making comments. Read the thread.
    .
    I have been reading the thread. Did Markor do the math? I can’t find where he did the math.
    ..

  137. 137
    mikal says:

    I think he did, but didn’t want to comment because it involved real estate making money.

  138. 138
    TJ_98370 says:

    mikal –

    you said, “Markor, I already did the math. I would have to get more than $150, 000 more than they could have ever valued out and that is max….”
    ..
    Are saying that your mortgages are $150K more than the current market value of your rentals? If so, so what? If you’re in it for the long term, you’ll come out ahead eventually, especially if you are netting $1950 a month right now.
    .

  139. 139
    mikal says:

    No, my mortgages are at least $500,000 less than their peak value. But then I had the guts to buy three houses. I sure as $hit wouldn’t buy anything now.

  140. 140
    TJ_98370 says:

    mikal –
    .
    ……. I sure as $hit wouldn’t buy anything now.
    .
    Which is a major point of posts made by The Tim, Eleua, etc.
    .
    For what it’s worth, getting near a 120% annual return on your investment in your rental properties is beyond fantastic. That will never happen to me in this lifetime. I know people who would give their left appendage (you pick which) to get anything close to that.
    .
    Despite the fact that a lot of very intelligent people are making all sorts of predictions about future trends in the real estate market, the truth is there are too many variables to make a prediction with any kind of precision, especially long term. I wish you the best of luck with your other three home purchases.

  141. 141
    TJ_98370 says:

    mikal –
    .
    ……. I sure as $hit wouldn’t buy anything now.
    .
    Which is a major point of posts made by The Tim, Eleua, etc.
    .
    For what it’s worth, getting near a 120% annual return on your investment in your rental properties is beyond fantastic. That will never happen to me in this lifetime. I know people who would give their left appendage (you pick which) to get anything close to that.
    .
    Despite the fact that a lot of very intelligent people are making all sorts of predictions about future trends in the real estate market, the truth is there are too many variables to make a prediction with any kind of precision, especially long term. I wish you the best of luck with your other three home purchases.
    .

  142. 142
    johnnybigspenda says:

    so this is the BIG one huh? would you go so far as to say: “its different this time?”

  143. 143
    johnnybigspenda says:

    everyone: step away from your computer monitors… look around… we are still making airplanes, growing apples, writing code, drinking coffee ect ect.

    it may take a number of years, but in the mean time, we will find alternative bubbles to invest in and life will go on (with a the same quality of life as you are currently used to)…

    obviously, we’ve learned a lesson here: don’t go ‘all in’ on ONE investment going forward. If that means you have to wait for prices to continue falling in housing before you buy in, just wait then… in the mean time, look at the big picture and decide for yourself what has sunk as the tide as gone out…. the tide will come back in, and many boats are ready to rise quickly.

  144. 144
    Harley Lever says:

    Eleau,

    Could you pick a more pathetic scenario for an example?

    Buying a house on Bainbridge Island and renting it out… yeah because we all would do that!

    Nobody here is saying “Be a complete moron and put 100k down on a house 650k that you can rent for $2200/month on Bainbridge Island”. For the record, I completely agree with Eleau in this absurd scenario.

    You may have missed an opportunity to make your already absurd scenario twice as pathetic. Let us not forget the jumbo loan premium, a credit score of 450, and the fact that you have not put 25%+ down. In addition you should highlight the fact that putting 15% could have yield almost 1 million dollars at 8% over 30 years.

    May I recommend that you change your name to the “Institute of Pathetic Scenarios”.

  145. 145
    mikal says:

    TJ, I didn’t buy three more. Harley, you are correct again. Eleu, you better get back to building that apocalypse bunker.

  146. 146
    Eleua says:

    Harley,

    I never suggested that buying out a Bainbridge house to rent is common or prudent. I was showing what the speculative premium is and how the market is vulnerabe if people decide that they don’t need to speculate in housing. In other areas of the country where breathtaking real estate speculation is not the norm, rental values and market values are much closer to parity.

    Your suggestions of a name change for my think-tank are duly noted. May I suggest a critical reading course at the local community college? A survey of economic history may also be in order.

  147. 147
    mark says:

    Eleua’s analysis is music to the ears of people reading housing bubble blogs. There aren’t very many of those people, even now after a year of housing pain. For the majority out there, it doesn’t make sense to think of a house as a rental with a business plan.

    Most people are buying houses because they think it will appreciate in value. Period. The only analysis that they might understand is this. Take a 6.5% mortgage. Reduce it by the tax deduction — get 4.6%. Add in taxes, maintenance, etc — get 5%. If your appreciation is greater than 5% annually you make money. If not, you lose. It’s as simple as that.

    Even the educated people I talk to are becoming panic buyers because realtors are telling them they have to hurry up before interest rates rise. It’s pure speculation, and in speculation values and ROI aren’t particularly relevant.

    PS — I love the following comment from 126:

    Prices are too high and we need home prices to continue to climb to keep people from defaulting. IOW, we need to continue to drive demand for houses by using stupid loans. We just got done with the private sector doing dumb loans, now we are going to have the public sector try it.

    I know what you are thinking and yes, they are THAT stupid.

    The problem is the only alternative is a massive contraction in home prices, and all of the fuss that brings.

    The entire world economy hinges on J6P making his mortgage payment on an asset that is overpriced by every historical metric.

  148. 148
    Garth says:

    With the 1% rule of thumb my house should turn a profit from being rented of about $25,000 a year or break even by being rented only 6-7 months of the year. I would take it if it was available, but I don’t think it is a very instructive “rule of thumb” unless you are in an area that is predicted to have population and job contraction.

    .5% Would pay my entire mortgage and annual property taxes in 98115 (25% down, 30 yr fixed)

  149. 149
    Eleua says:

    Mark,

    You are correct when you say that people are buying homes to take advantage of the perceived lock on price appreciation. Like any other field of human behavior, condition-response is very powerful.

    I poured a few hours into a mathmatical analysis of how much premium people would be williing to pay if they knew that home prices would appreciate 3%, 5%, 8%, 10%, and 15% per year over a 3 to 10 year period. I took these values and discounted them against prevailing 10Y treasury rates and held the rent constant.

    It showed that the greater the expectation of appreciation, the more money people would put toward capturing that appreciation. At some point, the appreciation could not be discounted, because the return differential became infinite. Only boundary values associated with income and down payment limitations came into play.

    Duh.

    Stepping back, it is obvious that the more money you can make by appreciation, the more money you want to throw at the endeavor. The inverse is also true – the more your capital will be destroyed, the less you would throw into that briar patch. It is the second premise that will drive home prices to my “20 cents on the dollar” target.

    For anyone to suggest that the more speculative areas of the country are “special” because of land management, mountains, and water, and not the expectation of speculative return, is ignorant, IMAO. Incomes drive prices, and they support prices. Speculation will drive it violently in either direction (as we have recently seen with the housing bubble).

    Why aren’t Port Angeles, Quilcene, and Forks “special?” They have more mountains and water than Seattle does. PA is much more beautiful than Seattle. Why is San Diego dropping? It is the most “special” place in the entire US.

  150. 150
    mikal says:

    Eleu, What point are you trying to make. Port Angeles, Forks and Quilecne don’t have jobs.

  151. 151
    TJ_98370 says:

    mikal –
    .
    What about Sequim. Sequim has few middel / high-income employment opportunities, yet it experienced big time appreciation. I know this first hand because I watched a co-worker try to ride the speculative wave.
    .
    Sequim was supposed to be a retirement mecca for the rather well-to-do boomers and was pushed as such. Thusly, the speculative premium kicked in for all those investors expecting appreciation.
    .
    My co-worker got in a little late, sold the house that he had built last winter at around 15% less than local comps (nothing was selling) and just broke even with his venture.
    .

  152. 152
    mark says:

    Eleu — Agreed!

    My friend pointed out that his home appreciated 100% since 1999. Let’s use round numbers. From 100% in 10 years, we subtract 6% annually for interest (net of tax deductions), taxes, insurance, etc. The resulting gain in equity is about 30%. If you do the math — 30 percent gain in 10 years comes from 2.6% annually.

    So the folks who bought on spec — i.e. the hope of appreciation — made an average return of 2.6% annually. That’s roughly a bank CD or money market. And that’s during the best-case period of appreciation.

    Most of the people I talk to just see the 100% gain, and don’t realize the risk it took or the comparable investment gain. If we were to take the amount they would have saved by renting an equivalent house and investing the difference, it certainly would have come out ahead for the renter.

    Conclusion — it’s very hard to make money when you’re paying 6% a year just to maintain status quo.

  153. 153
    mikal says:

    Except Mark, my first house went from $95,000 to $650,000 in the last ten years. Do the math for me. I have no intention of selling, so I do expect that number to drop. You guys can keep whining all you want. Now isn’t the time to buy , but there are times that are good to. Some of you sound so bitter and unhappy.

  154. 154
    Harley Lever says:

    Eleua,

    I have just enrolled in the critical reading class. The good news is they have a class on “concise communications”. Nice dissertation.

    Please forgive me, but I am not sure why you had to pour over information to come up with this gem of knowledge “It showed that the greater the expectation of appreciation, the more money people would put toward capturing that appreciation.”.

    Your statements about “putting more money toward capturing that appreciation” does not really fly with the previous credit market. I think you are forgetting that many, prior to last year, did not have to put much money down and had the ability to save their cash in which they could earn interest. This is combined with lower interest rates and lower closing costs. For those who bought a house they can afford with a 30-year fixed rate it was the best margin call ever in that you could put little to nothing down and your contract expires when you decide to sell. Simultaneously, they could preserve capital for other investments.

    The problem we are seeing with foreclosures is arguable driven by the fact that many put nothing down and therefore had nothing to lose. Some had an “All in” mentality and over leveraged themselves foolishly. However the majority made intelligent decisions, and most did not buy at “the top”. Loss or profit is only realized when and if the house is sold. Your capital destruction scenario is alarmist rhetoric. At the end of the day people still need some place to sleep and the world is still procreating faster than deaths.

    Posts like “Foreclosures Up 50%” is alarmist at best. Look behind the numbers and you will see that it is 1 house in 1049. The world economies collapsing because .01% of the people default is absurdly speculative. If home prices drop to 20 cents on the dollar as you predict, many here will not have the jobs or down payments to acquire a house. Incomes have risen in King County consistently since 1990 and they are rising throughout the world. What history are you referencing?

    What is the ROI for renting?

  155. 155
    Harley Lever says:

    Mark,

    What everyone here seems to forget is at the end of the day we all need a place to sleep whether we rent it or own it. You have absolutely no ROI on a rental.

    A home offers you both a place to sleep and for many a ROI.

    Crunch some numbers and tell me what your ROI is on renting.

  156. 156
    b says:

    Harley –

    Tell me what my ROI is when my rental declines in value. It goes both ways, and right now the trend is not in favor is buying.

  157. 157
    TJ_98370 says:

    .
    Every House’s Value is Dropping, Except Mine!
    .

    Harley, with reference to Eleua’s comment : “…It showed that the greater the expectation of appreciation, the more money people would put toward capturing that appreciation….”
    .
    How about – The lower the perceived risk, the greater amount people are willing to “gamble”. Does that work better?
    .
    The linked article above indicates that for many people there is still a disconnect between expectation of appreciation and reality.
    .

  158. 158
    EconE says:

    Crunch some numbers and tell me what your ROI is on renting.

    500k condo (purchase price of my LL) + almost 500 for homeowners dues.

    I’m not including property taxes as the “tax write-off” makes it a wash.

    less than $1700 to rent.

    My ROI is the difference between what my LL has to pay and what I have to pay.

    That difference is currently earning interest (albeit not much right now).

  159. 159
    Alan says:

    I am getting around a steady 22% ROI in the stock market based on my original investments. The thing you don’t understand is that the companies I invest in pay me the capital that I am earning 8% on.

  160. 160
    Harley Lever says:

    b,

    There is no loss or profit until the time of sale. You are simply talking theoretical loss. Renting will never have a return on investment… ever.

  161. 161
    Harley Lever says:

    Econ E,

    Believe it or not, the majority of land lords are not in a negative cash flow situation. Your land lord is not everyone and the majority of people did not purchase at an all time high.

  162. 162
    mikal says:

    No Harley, but tghey quote that to make themselves feel better. I think renting at some price point makes sense. Anyone that is spending more than $1500 renting anything is a FOOL.

  163. 163
    Harley Lever says:

    Alan,

    You make a great point that I have been repeating here, but everyone does not want to face. The previous credit market afforded us the ability to preserve capital by not having to make huge down payments.

    The Tim and the rest of the Bubbleheads scared people on this blog saying don’t buy the price is too high and down payments, interest rates, and closing costs don’t matter.

    Today down payments have to be 25% to avoid a hit on on the already higher interest rate and in October that may go up to 40%.

    Take your 100k at as you state at 22% (quite astronomical) and compound that over 30 years and you get $38,975,789.42. Even at an 8% return you would receive $1,006,265.69. With today’s credit market all of this money is gone and for many Interest rates are 2% higher than they would have been if they got in 2 years ago and will likely climb. In 30 years there is an enormous likelihood that your home will be worth more than you paid for it.

  164. 164
    Harley Lever says:

    Mikal,

    I agree completely. I see rentals all the time that go for $2200 – $3000. It blows my mind.

    It is the same demographic that has the tricked out Escalades and must wear the finest of clothing. EconE, weren’t you the one bragging about driving your Mercedes???? It might have been someone else.

  165. 165
    mikal says:

    I think if we lost 80% equity as Eleau and Sniglet foolishly think as there is no basis to it historically, you would still make money over 30 years. The only losses I forsee are if you go back to the 2000 value and use a normal historical appreciation. That certainly gets you no where near %80 loss. I think someone here said worst case it is 30%. That still also doesn’t take into consideration land use laws which haven’t been on the books long enough to give a clear view. If values do drop below that 30% value it si because the market over corrected. Nice run on in the first sentence. I’m dead sober. I write better after a few.

  166. 166
    EconE says:

    No Harley….wasn’t me. I don’t judge people for the cars they drive. I don’t drive a Mercedes and I’m a t-shirt and jeans type of guy.

    For the record, I have never predicted 80% losses and I’m not building a bunker.

  167. 167
    Eleua says:

    @Harley #155,

    Let’s put it in perspective.

    I save a HUGE amount by renting compared to what I would experience paying PITI and being responsible for the capital value of the home.

    Last year, my house Zillowed for $650K-ish.

    This year, it Zillows for just under $500K.

    My rent is appx $2100 less than the PITI (not including the second), which includes the most generous tax benefit. That number also includes the opportunity cost of the down payment, but not the cash flow benefit of the monthly payment.

    2100 * 12 = $25200 tax free benefit to me

    $150K loss I didn’t take.

    By renting, I’m up around $175K over what I would be if I had purchased the house last summer. Uncle Sugar doesn’t force me to declare that as income on my 1040.

  168. 168
    Eleua says:

    Before Mikal jumps up my butt to the third bend…

    The $25K cash flow benefit is actual money that I have over what I would have if I had purchased last summer.

    The $150K capital loss that I dodged is a paper benefit.

  169. 169
    whats my name says:

    Eleua,

    I am so sorry to have missed your hour in the sun. I am truly a fan of your writing style: the smooth exposition, the clear linkages, the liberal sprinkling of bon motts. It is such a pleasure to read you that I nearly miss the assumptions: 150-200% price increases over the last 10 years?, the 5% CD’s, the blithely presumed 0% price increases for the next 10 years. I paused briefly at your $650M rental house. Surely Eleua knows that median BI house is not a standard or long term rental. Surely we can scoff at the Martha’s Vinyard comparisons without believing BI is akin to White Center. But you lost me with your incredulity that after 10 years we would need to see that house sell at roughly $1MM for a beakeven. Breathtaking if your expected (though unprecented) increase is 0%, but at 65% overall it represents an annual appreciation of just over 5%. Inflation, my brother, and the miracle of compounding. When I had my first analyst job, some 20+ years ago, we used to joke that analysis was the process of breaking down one big error into many little errors. I always liked that joke. Thanks for the reminder.

  170. 170
    Eleua says:

    Mikal,

    Before you get too confident about property price action not showing precedent for a massive 2/3 – 3/4, with -80% off in many examples, you might want to review what happened in the last depression we had.

  171. 171
    Eleua says:

    Whatsmyname,

    I’m glad I gave you reason to live. It’s just another benefit I provide.

  172. 172
    Eleua says:

    BTW, does anyone have the over/under on when the local NAR is going to blame bad weather for poor sales this summer? Normally, late August is an absolutely bankable time to conduct open houses and sell real estate.

  173. 173
    whats my name says:

    I already have reason to live. You just bring me pleasure. Making these kind of distinctions is what I am encouraging you to do.

  174. 174
    Harley Lever says:

    Eleua,

    Perhaps the best way to start the post is say “Let’s pretend”.

    I am glad you can use your imaginary $175k to make you feel better, but at the end of the day you are still pretending. Throwing away 25k year sounds great. I am sure you have a big rented house, with some big rented views, and enjoy the big rented space. However at the end of the 30 years you will have nothing to show for this. There is no greater depreciating asset than paying rent.

    Your examples are exactly what Enron was doing when they tabulated their revenues and profits. No one has lost anything because nothing is sold. You can tell people all day long about how you made 175k, but in the end you are just pretending. Your reality is that you are paying 2/3 of landlords mortgage.

    Let’s pretend that you rent it for 30 years. In the end, you will have footed the bill for 2/3 or your landlords mortgage and he will own the property outright. This is assuming that your rent will never go up. What will you have?

  175. 175
    b says:

    Harley –

    He will have lived there for 30 years risk and maintenance free. Apparently you believe this is worth nothing, whereas I think pretty much everyone else in the world would disagree with that assertion.

  176. 176
    Harley Lever says:

    b

    Can you show me any stretch of 30 years where the house was not worth substantially more than it was 30 years prior? I can’t wait to see that!

    Yes and in the end he will have spent at least $1,285,748.52 being “risk free” and have nothing to show for it.

  177. 177
    Eleua says:

    I’m just guessing here, but I wonder how Detroit did over the past 30 years?

    How did Florida do from 1924-1954?

    What was the result of the Depression on NYC real estate?

    Detroit and Pittsburgh were once the wealthiest cities in the US with the highest home prices. However, I am reminded that Microsoft is forever and Seattle is special.

  178. 178
    Harley Lever says:

    Eleau,

    http://www.census.gov/hhes/www/housing/census/historic/values.html

    Michigan went from 39,000 to 136,000.. that one didn’t work for you… sorry.

    Florida went from 2,200 – 6,612 from 1940 – 1950 I cannot find any previous data. I can see you are trying to set me up with the statistical outlier. Good one!

    I would say if you look a the historic trends cited above that in general you do not have a leg to stand on.

  179. 179
    Eleua says:

    Harley,

    Like I said, “I’m just guessing here.”

    Thanks for clearing that up. I’m going out tomorrow morning and buying 4 Bainbridge houses.

  180. 180
    Eleua says:

    BTW, I said Detroit, not Michigan. Those homes that are selling for 4 digits probably were higher than that back in the day.

  181. 181
    TJ_98370 says:

    whats my name –
    .
    Your post #169 implies that you are some kind of financial analyst. I detect a bit of professional jealousy / resentment?
    .
    You challenge Eleua’s assumption of 150 – 200% price increases over the last ten years. It is a provable fact that the county assessed value of the house I live in increased by 149% since the year 2000, and I live in Hicksville, Central Kitsap. The house that I live in is not unique in any manner. As far as having CD’s with 5% annual return, up to six months ago they weren’t really that hard to find. In fact I have a CD paying 5.125% right now. If you are unaware of these two easily rersearchable details, I suggest that you consider the possibility that your credibility as being suspect!
    .
    If you really do have a background in professional financial analysis, as you imply, I can guarantee that many would be hanging onto your every word if you had the courage to do an analysis like what Eleua did. I challenge you to put something other than criticism on this blog!
    .

  182. 182
    Harley Lever says:

    Eleau,

    It looks like Detroit is staging a turnaround: http://www.detnews.com/apps/pbcs.dll/article?AID=/20080814/BIZ/808140356&imw=Y

    I am still looking for Detroit numbers. However, I think my point is clear and for the most part proven. Over a 30 year time span the vast majority of houses have increased in prices and in many cases fairly substantially.

  183. 183
    Alan says:

    Harley,

    You should read my post again and understand what it is saying.

  184. 184
    Eleua says:

    Harley,

    My point is three-fold:

    A city can lose its hegemony over an industry (Detroit)

    A speculative bubble may burst (Florida)

    A depression may reduce prices (NYC).

    Yes, it is likely that your house will have a larger price tag in 30 years, but it is still an illiquid asset and it very well may not beat other, mainstream cash investments over the same period.

    The fact that Detroit is not absolutely lower than it was in 1978 is irrelevant. If you had taken the same money in 1978 and gone to cash investments, you would likely be well ahead of your house in gangland.

    My grandparents bought their homes in nice neighborhoods over 30 years ago. Today, their homes are surrounded by urban blight.

  185. 185
    Harley Lever says:

    Eleua,

    I agree with many things that you say, but you cite isolated incidents. Even now, I would venture to guess that your grandparents property is still worth a lot more.

    There are better investments. My point is I am allocating housing dollars towards a choice that has historically had a ROI. You are allocating your housing dollars to something that has absolutely no ROI.

    I have leveraged little and am positioned extremely well against future housing costs. You will be forced by today’s credit market to leverage much more and are positioned to see increased rental costs through the next 30 years.

    Historically, rents will quadruple over a 30 year period. http://www.census.gov/hhes/www/housing/census/historic/grossrents.html

  186. 186
    Eleua says:

    My grandparents’ homes are worth more in dollars that are not. Granted, at the time of their purchase, the rents were likely much closer to parity, so there was not the extra bucks to invest in other instruments. That is not the case today.

    One of the fundamentals of any economic analysis is the “opportunity cost,” as that is the true price of what you are buying. You judge the price of something by what you have to give up to get it. In the case of buying today with the enormous speculative premium, you are giving up the ability to churn those dollars in another vehicle, and deciding that, while we are close to a historic top, that those dollars will continue to outperform other investments.

    You will be forced by today’s credit market to leverage much more and are positioned to see increased rental costs through the next 30 years.

    I disagree on both of these points, as I have outlined in my original posting and the follow-up comments. I believe that over the next decade that wages will fall in the USA, as well as most of the world. With that, like anything else, the ability of people to afford rising rents will diminish. We have seen an epic expansion in supply of housing units over the past decade, which will be realized when the banks are forced to send their massive REO to market, and builders capitulate and release their stock.

    I am also of the opinion (as if it wasn’t obvious over the past 170+ comments) that the speculative premium that exists today will vanish. This will reduce my leverage for housing. Rising interest rates will further push down prices. These rising interest rates will also cause my cash investments to pay more, while people whom “invest” in housing will have thier investment diminish. Remember, housing is leveraged and the first loss comes out of your pocket.

    The three examples that illustrated potential problems that I listed in #184 have the very real likelihood of hitting Seattle all at once. We may lose our hegemony over software and bitter water, have our speculative bubble pop, and hit an economic depression all at once.

    I wish you well with your investment.

  187. 187
    Eleua says:

    @Harley #174,

    You can tell people all day long about how you made 175k, but in the end you are just pretending. Your reality is that you are paying 2/3 of landlords mortgage.

    Let’s pretend that you rent it for 30 years. In the end, you will have footed the bill for 2/3 or your landlords mortgage and he will own the property outright. This is assuming that your rent will never go up. What will you have?

    OK, let’s pretend.

    The scenario is as follows:

    One guy rents a house for $2100/mo and another decides to buy a house and rent it out for $2100. The purchase price is $650k, with a 30Y fixed mortgage at 6.5%. Taxes are 1% (low) and maintenance is $500/mo over the life of the house. At these prices, this is not a new house, but an early 1990 era house, and he is going to hold it for 30 more years. $500/mo is a gift. Insurance is $75/mo and we will give the owner a 25% tax advantage over the lowly renter. The house is vacant for 10% of the time and a 10% management fee is in place.

    The renter invests the excess money he saves over PITI at 5% and will draw it at the end of the 30 years. He pays tax annually on his gains.

    At the 30 year mark, the two gentlemen agree to meet for lunch. The renter goes to the bank and draws his CD and pullsout $1,493,000 after taxes have been paid. His rent over the past 30 years totalled $756K. From his perspective, after taxes, he was paid $737K, tax free to rent.

    The landlord sold his house on the same day he paid off the note for the original price he paid for it. He goes to the closing and collects his $650K, and pays Cookie and Candi, and all the associated fee and walks with a check for $605K. Over the same 30 years, he paid $1,586,000 in principal, interest, taxes, insurance, and maintenance. He received $612K in rent, after correcting for management and vacancy.

    The loser-renter is sitting at the table with a briefcase full of cash – $737,000 to use round figures.

    The member of the landed class has a check for $604,500, but has a $974K hole in his checking account that was obtaining that $604.5K. He is $370K in the hole, and behind our renter by $1.1M.

    For our brilliant land investor to reach parity with our cave-dwelling renter, he would have needed to sell his house for $2.22M.

    I’m sure you are incredulous at this, but consider that the house was not owner-occupied, so it does not get the cap-gain exemption. He would need to pay taxes on the difference in home prices over the original payment, plus fees and closing costs.

    BTW, all of this has taken place against a stable dollar. If you want the inflation, then you have to accept that the dollars you receive in 30 years would be diminished by that amount. If so, it would only be fair to allow the renter a chance to move his investments to capture this inflation. The dollar may deflate, inflate, or stay the same. The same goes for housing prices.

    It’s a fool’s game to think that getting paid more dollars that are worth less is a good investment. This is assming what we know, rather than speculating on what might be. It cuts both ways.

    Also, this example assumes our landlord lived in his mother’s basement for 30 years. In reality, he would be paying rent or buying his own place, which, as you can see, would only compond his problems.

    Thanks for pretending. I am of the opinion that the renter was more than happy to pay his landlord’s rent.

    …and as a point of clarification, it would be more accurate to say that I didn’t make the $175K over the past year, but saved $175K. Savings are counted tax-free.

  188. 188
    mikal says:

    Eleu, I’m not interested jumping anyone’s butt, PERIOD. I could talk about what the civil war did to anyone’s house value, but it doesn’t matter. If you know what is coming become a day trader. Until then you are a wish for the Road Warrior life nut. Your statistics and point of basis don’t bear anything to reality. Jillayne seemed on it until she bought in to some of your points.

  189. 189
    mikal says:

    Make a point based on my investment and how I will lose everything and lets talk. What shocks me is Tim makes sense most times even if I don’t agree with it and he lets you drag it down with this APOCALYPSE $hit. Sorry about the typing, just had football draft and have been drinking for hours. I still type better STEWED.

  190. 190
    mikal says:

    Harley. that LETs pretend comment was historical. Thanks.

  191. 191
    Eleua says:

    The dog that yelps is the one that got hit by the stone.

  192. 192
    mikal says:

    Meant hysterical. I’ve had about twenty beers and that is a conservative estimate. But I had a good draft.

  193. 193
    Harley Lever says:

    Eleau,

    I only read the first paragraph and I stopped. I would never buy a 650k house that I could only rent for $2,100. This is just more pretend scenarios. Yes, it is stupid to buy a house in your unrealistic worst case scenario. Your Enron rental earning schemes are just that, heady theoreticals that are truly baseless and laughable. At the end of 30 years you cannot cash your imaginary check.

  194. 194
    mikal says:

    Eleaus has the most comments here so he is right about something. sticks and stones.

  195. 195
    Eleua says:

    Harley,

    My sceario is real world. There is a house, owned by a friend, that has these numbers. A $650K Bainbridge house rents for $2100ish. If the numbers say for him to sell the house, as it does not justify the rent (MY ENTIRE POINT OF THIS BLOG POSTING), and he chooses to keep it, he is selling it to himself.

    Make up your mind. Are you going to agree with my basic premise (speculative premium is very large at this time), or not (homes are fundamentally sound on valuations)?

  196. 196
    Eleua says:

    My loser renter is sitting at the table with $1.493,000, which is $737K more than he started with.

    Just to be clear.

  197. 197
    mikal says:

    I agree that you know some morons. That doesn’t make it typical. I’m making $2000 a month on my real estate. My valuations seem to work better. I guess even if the Great Depression II happens, I will still be paying my own mortgage from my rentals. Do you have any examples from people that aren’t very bright. Perhaps without the MAD MAX car.

  198. 198
    Eleua says:

    Mikal,

    If it is typical for a $650K house on Bainbridge to rent for $2100, then that is the market price. This is not an isolated example, nor is it the worst. I chose it because it was very typical of what the rental market looks like.

    That knocking on your door is reality. You are late for your appointment.

  199. 199
    mikal says:

    Reality isn’t a picture from Quit Riot. But then again, I’m the one living for free.

  200. 200
    mikal says:

    I have been living for free for two years. Why don’t you do the math and tell me how bad the economy would have to get for you to even break even with me.

  201. 201
    b says:

    Mikal –

    YOU BOUGHT 10 YEARS AGO. When there wasn’t a bubble! Your rentals should not even enter into conversations about real estate valuations and purchases TODAY. What Eleua says is not a strange scenario, any who has rented in the last couple of years can tell you that. I believe the entire point of this blog and everything discussed here is that around 2003/2004 things accelerated into a BUBBLE. If you bought before then, great! You do not factor into the discussion or comparison.

  202. 202
    mikal says:

    Every body factors into this. THE GREAT DEPRESSION IS COMING. He doesn’t need your help. I thought real estate was a bad investment. Is it a good investment b ?

  203. 203
    Eleua says:

    The only significant piece of information that we need is the current market value of Mikal’s wonder-properties. If he isn’t selling them, then he is the defacto highest bidder, and the CURRENT analysis of the property might give him a sell indicator. He may have bought a great deal 10 years ago, and that is a good thing, but the value of the property 10 years from now has the very high likelihood of being lower, when compared to TODAY. This is the point I am trying to make.

    I’m not comparing the valuations of homes 10 years ago to what they rent for today. I am asking if TODAY’s prices are justified by TODAY’s rents.

  204. 204
    Eleua says:

    Mikal,

    People that were holding JNPR stock in 2002 were feeling pretty smug about the stock price, compared to what it was 18 months earlier. 18 months after that, they were not feeling so smug (98% loss).

  205. 205
    mikal says:

    If reality knocked on your door, your power would probably get turned off. CUM ON FEEL THE NOISE.

  206. 206
    mikal says:

    Is it just me, or are you the kinda of guy that would buy into the comet cult? Bring something with some level of reality.

  207. 207
    Eleua says:

    Mikal,

    I think you have had too much. Let’s continue this when you have less ethanol sloshing aroung your head.

  208. 208
    mikal says:

    I make more from the rents on a per basis than if I would sell them. That doesn’t make me the highest bidder. I only lose if rents go down a bunch. If I were charging max rents I might be in for it, but I’m not nor have ever. It is easier to find a good renter and charge a little less. I have other business interests.

  209. 209
    mikal says:

    Eleau, this will be the closest you will ever get me, BRING IT. YOU HAVEN”T YET.

  210. 210
    b says:

    Mikal –

    It certainly can be a good investment. It isn’t right now, nor has it been the last 3-4 years.

    Your arguments are really quite silly when you drone on and on about your rental properties. Here let me sum them up for you in an analogy:

    I bought MSFT in 1994. Therefore, there was never a tech stock bubble.

  211. 211
    mikal says:

    If you ask the right questions here you can hear the crickets chirping. Good thing Peter King’s column on SI is out early.

  212. 212
    mikal says:

    B. the whole point of this site is that it isn’t. Is the droning any different than what this topic is trying to justify?

  213. 213
    mikal says:

    More crickets. Good night.

  214. 214
    What goes up must come down says:

    mikal, you need some serious help — you have way too much anger.

  215. 215
    mikal says:

    Me, I am joking about all this. You are taking me as angry? You guys put all this negative stuff and have me and Harvey counter it and you can’t handle it.

  216. 216
    TJ_98370 says:

    mikal is funny.

  217. 217
    Eleua says:

    You guys put all this negative stuff and have me and Harvey counter it and you can’t handle it.

    Delusional. Your objections were thoroughly dismissed.

  218. 218
    mikal says:

    With that picture and comments who is delusional. You do write eloquently. But your points are nuts.

  219. 219
    los says:

    mikal, your comments might have more revelance if you responded to the actual points that Eleua made, rather than some strawman Eleua that you have set up. As others have repeated pointed out, you are continually responding to arguments he never made.

  220. 220
    Everett_Tom says:

    I though we all were in agreement here, as mikal put it @68

    Anyone who buys anything now is out of their mind.

    .
    Wasn’t the point of this post?

  221. 221
    Eleua says:

    @Everett #220,

    Yes, it is. Even the lumpenhomeowners agree with the premise, but they reflexively disagree for unknown reasons.

  222. 222
    WestSideBilly says:

    A few thoughts:

    – Mikal’s example is irrelevant. We can’t buy houses 10 years ago, only now or in the future. It’d be nice if we could all buy houses at 1998 prices, eh?
    – Eleua’s Bainbridge example may be a bit off, but it’s not as uncommon as a few people seem to think. $2100 rent puts you in a $500-600k (early 2008 price) SFH or condo. It takes a lot of years (7-10) of steady rent hikes plus appreciation before buying pays off (becomes cash flow positive if it’s a rental). If declining/stagnant house prices are a reasonable assumption for another 1-2 years, 7-10 becomes 10-15. If owning the property for at least that long is not a reasonable expectation (and it probably isn’t for a lot of people), you never come out ahead.
    – Renting absolutely has an ROI, and right now it’s positive. 10 years ago, not as much. Whether you want to call it opportunity cost or simply compare it to investing the cost difference between buying and renting, either way renting is very favorable (economics) right now.
    – I looked at investing in two cheap places (one in WI, the other in IN) where nice homes start at < $100k (recently built 3&2 on 0.25 acre lot) and renting is better there, too. Or, more to the point, it takes a lot of years of eating huge losses before buying rentals in 2008 starts making money. Seattle isn’t special, the numbers are just bigger.

  223. 223
    Rob says:

    I didn’t see any nod to the income tax reductions granted to homeowners. Without a primary residence, most folks are stuck with the standard deduction.

  224. 224
    Eleua says:

    Rob,

    I put a 25% tax advantage for the homeowner in the comparison. In reality, unless the home owner has a large income, the standard deduction captures most of the itemized deduction.

  225. 225
    johnnybigspenda says:

    I would just like to say “thanks” to all for such a solid discussion on this topic. Its one of the best threads I’ve ever read on seattlebubble.

    A few factors that I think are relevant, yet not as certain as a purely numerical cash flow analysis:
    -gentrification: many neighborhoods have been upgraded from ‘working class’ homes to ‘trendy neighborhoods’… so comparing prices today vs. 10 years ago (in Ballard or alike) is not a 1:1
    -demographics: retired boomers’ hold the wealth in our country… that does not mean that they have $200K incomes… (although many used to). Based on this, you will likely see many ‘cash’ purchases of condo’s ect as they downsize… the ratio’s of income to house price are not as relevant… we should be looking at income/mortgage valuations going forward to see if homes are ‘affordable’.
    -inflation: if you have a 30yr fixed mortgage and we get into double digit inflation, that same mortgage will be easier to carry going forward. (yes, the downside to this is that the proceeds from the sale of your home will also be worth less in future $). Eleua is predicting DEflation… quite a different outcome.
    -pent up demand: I agree that there is some % of first time home buyers that bought before they were ready (due to the financing availability)… over the past year, there are many new first time home buyers that are itching to get into the game… if/when loans become available (loans right now are BEYOND historical requirements and are tougher to get than they ought to be…. lucky for those first timers who would have been sucked in to buying a house if they could have gotten the loan)… we should see the months of supply quickly reduce as the rate of sales goes up. The banks / govn’t WILL find a way to make reasonable loans in the near term. If they can’t, we may get 1/2 way to Eleua’s predictions.
    -future expectations: the buyers in the market have LOW expectations for the near future 1-5 years… this is driving home prices lower even if a sell price is at a ‘fair value’ based on today’s comparables. If future expections shift to something even a little more positive than ‘a sure loss of 10-20%’, you will see buyers come back quickly… even ‘flat’ would attract buyers…
    -there are many people on the bubble so to speak as far as it making sense to sell now and come back when the market has bottomed… but for many, if you combine their expectation of 1-2 years of downturn, the transaction costs alone mean that they will be at about breakeven for selling and then renting….so likely they won’t sell. If they were right, and it gets better, they are ahead… otherwise they become the 2005/2006 buyers from a cushion perspective.

  226. 226
    mikal says:

    Eleu, how much are you paying to rent that $650,000 house?

  227. 227
    What goes up must come down says:

    “The banks / govn’t WILL find a way to make reasonable loans in the near term. If they can’t, we may get 1/2 way to Eleua’s predictions.”

    If the govt/banks do boy will things be worse ten years from now. Eventually, you have to pay the piper or your kids will — anyone for a couple more trillion on the national debt.

  228. 228
    Eleua says:

    -gentrification: many neighborhoods have been upgraded from ‘working class’ homes to ‘trendy neighborhoods’… so comparing prices today vs. 10 years ago (in Ballard or alike) is not a 1:1

    That works both ways. Some neighborhoods were once nice neighborhoods, and now are referred to as ‘da hood.

    -demographics: retired boomers’ hold the wealth in our country… that does not mean that they have $200K incomes… (although many used to). Based on this, you will likely see many ‘cash’ purchases of condo’s ect as they downsize… the ratio’s of income to house price are not as relevant… we should be looking at income/mortgage valuations going forward to see if homes are ‘affordable’.
    Boomers have less wealth thatn you think , and a sizeable chunk is in their home equity and the same 600 stocks that almost all Boomers own. One good punch to the stock market, and you will have a wealth destruction phenomenon that falls disproportionately on those Boomers. I am of the opinion that most boomers will only leave the office wearing a toe tag. They will not be able to afford to retire.

    -inflation: if you have a 30yr fixed mortgage and we get into double digit inflation, that same mortgage will be easier to carry going forward. (yes, the downside to this is that the proceeds from the sale of your home will also be worth less in future $). Eleua is predicting DEflation… quite a different outcome.

    I don’t want to hash out my DE-flationary arguments here, but if the future holds price inflation, rather than monatary inflation, then the outlook is for somewhat stagnant incomes with escalating costs of commodities and the necessities of life. That money will have to come from somewhere, which will likely be the large speculative premium that is in homes.

    -pent up demand: I agree that there is some % of first time home buyers that bought before they were ready (due to the financing availability)… over the past year, there are many new first time home buyers that are itching to get into the game… if/when loans become available (loans right now are BEYOND historical requirements and are tougher to get than they ought to be…. lucky for those first timers who would have been sucked in to buying a house if they could have gotten the loan)… we should see the months of supply quickly reduce as the rate of sales goes up. The banks / govn’t WILL find a way to make reasonable loans in the near term. If they can’t, we may get 1/2 way to Eleua’s predictions.

    When this is over, we will be rebuilding from a systemic banking failure, so easy loans are going to be things kids read about in history books, not reading about in their mortgage documents. Since the REIC has sold homes as “investments,” people are not going to be looking to jump in at the first opportunity. The knife-catchers that the sleazy RE agents are shoehorning into homes (because this is a generational bottom on home prices, right?) will have stories to tell, and they won’t be pretty.

    -future expectations: the buyers in the market have LOW expectations for the near future 1-5 years… this is driving home prices lower even if a sell price is at a ‘fair value’ based on today’s comparables. If future expections shift to something even a little more positive than ‘a sure loss of 10-20%’, you will see buyers come back quickly… even ‘flat’ would attract buyers…

    Doubtful. Once people realize that homes do go down in value, and if they do not have easy access to credit, they will take a very hard, and conservative look at housing. As PITI approaches parity with rent, then you may have people look more favorably at buying, but not until then.

    -there are many people on the bubble so to speak as far as it making sense to sell now and come back when the market has bottomed… but for many, if you combine their expectation of 1-2 years of downturn, the transaction costs alone mean that they will be at about breakeven for selling and then renting….so likely they won’t sell. If they were right, and it gets better, they are ahead… otherwise they become the 2005/2006 buyers from a cushion perspective.

    What happens if they are looking at 1993 prices and held all the way down? What if we get a 20-30 year bear market in real estate?

  229. 229
    mikal says:

    What if pigs start to fly? What if gravity stops working? What if indeed.
    Remember, Solyent Green is People…. People.

  230. 230
    Sniglet says:

    Mikal & Harvey,

    Do you believe it is possible to find homes for sale in the Bellevue area today that would be profitable to rent out, even if there was no appreciation for 5 years or so? I definitely understand how rentals are working very well for landlords that bought years ago, but I am just trying to understand if today’s prices are attractive for new would-be landlords?

  231. 231
    mikal says:

    Why would anyone buy anything now? There is to much uncertainty in the market. The point of this gloom and doom article is to make Eleau feel good about the $2000 a month he is flushing every month on rent.

  232. 232
    Sniglet says:

    The point of this gloom and doom article is to make Eleau feel good about the $2000 a month he is flushing every month on rent.

    So what would you recommend someone who already owns their own home and is considering becoming a landlord as a way of investing their extra income? Should they just sit out the current market in Bellevue (where I live) because prices are too high at present to make rentals profitable? Or are there ways to make Bellevue rentals pencil out even now?

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