Sunday, July 13, 2014

The New Housing Bubble in California

Housing prices in San Marcos are about back to pre-bubble prices. A house like we rent for $1750 a month is now going for 560K. That would be about $3,000 a month to own it plus another $5,600 in property taxes. So renting costs us about $21,000 a year while owning would cost us about $41,600 a year. Notice the cost difference. If you wanted to turn the property into a rental, it wouldn’t be worth the effort at these prices.

In the past, many people said, that paying rent was just throwing your money away. Owners rationalize when the home is paid off, "they get to live in it rent free." Actually, they forgo the interest of the dollar value of the home. A paid off 560K home would generate 17K at 3% interest. So if you take the 17K and add the property taxes, of $5,600, you get $20,500. Divide that by 12 and they are still paying $1700 rent a month. We are not even talking repairs here, I've got a $7,000 repair bill to rebuild one bathroom on my rental.

The real reason for home ownership in the past; it was cheaper to own than to rent. The renter paid extra for the freedom to pick up and move when they felt like it. With housing prices up 160K in two years, that thinking has changed a bit. The funny thing for this area is that the people that bought at the height of the last bubble are still underwater after 8 years. They need 34K in equity just to pay the realtors fees if they were to sell without a loss.

In a roundabout way, the Federal Reserve and your retirement funds are what keep the real estate prices artificially high. Beginning in October, the Feds will no longer be buying the real estate paper. The estimates of the dollar value of the paper owned by them is around 2.3 trillion dollars. No big deal on this, the home loans will be paid off over thirty years and the 2.3 trillion will go to zero ---if the real estate doesn’t go back into foreclosure.

The trouble begins in October. Here is a simplification of how the present banking system handles real estate. The bank loans a home buyer 500K for a home loan. The bank then sells the loan to whomever, in this case the Federal Reserve and keeps a half percent of the loan for management fees. The bank then loans the money out again and does the same thing and gets another management fee. If the bank does this 10 times, it is getting 5% in management fees on their depositor’s 500k with little or no risk. Before the Federal Reserve and the Fannie and Freddie bail out, the loans were sold to private parties. So now, it looks as if interest rates will have to rise up about 300 basis points to create interested third parties willing to invest in the real estate note market. You ask why?--- the banks don't want to hold on to 30 year 5% paper. Will rates rise, or will the Fed throw in the towel and start buying more paper?

I think all of us can agree that the stock market has reached new highs for no good reason. A lot of hard working people have retired because they can’t find a job. Many college grads are finding out that their degree isn’t worth the money they borrowed to get it.

Our government has enabled every dreamer the right to become a failure. Buy a home, get a college education and become a part of the American dream. Buy a Lotto ticket and win. And if you can't speak Spanish, you'd better learn.

So we have a housing bubble in San Marcos, I wonder how it will end? If the government rewards failure, I guess we will get more of it; it’s tragic to think that we earned it by hard work rather than ineptness.


dearieme said...

"will the Fed throw in the towel"? I'm confident that the Fed will throw in the towel repeatedly, on one topic or another, until finally catastrophe arrives. I expect that the catastrophe is more likely to be by an inflation rather than a default, but you never know. There will certainly be elements of default: many a political promise will be broken, many a generations-long assumption shattered.

Of course, there must be a possibility that when the Fed wants to run a serious inflation it will find that it can't get one going. God spare us all.

Joseph Oppenheim said...

People who do the best in great or bad times are the rich, because it's not about speculating, but capital preservation and contentment to earn just modest income returns on investments. And, only buying quality assets.

Sure, some rich will gamble, but not most.

So, easy, just copy the rich. Don't have the money? Save and live frugally....and only buy quality....most importantly, don't go into debt.

As for now, I agree about how derivatives are the biggest danger. I see some stuff unreasonably inflated, but also see some quality stuff reasonably priced.

So, many will get hurt, but also some will do very well. People have a choice.

Don't forget, those who bought quality, even in 1929, with cash, did wonderfully if held on long term.

Anonymous said...

Your 21k vs 40k argument doesn't take into account tax savings and appreciation, classic bias type of writing you do.

Jim in San Marcos said...

Hi Anon 8:27

You build a house and you think it is worth more as it ages? Technically you can sell it for more many years later, but that is just the ravages of inflation.

I don't see anyone bragging about how gas prices have gone from 25 cents a gallon to $4 a gallon.

Who cares if you throw your money into the interest maelstrom of the banks and at the same time get a tax deduction. You are only choosing which trash can you are throwing your dollars in.

Under the present economic conditions, tax savings and appreciation are about nill. But the return on RE with the banks paying one half percent makes real estate a very good return at 5 percent, but it is still way below historical norms of 20 percent. The risk is extremely high for very little gain.

Jim in San Marcos said...

Hi dearieme

Thank you for the link on the last post.

I tend to agree, but the Fed is getting to the point where more money has less and less influence on the economy.

And as you suggest, they may go to the well one too many times.

Jim in San Marcos said...

Hi Joseph

One thing that was pointed out to me by writers of the time, was that many people were retiring in 1929.

So you are right, in assuming if you held on, you would have been made whole by 1953, the trouble is many of these people didn't live to see the year 1940.

Their retirement plans were not quite what they had planned.

Joseph Oppenheim said...

My main point was buying QUALITY in 1929. And, staying out of debt. All crashes do for such people are provide bargains.

Jim in San Marcos said...

Hi Joseph

I agree with you 100 percent. I didn't mean to impugn your investment strategy, only point out the error made in 1929 by retirees.

I'm 68 and I don't think even with a crash, that the aftermath of 1929 will project out today, for one reason, all governments are printing money. I very seriously entertain the idea that our retirement plans, what ever they may be, could collapse from underfunding and a black swan event.

I am a firm believer that people act with a herd mentality, buy what they don't want, and you'll be able to sell it back to them when it comes back in fashion.

There are two ways to get rich, the fast way or the slow way, I think you and I will make it the slow way, and as long as you get there, that is all that counts.

Take care.

Joseph Oppenheim said...

BTW,Jim, the company that pays my pension just offered me a lump sum payout. I will likely take it and rollover to an IRA, into an insured CD.

So, I do see the current bond and stock market booms as a way for pension funds to reduce their risks.

Anonymous said...

The 8:27 poster wants to include appreciation on a house in a bubble market? Good luck with that plan.