I live in the hills of the Bay Area, in a little rented house some forty miles away from San Francisco. Most of you are probably aware of the real estate boom here. Forty miles out from the city provides scant relief from inflated real estate prices in this region. A little 1,000 square foot bungalow down the street from me -- two bedrooms, one bath, small yard, needing a new foundation, plumbing, roof and windows -- was snapped-up for $485,000 just the other day. Another $200,000 will probably be poured into it to make it livable.
Half a million dollars. If milk cost $25 a gallon, that might make sense to me. But it doesn't. I was talking to my barber, an old man with a white pony tail, about 80 years old now. He's been manning his one-chair shop in this little town since 1946. He lamented how things have evolved here: "There's no way I could live the life I've had in today's realities -- not on a barber's wages." He has two houses, raised three kids. Divorced; remarried; divorced again. He has some land up in the Sierras where he hunts deer. All that from cutting hair, one lock at a time.
In his time, this little town 40 miles away from Somewhere officially designated it as Nowhere. And Nowhere was cheap. He could live a slow life, and still help himself to a slice of the American dream.
"I'm living on a combination of my cheap second mortgages and cutting scalps part time," he told me while snipping my graying mop. There's always about four or five other old guys waiting in his shop, leafing through ragged copies of Playboy magazine, talking about hunting the local turkeys and waxing nostalgic about simpler times. Some of them haul stuff in trucks, others work for the city, many are retired. Most of them have lived here all their lives, and agree that while it's nice their little stucco hovels are turning them into millionaires, its affect on the township is changing everything they once knew. Accessibility is in decline. Their kids and grandkids can't live here. When the old barber eventually hangs up his shears for good, no one's likely to replace him -- a corporate franchise like SuperCuts will take over. Bye-bye, little town. Blank-Mart comes in many forms, even as barbers.
David Streitfeld of the Los Angeles Times recently ran an article that is overlooked in the media. It concerns the kind of loans that many people are securing here in the Golden State so they can get on the real estate merry-go-round -- They're In -- but Not Home Free:Many Californians have 'interest-only' loans. They might be living on borrowed time.By now you know the blogger Cicero is deeply troubled by a myriad of things, except possibly the finer aspects of a Madras curry, and his daughter's silly faces. This time I am troubled by two completely separate tracks that modern Americans appear to be riding, who assume that both will remain neatly parallel within their lifetimes.Confronted with soaring home prices, Californians are adopting a "buy now, pay later" strategy on a massive scale. The boom in interest-only loans -- nearly half the state's home buyers used them last year, up from virtually none in 2001-- is the engine behind California's surging home prices.
But all that borrowed money might be living on borrowed time. When higher bills start coming due, Herron and hundreds of thousands of other homeowners in the state will have to find ways to cope — or will have to sell.
...Interest-only loans, and other forms of so-called creative financing that are far riskier than the traditional 30-year fixed-rate mortgages, have allowed more people to afford homes in California even as prices have skyrocketed.
When the price of houses in California soared 17% in 2003 and 22% in 2004, a curious thing happened: Instead of home ownership decreasing because fewer people could afford houses, it rose to record levels.
... "If you can fog a mirror, you can get a home loan," said mortgage analyst Ralph DeFranco.
... In 2001, as the current housing boom got underway, fewer than 2% of California homes were bought with interest-only loans, according to an analysis done for The Times by LoanPerformance, a San Francisco mortgage research firm. By last year, the level had risen to 48%. Nationally, LoanPerformance says, interest-only loans were used in about a third of all purchases.
Here's how he thinks a collapse could occur: Rising interest rates put a brake on price appreciation and refinancings. People realize their interest-only period is coming to an end, raising their monthly payments substantially. Since they have no equity in the house, they choose to default.
"If housing prices go down or even are flat, heaven help us," said DeFranco.
Track One: Buy a house, and count on it appreciating for the rest of your life. By the time you are having a new heart and liver cultivated in a petri dish, you'll be donning a golden robe and cruising the Web with a golden mouse. Thank God those 30 years you put into the corporate cubicle earned you enough to become a real estate mogul. There's nowhere but up, up, up in real estate -- even if values dip for a few years, the long term is rosier than most any other investment. While the values of transistors decline, the value of Californian soil will climb indefinitely. So, do whatever it takes, and get on board! There's nothing to lose except precious time to accrue wealth. Why work and sweat when you can invest in stucco and drought-resistant ice plants?
Track Two: Our past is not our future, and the future has never been more uncertain. China's one point three billion are stirring -- and as Tom Friedman points out, they're starving and competing for our jobs now that the world is flattened by telecommunications. And they're getting a better education than we are, minting out more engineers and scientists than in America. India's one billion is doing the same. Europeans are drifting away with their thumbs up their pensions; Islam wants our souls delivered to Allah, soaked in blood; oil's running out, the Earth is warming, and the sky slowly falls. Big changes are underfoot. Anyone driving a SUV is living in a fantasy, much less someone who thinks that their slice of American suburban soil will forever be gold. It won't. Once people experience the backlash of rising energy costs, the Swiss cheese that ones and zeroes will make of the world's borders, or if a rogue nuclear attack wipes out Anywhere, USA -- our tidy world will be wrecked. It's only a matter of time -- and if you're lucky, not in your time.
I've talked to so many people who are in a froth over the real estate market, the cheap stuff at Costco and the Apple Store while they knowingly push back the frightful demons of political, scientific, technological, international and human evolution. Which track is a delusion, and which is a reality? Are these two tracks simply a choice between being optimistic or pessimistic? Are optimism and pessimism code words for denial and being a realist? At what point does the American dream become fantasy? Should I be putting all my meager pullet eggs into a Californian basket or a Kaczynski shack in the woods somewhere?
Stupid, naïve me. All I really want is a reasonable, modest life. I'm accustomed to living with just enough. That used to be a virtue. In this era, it's pathetic. It may be that looking into a foggy mirror is the most virtuous way to get ahead in this life, by today's rules. For all the plethora of facts, figures and opinions this information age bestows upon us, fog appears to be the most abundant reality.
How long is the interest only period?
Look for declining sales when a large number of interest only loans start requiring capital paydown.
Have your ermines packed.
Cicero
There's 200 large that will certainly keep people employed and the economy going.
All that on a barbers pay compared to the economies of scale when he obtained those assets. After the divorces I'm surprised he has two houses and property in the Sierras. Inheritance maybe?
Sounds like what used to be Mayberry RFD. Did he ask for the population growth and economic expansion? Did people just show up on the door step and decide to stay? Each new resident offered the potential gain of remittance for services rendered. All this sort of reminds me of the "What Year Were You Born" pamphlets that reveal the price of bread, gasoline, new homes, milk and televisions. Yes an era and a corresponding economy past.
Anyone recall what the home mortgage interest rate was in 1980? Try 13% compared to interest rates today. Housing costs have traditionally gone up with economies of scale. Remember the oil bust in Houston? People literally forced to give houses away or take a bath in losses because the local economy went south?
Rather than being pessimistic it sounds to me as though communities should be more protective of their economical environments.
Does Mayberry RFD still exist? Sure it does (fly over country) and for those that want that lifestyle they can move to those areas. Are the economies of scale in Mayberry RFD the same as they were years ago? No they have progressed with the economies of scale that fit their environments.
Okay - I'm done with nostalgia and I'm going to point out something that needs to be answered.
I'm still a bit confused as to how interest only loans are the culprit for rising home prices. Rising home prices are caused by supply and demand. Note I'm dispensing with governmental controls for the moment. Bottom line if people didn't buy them they would drop to what people could afford.
Will the Mayberry RFD see 50 / 100 year mortgages?
It's comforting to see that there are places where a Real Estate bubble is worse than here (17% price increase in 2003, 15,4% in 2004, averaged). Yes, living it, the feeling is as everybody has got crazy. I suppose that reality will finally prevail and prices will be corrected downwards.
USMC,
The "price" of a home for most people is the monthly payment, not the nominal cash price.
So if you get a loan with more favorable terms, you can afford a greater purchase price at the same monthly payment.
Supply and demand still drive the "price" in the form of the monthly payment, but interest-only loans allow the purchase price to be higher without affecting the bottom line of most home buyers.
I agree with USMC, I have a hard time seeing how things are worse now than they were in the late 70's, or the late 30's for that matter. As for the changes of the little towns outside the Bay Area, what about the Peninsula 40 years ago? It was like American Graffiti, literally. California's a beautiful place and people want to live there. Boston suffers just the same kind of high home prices, the only difference is that the change isn't as palpable because it stop growing as much years ago.
As for interest only payments, someone may purchase a larger home by utilizing interest only payment loans, but that does not mean they can afford it. As rates keep rising and the piper calls for more and more every month, people will have to judge whether they chose wisely in the size and price of house they purchased. These intstruments may have something to do with the rise in housing prices, certainly in perceptions of what is affordable; but the no.1 reason for high prices in California is simple demand. It's the most populous state, it's growing and has limited buildable land. I loved it when I lived there, but it exacts a high price.
If you can swing more dollars with a given income that looks like an increase in demand.
In 6 months to a year the story will be those who cashed out and moved to a cheap place in the Mid West. Putting the balance in bonds.
Cicero, MOVE OUT. You are lamenting the fact that things change. I was raised in Los Angeles. It was a great place 50 years ago, but you couldn't force me to live there now. These days I live in Oregon. My 3 bedroom house on a large city lot is only worth about $150K in one of the most expensive places in Oregon. There are lots of other places near here you could pick up for practically nothing. By the way, I have a young friend who is a barber in a place similar to what you describe and he does OK on what he makes.
Question: How can I make money on the coming crash? I am not invested in Real Estate now, so I can't sell out and move.
--Fred
What a lot of people don't see here is that this increase in demand is artificially inflated. Fifty years ago you bought a house based upon your ability to repay the loan - period. No talk of real estate as an investment, no thought of appreciation, no tricks or gimmics. You only bought a house when and if you could afford it.
No matter what anyone says, housing costs on the coasts and other major metropolitan areas are skyrocketing, and they are increasing far faster than the incomes of the people buying them. The people who make money in these situations are the builders and the bankers. The homeowner, duped into thinking of their house as as investment, are gambling with his/her livelyhood.
These unique ways to make housing affordable do anything but. They justify the ever-increasing cost of housing, and put people at the mercy of the real estate market to survive. The housing and mortgage industries is pleased as punch and they have record profits to show for it. So basically, people are paying more and more so these companies can make more profit.
The only real way to make housing affordable is to lower housing prices, not the monthly payment.
Compare the rate of inflation, salary increases, and housing costs in a major metropolitan area and you will see exactly what I mean. No matter what is being said about new and unique ways of becoming a homeowner, all these ruses are hiding the fact that people are now able to buy much more house than they can afford, and there is more risk to the buyer than ever before.
The crash of the housing industry seems imminent.
Rob
Agreed. The issue here is what you can afford.
Certainly you can but the loans we are talking about are based on paying interest rates only. The assumption being the equity in the home will grow. I'll sell at a later date and take the equity with me. In most cases this is true.
This is nothing more than a twist on the negative amortized and adjusted rate mortgage (ARM) loans introduced in the early 80's. What makes this unique is you and the bank will always own the house since the principal is never paid. (IE you are renting with a vested interest) It is a gamble and that is why I grudgingly accepted a 13% interest rate back in 1980. Yes I sold the house in 1985, made a profit and had a house built (much larger than one I sold) with a mortgage rate of 9% (and a payment less than that of my original house) and have since refinanced the home for a more favorable rate 5¼% over less time.
My point is people make decisions based on risk and assessment. The banks make loans based on risk and assessment. Banks wouldn't offer the deal if people didn't take it. Some people are better at decision making than others but in any case the bank will not lose.
I agree with #7, 'Move Out.' Sad, since I am rooted here. It feels like exile. But I should probably think of my forefathers who were on ships crossing the Atlantic, or covered wagons fanning across the Great Plains.
USMC #9, your points are well taken, but I can't help but smell a rat in this economy out here. I know far too many good, talented people who are either unemployed or forced to work below their worth. People who are making it seem tied into the real estate industry in some way, either as contractors, architects, sellers, etc. The real estate boom out here was originally sparked by the vibrancy of Silicon Valley, and it's anything but vibrant these days.
And that $200K going into the bungalow's upgrade isn't necessarily trickling down into our economy -- at least not all of it. If anything, I have noted that the real estate boom has been a boom for illegal immigrants who swing hammers and take the money back home.
If I didn't say it, I should say that I didn't intend to whine in this particular post. Really, I'm just lamenting the loss of certain values that were a part of small towns like the one I am in. It may be inevitable, but it is still sad.
Alas. The only constant is change.
Two factors at play in the future concern me.
have a hard time seeing how things are worse now than they were in the late 70's, or the late 30's for that matter.
Partly things are worse because the demographics are so different now.
In the 70s we had a lot of young adults just entering the work market as well as the real estate market. We could count on the likelihood that they would generate demand for decades to come.
Now, baby boomers like me will be selling off their big houses over the next decade or so. Some already have, driving up the price of condos and townhouses in convenient areas. Others have drawn down house equity to tide them over college tuition, health care problems or losing a job. This is particularly true of the younger boomers who haven't yet downsized their homes, many of whom will end up dumping that real estate on the market over the next 10-15 years.
Second, negative amortization helped some people hold onto their homes in times of high interest rates. To see it when interest rates are low suggests a serious overextension .... not a good sign, especially given that many consumers have little in the way of savings apart from the putative equity value of their homes.
I don't ascribe to either of your scenarios, Cicero. Or rather, I ascribe to elements of both of them as possibilities. A prudent person takes a moderate approach and leaves him/herself a little safety margin for downside.
We used to live in CA, both north (where my in-laws still are) and south. We sold our townhouse when we left in 90 and while we missed some upside in sale value it's not a market I'd come back into eagerly.
I can certainly agree with that position. The wife and I (28 years May 13) are already in the planning stages for such a move. Takes awhile to raise 4 kids especially since there is a difference of 14 years from youngest to oldest. Yes I've traveled all over the place and yes I've lived in more places than I care to count. Mayberry RFD (Shenandoah) here we come. A slower pace and simpler life.
USMC - the banks won't lose money b/c we'll be bailing them out ala the 80's S&L crises.
Curious the bankruptcy bill was such a hot item recently...
This is an artificially "free" market, subsidized by low interest rates from the Fed and the Fannie Mae "keep drinking the kool-aid" view. Alot of Hedge and regular funds are using these rates to speculate, and banks (in all probability) are saying "that valuation looks swell to me, wink-wink" just like they did in the 80's.
Alas. The more things change, the more they stay the same.
Cicero, count mine as another vote for "move". I too live in Oregon, and I'd be happy to show you around if you want to visit.
I got completely burned when the housing market crashed in Boston around 1990. I went to CA, then OR. Invested in stocks, not real estate (funny how people can look at piling their entire nest egg in one single entity (their house) in one single sector (real estate) and consider it an "investment").
Yes, it felt like exile for a while, but I learned to make a home of where I was, which is not a bad thing.
There's always something new to worry about in all periods of history. The US has been supposedly going to hell in a handbasket since I was a kid, and was being overtaken by the supposedly better educated and more hardworking Russians/Japanese/Arabs/Euros/Koreans/SE Asians/etc. We have the usual "intractable problems" that we always do: various deficits are always a disaster, always intractible, and always about to Destroy Our Way of Life Unless We Do Something (and that something always involves something involving bureaucracy and big tax increases). As long as we don't actually Do Something, I think we'll be fine.
As for the supposed hotshot scientists and engineers being churned out by top-tier Indian and CHinese universities, one must remember that IIT and Tsinghua are one thing, the "institutes" (degree-mills that teach a few hours of Java and cut you a diploma) are entirely another, and that is where the supposedly vast numbers tend to come from.
Also, there is an underlying conceit that Americans don't study science and engineering because they're too stupid or uneducated to do it. This is profoundly false: they study other things because this is where the money and return on the college investment is. Indians and Chinese are drawn to educational fads just as Americans are, and today engineering (more than science) are "hot" fields, while Americans see outsourcing, layoffs, and would far rather be the head-office guy spouting about all the money saved doing the outsourcing than the guy losing his job. Improving K-12 science education would be good, but it won't produce more engineers - economics will take care of that.
Fred, save all your money and wait for the fall. The bubble may not burst everywhere equally, but if there's somewhere you want to live, and real estate there is over inflated, then they'll be giving houses away like in the late 80's.
Someone elses disaster is your opportunity.
CA and FL will recover, everybody wants to live there. Cities with diverse employment (state, federal, university, technology, medical, etc) will weather well.
The question is, as always, the timing of any anticipated recovery. California has been in serious financial trouble as a state for a good long while now. Its business base has been fleeing the high taxes, stifling regulation and high cost of living for some time now.
Is it all doom and gloom? Of course not. And some of the housing bubble is a return to prices from 7 yrs ago or so.
But they weren't very realistic then either.
Some will make lots of money, some will find their houses aren't worth anything near what they think and some won't have time to wait out the cycle.
#7 (Move out) might be right. The real estate market may have some troubles in the future, but one factor is relatively constant – the huge baby boomer population. They’re retiring, and the trend is to move from the Bay Area or LA to less expensive places. A small low maintenance house, located in a quiet neighborhood that’s proven to be attractive to retirees (but not too far from work & city) would be a good place to live and a reasonable investment.
About India and China – back in the good old days, our parents used to tell us to eat all of our food – "think about the starving kids in India/China". Well, they’re not starving anymore – they’re making money and they’re buying our products. In the long run, it’s a good thing.
As investments, companies related to the Asian market or alternate-energy related companies are interesting. We invested in dot com stocks before the boom, lost after the bust, but were ok because of real estate investments. Diversify. Change is constant, so try to enjoy the ride.
From the trackbacks above here
He can add to that Agenda 21 and the wildlands project.
Where the left rules, and where we see leftist levels of govt authority to control everything, why is there any surprise there is market distortions ?
Well, im not really opposed to all of this, when the founders envisioned federalism and states rights et al. they did invision that some states would be governed by crackpots.
Not that california does not violate consitutional rights to the extent that would have had them sending in federal troops to arrest and hang the marxists. Just the gun regulations alone would have them be hanged for offending the bill of rights so badly.
But this land managment boondoggle on the face of it isnt it, and the founders held the view that the people could vote with their feet.
Im sitting on 10 Acers and I mow my yard with a diesil tractor, bask in the shade of some 200 trees and often spend time at my own outdoor pistol range and eat plums off my own trees every year.
And all of it isnt worth the money you cited to fix that old house. and my yearly taxes are less than the payment et all that guy will spend for one month.
Hey Marcus, the water and the sunshine is mighty fine out here in these red states, here in Texas, our state house is only in session every two years , ahh the benifits of non-career politicos.
No income tax, man is it nice out here in the open spaces not ruled by the commies, comon out, the people are friendly, the gas is cheaper, and the people packin pistols are our grand parents and wives, not thugs who have run away to find easier targets elsewhere.