Asymmetrical Information

OK, Jane, I'm moving to the Washington DC area. Don't have to pay for private schools becuase Fairfax county has great ones. But to keep my commut down to under 1 hour I need roughly $700-$800K for the same size house I have in Shreveport. Should I buy? Rent? Commute for 2 hours and live in West Virginia? Its not that I'm a bigger fool, its just impossible to find quality housing in that area at reasonable prices! I moved away from there in 2000 and my house I sold is now worth about 40% more now. Best bet seems to be find a job somewhere else, but that may not be an option.
How do you minimize downside risk when buying into a bubble??? I'm all ears.

OK, Jane, I'm moving to the Washington DC area. Don't have to pay for private schools becuase Fairfax county has great ones. But to keep my commut down to under 1 hour I need roughly $700-$800K for the same size house I have in Shreveport. Should I buy? Rent? Commute for 2 hours and live in West Virginia? Its not that I'm a bigger fool, its just impossible to find quality housing in that area at reasonable prices! I moved away from there in 2000 and my house I sold is now worth about 40% more now. Best bet seems to be find a job somewhere else, but that may not be an option.
How do you minimize downside risk when buying into a bubble??? I'm all ears.

Sorry about triple post- only hit post once!

I wonder if a lot of the housing bubble talk isn't driven by people in SF or NYC or Boston, etc.

Everything Jane says is true to a point. There certainly is a disconnect between people's expectations and the inevitability of at least a slowdown in the market. I agree the Greater Fool Theory is extant in many places, which is interesting in itself so soon after the playing out of the stock market version of same. But what I wonder about is that my suburban contemporaries (and I) have been guilty of feeling the same about our local housing markets. Yes, new developments continue to toss up the 3000+ sq.ft. 4-bedroom homes we all want, with accompanying ever-rising prices. And we all talk in amazement about how our homes have gone up by $150K in a few years, etc., but that works out to only about 5%/year. Local news stories breathlessly report on this sort of thing all the time. The thing is, it's really not much of a story in a lot of areas, because the price increases are really not so large. Maybe it's a product of our inability to deal with the idea of $500K homes when our parents raised us in $20K homes.

I wonder also about Jane's assertion of boomer demographics hammering the housing market in several years. I wonder if the overall rise in population coupled with the general uptrend in affluence will mitigate this somewhat. I'd be interested to see a more expansive treatment of that idea.

What I'm saying is that outside of major metropolitan areas, where this sort of thing is also tied to space limitaions in the defined desirable areas, I'm not sure this is as much of a bubble as it might appear. Another key figure is the size of mortgages vs. what people "ought" to be carrying, and that gets into the market being partly driven by historically low mortgage rates. A future bout of inflation will help out a lot of over-mortgaged people. I think this one's rather complicated, Jane, and I'm not sure what to think about it. I am glad we have a 20, and make extra payments, though.

Sorry about triple post- only hit post once!

If I didn't live in flyover country, I would worry. But every market is different and some bubbles are much larger than others.

Buffpilot: the unpleasant answer is "buy less house than you need". Cram the family into two bedrooms; give up a livingroom; make do with a carport instead of a garage. Get rid of your stuff or put it into storage. Or rent, if the differential is good. (Often rents are ridiculous too.)

Yes, of course you can't single-handedly make the market go down. But you can protect yourself from being hurt too badly when it corrects. And it's likely to correct at least a little bit in the near future, because interest rates have only one way to go, and when they go up, housing prices will have to drop even in the frothiest areas.

Unfortunately, the only way to protect yourself is to downscale your expectations of how much housing you will consume. If commute time and schools aren't negotiable for family reasons, then bedrooms and amenities have to be.

I realize that this amounts to saying "sucks to be you". But believe me, I say it with sympathy -- I'm renting a one bedroom of perhaps 450 square feet in Manhattan for the monthly payment on a four bedroom palace in a more reasonably priced area. It helps me to keep in mind that my mother has never, in her entire life, had her own bedroom, and the house she grew up in, considered cushy back then, has about the same square footage as a modern condo. We've grown to expect that each kid has their own room, the livingroom and dining room are separate and large, and so on. But our parents and grandparents didn't expect these things, and didn't feel themselves particularly deprived. If you're willing to downscale your lifestyle in an urban area, the higher salary can generate quite a lot of savings cushion.

Thanks, I knew that was the answer but I was hoping you had a brilliant insight that would cut the buying price of my future house by 50% :)
Glad you like New York, I could not live in the steal jungle, crew up in farm country...

Also could you delete all thos extra posts?

Thanks, I knew that was the answer but I was hoping you had a brilliant insight that would cut the buying price of my future house by 50% :)
Glad you like New York, I could not live in the steal jungle, crew up in farm country...

Also could you delete all thos extra posts?

I knew, I just knew, that if I continued to browse this blog I would eventually find some common ground with the proprietor!

Here in the San Francisco Bay Area, most of my late 20's/early 30's friends are transitioning from the rentier to the propertied class.

Without exception each of the new or potential new home buyers (we're talking 9 buyers at this point, another two handfuls still looking....) have soothed their bubble anxieties with some combination of the "everyone wants to move here" and the "land is so scarce" red herrings.

As an economist, I feel compelled to share with them the definition of a bubble, and why the local housing market is quite likely to be a bubble. And I also point to the falling rents (mine is down 15% from 2 years ago when I first signed a 6 month lease) which are not consistent with the rising housing prices.

Some people just love to blow bubbles, I guess.

Good post

Thanks, Jane, for a fascinating post. Those of us looking forward to transitioning from life as renters to life as owners will correct our dreams accordingly.

If the bubble's really going to burst in 2010, then you'd expect the market to anticipate that...

I like the real estate agent saying people worry too much about prices. Of course, she gets her 3% anyway, and isn't risking 10 years income...

Surveying recent buyers is a good way to find the Greater Fools at any time. I guess the proportion of rational people would decline as a bubble expands.

Suggestion for Buffpilot: even if you're buying a big house, look for one with a ground floor bedroom (or something on the ground floor that can be turned into a bedroom). Even better, buy a one-floor house (eg a ranch). This sort of house is extremely rare around here, but it's one of the things retiring people look for. Also, it might be worth the extra to be near public transit and shopping.

There's a new development near me that was supposed to be townhouses (aka rowhouses), but there wasn't much interest. (They started advertising in 2001, if I recall correctly.) They decided to redesign and go with single-story townhomes targeted at the senior market, and sales took off. Last I heard, they'd upped the basic price from around 170k to 220k and now almost 250k.

bubble depends on where you are...

housing in downtowns is on a growth curve, as cities become more liveable and people get tired of commuting. some cities' engines are also more likely to keep going than others: NYC looks stable to growing as a world city (though its economy sucks), while SFO looks to be on the decline (valley still good, but SF has horrible politics that look to keep it in a downward spiral)

DC should be a good market, as its prime movers don't look to be folding up anytime soon, so go for the big house.

Remember, property markets are still local, and while demographics will have an effect on the national market, local markets will vary (see houston in the late 80s... it crashed while the rest of the country boomed)

Heh, some of the quotes you pulled look exactly like what people were saying about the stock market circa 1998. A fool and his money are doomed to repeat history, or something like that.

Here in the Denver/Colorado Front Range area housing continues to go up right and left. There is a new neighborhood (less than seven years old) in the former wheat fields surrounding the thirty year old subdivision where my folks live, and if you drive through that neighborhood, maybe a quarter of everything there is for sale. Meanwhile, comparable and even bigger residences are being erected in four or five locations within a five-mile radius of said new neighborhood.

Rather ridiculous, it looks...

scarcity and desirability are a notch up from the argument I usually hear. what I hear most commonly (from friends and esp. real estate agents) is that house prices almost always go up; even when the go down, it's usually just short term. what could be a better predictor of future performance than past performance ;).

the fed has an article that looks at the historic relationship between house prices and rents nationwide:

http://www.frbsf.org/publications/economics/letter/2003/el2003-06.html

the short of it is that we can return to historic averages with just a mild cooling of the housing market and average increases in rents -- nationwide.

Ed Leamer of the Anderson Forecast looked the house price / rent ratio in select markest and found that it looked like trouble for many of them:

http://www.anderson.ucla.edu/research/forecast/forecast/2003/June/Articles/PE_ratio_update.pdf

looks like trouble for some of the hot housing markets -- SF, Boston, Denver, etc.

I think it's interesting that now that interest rates have steadied, buyers in hot markets are turning to ARMs to push their offers even higher:

http://www.mercurynews.com/mld/mercurynews/business/7580018.htm

looks like the demand side of the equation is starting to assert itself as buyers are forced to take on more risk in order to fuel those hot housing markets.

scarcity and desirability are a notch up from the argument I usually hear. what I hear most commonly (from friends and esp. real estate agents) is that house prices almost always go up; even when the go down, it's usually just short term. what could be a better predictor of future performance than past performance ;).

the fed has an article that looks at the historic relationship between house prices and rents nationwide:

http://www.frbsf.org/publications/economics/letter/2003/el2003-06.html

the short of it is that we can return to historic averages with just a mild cooling of the housing market and average increases in rents -- nationwide.

Ed Leamer of the Anderson Forecast looked the house price / rent ratio in select markest and found that it looked like trouble for many of them:

http://www.anderson.ucla.edu/research/forecast/forecast/2003/June/Articles/PE_ratio_update.pdf

looks like trouble for some of the hot housing markets -- SF, Boston, Denver, etc.

I think it's interesting that now that interest rates have steadied, buyers in hot markets are turning to ARMs to push their offers even higher:

http://www.mercurynews.com/mld/mercurynews/business/7580018.htm

looks like the demand side of the equation is starting to assert itself as buyers are forced to take on more risk in order to fuel those hot housing markets.

scarcity and desirability are a notch up from the argument I usually hear. what I hear most commonly (from friends and esp. real estate agents) is that house prices almost always go up; even when the go down, it's usually just short term. what could be a better predictor of future performance than past performance ;).

the fed has an article that looks at the historic relationship between house prices and rents nationwide:

http://www.frbsf.org/publications/economics/letter/2003/el2003-06.html

the short of it is that we can return to historic averages with just a mild cooling of the housing market and average increases in rents -- nationwide.

Ed Leamer of the Anderson Forecast looked the house price / rent ratio in select markest and found that it looked like trouble for many of them:

http://www.anderson.ucla.edu/research/forecast/forecast/2003/June/Articles/PE_ratio_update.pdf

looks like trouble for some of the hot housing markets -- SF, Boston, Denver, etc.

I think it's interesting that now that interest rates have steadied, buyers in hot markets are turning to ARMs to push their offers even higher:

http://www.mercurynews.com/mld/mercurynews/business/7580018.htm

looks like the demand side of the equation is starting to assert itself as buyers are forced to take on more risk in order to fuel those hot housing markets.

There is a huge psychological part of the housing market though, (stock market too, but not as much as in the housing market). For one, most people buy a house to live in it and intend to do so for a long time. If someone wants to put their house on the market and can't get what they think its worth, they will simply pull their house off the market and wait. There are exceptions..if someone is moving out of town or going broke, but that still constitutes a small minority of people. But by-and-large, owners of homes are protected by their and their neighbors desire to see appreciation in their property values. If no one wants to sell for less money when the "bubble bursts", then there is no decline in property values, just a decline in number of homes sold.

Doesn't the change in tax exemption law in the Taxpayers' Relief Act of 1997 have something to do with this? Being able to roll-over profits from sales of one home after another, after living in each for two years to establish eligiblity, is a major change in the way that people deal in real estate. It seems to me that this change in the tax law will lead to a much higher floor being placed under residential real estate.

scarcity and desirability are a notch up from the argument I usually hear. what I hear most commonly (from friends and esp. real estate agents) is that house prices almost always go up; even when the go down, it's usually just short term. what could be a better predictor of future performance than past performance ;).

the fed has an article that looks at the historic relationship between house prices and rents nationwide:

http://www.frbsf.org/publications/economics/letter/2003/el2003-06.html

the short of it is that we can return to historic averages with just a mild cooling of the housing market and average increases in rents -- nationwide.

Ed Leamer of the Anderson Forecast looked the house price / rent ratio in select markest and found that it looked like trouble for many of them:

http://www.anderson.ucla.edu/research/forecast/forecast/2003/June/Articles/PE_ratio_update.pdf

looks like trouble for some of the hot housing markets -- SF, Boston, Denver, etc.

I think it's interesting that now that interest rates have steadied, buyers in hot markets are turning to ARMs to push their offers even higher:

http://www.mercurynews.com/mld/mercurynews/business/7580018.htm

looks like the demand side of the equation is starting to assert itself as buyers are forced to take on more risk in order to fuel those hot housing markets.

Whoa, Pete D.! Easy now! It really does post the first time you click :)

Jane, do you have an opinion on NYC rent control?

I think if it were removed after these 60++ years, NYC might become more attractive. After reading that a $3K (per employee) "penalty" for lack of a better word will be put on small businesses whose employees don't have insurance, I'm just wondering. With 9/11, losing population and the extremely high prices, seems to me NY is becoming less attractive.

I also really wish the UN would leave, but can see the downside.

buffpilot: I worked a couple of years for a defense contractor in Warrenton, VA, in the late 80's. (This is more or less where your two hour commute might start.) Since there wasn't much permanence to that job, I rented. I could have bought a house on a 30 year mortgage (the house might not have held together that long) that took over half my paycheck, and with only 10% down. I think that after taxes, realtor fees, etc., 10% down actually works out to a negative margin on the loan, but the realtor was aasuring me that prices were rising so fast, I'd be making a profit after a year. IIRC, the way prices actually went, I'd have probably broke even in 2-1/2 years, but if I'd stayed much longer and then had to sell, I'd have been in bankruptcy. OTOH, a few more years and I'd have had a gigantic capital gain...

House prices always go up sooner or later, but there are years and sometimes a decade of depressed prices. If your job is really, really secure and you expect to stay there a couple of decades, buy all the house you can afford. It's best if you can pick the time to sell, but short of another Great Depression, market lows in 20 years will be higher than market highs today.

Bush's open borders policy has the potential to increase our population substantially, and this would increase demand for housing over the long term. Add to this the fact that there are many more millionaires today in China and India who might desire a trophy property in New York or California, and there may be some argument for why prices should increase in the most desirable places in the US. Arguments for a housing bubble are supported by the ease with which credit is granted for houses. Buyers don't need a down payment to buy a house these days.

I did some anecdotal research into this when I was buying a house. It seems that whether somone thinks there is a bubble is almost entirely dependent on one variable: whether they own a home or not (quelle suprise). Everyone had a rationalization for their point of view (Hyperinflation, Demographics, Offshoring, global warming, the bubble did pop( but only in High end homes $1-2 million+), etc).

Also, buying a condo / townhouse as a hedge against a bubble doesn't seem like a necessarily lower risk strategy. The cost is somewhat less than home but (at least where I live -- SF Bay Area), condo prices have been increasing much faster than houses. If house prices drop, I suspect condo prices will drop faster.

My take (full disclosure: I bought a house recently) is that demographic shift will cause house price stagnation for a period (could I be any more vague?).

I did some anecdotal research into this when I was buying a house. It seems that whether somone thinks there is a bubble is almost entirely dependent on one variable: whether they own a home or not (quelle suprise). Everyone had a rationalization for their point of view (Hyperinflation, Demographics, Offshoring, global warming, the bubble did pop( but only in High end homes $1-2 million+), etc).

Also, buying a condo / townhouse as a hedge against a bubble doesn't seem like a necessarily lower risk strategy. The cost is somewhat less than home but (at least where I live -- SF Bay Area), condo prices have been increasing much faster than houses. If house prices drop, I suspect condo prices will drop faster.

My take (full disclosure: I bought a house recently) is that demographic shift will cause house price stagnation for a period (could I be any more vague?).

If the bubble's really going to burst in 2010, then you'd expect the market to anticipate that...

If you believe that the housing market is efficient, then this is true. However, thanks to high transaction costs and the uniqueness of individual homes, this expectation doesn't hold much water.

On a related note, the sheer number of people who tell me about what a great investment real estate is should be a useful contrary indicator. When so many people believe that real estate is a risk-free investment, I gotta think that the shoeshine boy is giving stock tips again.

And, Jane--
It's known as the "Greater Fool Theory", and it's what made stock markets in the late 1990's so much fun . . . if you weren't invested in them.

I think you mean the "early 2000s". The late 1990s were straight up. It wasn't that long ago.

Buffpilot: As a homeowner in NOVA, I disagree with Jane. I don't see housing in NOVA crashing anyttime soon. Yes, it's painfully, painfully expensive. But on the other hand, there's only a finite amount of land inside the beltway. For folks not willing to commute incredible distances, they'll pay a high premium for this land.

Furthermore, DC is a bit unique in that it's virtually recession proof. Government employees don't get downsized when the economy turns bad.

Shop around..Be prepared to pay painfully high prices. But if you're in the NOVA area for 10 years I think you'll make some money.

dch

I bought a condo in the late 1990 in the DC are in what turned out to be a mini-bubble at the time. In 1993 I got a job in NYC and when I tried to sell my home discovered that prices had dropped 10% from when I bought the place. I took a small bath on the property. Of course there was an intervening recession at the time to blame for some of it, but the presumed "bubble" was not nearly as well advertised and fretted over as is the current one.

Suffice to say: excellent post, I believe that there are regional bubbles in the making and they will burst when interest rates rise again making the next mortgage payment that much higher than the last one contracted at the peak of the bubble. What one can afford depends on how much one can pay every month. Interest rates have a lot to do with it.

Thanks for all the advice. My financial situation isn't bad. I figure I'll have $100K for a downpayment. For my monthly I'll have $1000/month from my military retirement, $1200/month from money freed up from not paying private school tuition, and $1000/month being my current payment. Thus, assuming I make at least what I do in the military, I'll have about $3200/month available for a morgage. Big question is what effect state income taxes will be where I move (I don't pay them now since I am a Texas residence no matter where I live due to the Soldiers and Sailors relief act). I expect to stay in the house for at least 10 years. Just started looking for a job, but I'm fairly confident...

Localized bubbles. Until the supply exceeds the demand, no to a national bubble. Available houses reached a one year supply in the last bubble but, I'm told, are running at about a one month supply now.

My advice, buffpilot, is to wait to buy until you have a job. Rent something far out (since you're not yet commuting) and look around. You'll be better able to look for work without a big mortgage payment hanging over your head, and though it isn't fun to make the kids switch schools again, they may be surprisingly receptive to the notion that a little uproot now makes for more financial security -- and more stuff they want -- later. Plus, rates are probably going to go up in mid-2004, so prices will start to drop. That won't make much difference in your initial payment, but there are ways to reduce the total interest you pay (I'll get to that in a minute), while there's not much you can do about the sticker price.

Once you've got a job, shop at the lower end of what you can afford -- not a dump, but knocking the mortgage payment down a couple hundred a month makes a surprising difference.

Finally, since you're getting one fat check once a month, get online banking and arrange to pay your mortgage weekly or biweekly instead of monthly (In other words: make two half payments a month, or total up your annual bite, divide by fifty-two, and pay that amount each week). The effect is roughly as if you'd made an extra payment a year, because the interest doesn't compound. Since in your case, it's painless to do, it's a nice way to work that principal down faster.

(Sadly, this works better when interest rates are higher, but even at 5% it's worth doing.)

Of course, I'm no financial planner, and any advice I give is probably worth about what you pay for it. ;-)

C'mon Jane, you're a fresh water economist, right? How can you write something as outlandish as

Though anyone with any sense at all will tell you that shortly after 2010, housing prices in most currently hot markets are going to fall off a cliff, as boomers downsize.

1. Check your Ginnie Mae statistics. How long do most folks own a given home? Is it less than the time difference between now and your posited 'end-of-the-world-as-we-know-it' in 2010?

2. Check your facts. How much of a dip has housing EVER taken, relative to other non-liquid assets. Fall off a cliff, indeed!

3. Why should the size of a house matter in your doomsday scenario? Yeah, if an investment goes sour it's better to be in for less, but on a percentage basis -- what's the diff? You're far better off owning the most desireable demographic housing for a given locale than the outright smallest available. (e.g. Don't buy a one-bedroom condo in Greenwich, CT. Most folks who move here are in it for the schools and such because they have kids and need more space.

Between 2000 and 2030, California's population is expected to grow from 35 million to 52 million. I don't see demand for housing falling off a cliff in 2010 just because some boomers are retiring. On an anecdotal level, both my pre-boomer parents "downsized" into larger homes after they retired.

In the medium term, higher interest rates tend to accompany higher inflation, which increases the nominal value of assets such as housing.

In the short term, people are still camping out overnight for the opportunity to buy a new home around here, and builders will not sell to anyone who's purchase is contingent upon the sale of an existing home.

Right now in the D.C. area, there's a nearly evangelical aura to home-buying. Virtual strangers--waiters, friends of friends, the otherwise passionless dude seated next to you at your date's acquaintance's wedding--leap at the opportunity to share their personal stories of real-estate salvation.

Never mind that they bought their homes in 1997, when the local market was tepid. Never mind that they got in during the end of the first wave of gentrification in certain city neighborhoods, or that their commute, if they live in the 'burbs, is a grueling three-hour round trip each day. Never mind that in some neighborhoods still plagued by drugs and crime, the price of a small, unremarkable rowhouse rose from $160,000 to $300,000 in 18 months based solely on promises of economic redevelopment by the city. The fortunate folks who lucked out in the housing market three years ago now just can't see how much it's changed, or how high prices have become. They urge others to buy, sure in the knowledge that God has revealed to them a secret thing.

Is it a bubble? I don't know. I'm not an economist. But it *feels* like a bubble. There's a sense of overconfidence in the housing market that reminds me of the period just before the big dot-com crash. I can't quantify it, but it feels misguided, and it makes me nervous. For now, I'm going to continue to rent, and wait.

In any case, I'm glad to see the WSJ kicking around the very idea of a housing bubble. In some new-homeowner circles in the D.C. area, it's heresy, but Washingtonians should be thinking about it more than they are.

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