Asymmetrical Information

I think the recent popularity of REITS has helped the boom. It makes real estate trading more like stock trading.

I also believe that as the housing market cools, people will start moving REITS money into stock, causing an uptick in the market. This might explain the recent rise of the indexes, while housing has started to drop.

Jane - as anyone who's seen the price of gas climb when the refinery explodes or is threatened by a hurricane, prices are affected by anticipated future supply. One factor not examined in Prof. Piggington's analysis is the difficulty of bringing future housing to market. I'd not be surprised to find that San Diego County has seen a significant increase in restrictions and political expenses on new construction over the past few years.

It's a win-win for politicians, as they get increased bribes attention from lobbyists, and their homeowner constituents are happy because their houses increase in value. The people excluded don't vote for the politicians within the excluded area.

The CME information shows that the overall housing payment being made by homeowners has not been increasing very quickly, so there's no nationwide bubble. There may be local bubbles, however.

You have to see this:
http://www.bareknucklepolitics.com

When does the bubble pop? The minute I put my house up for sale, of course.

By not listing my house, I alone have kept prices up, thus making tens of millions of dollars for people I'll never know.

You're welcome, America.

I didn't write this -- Winterspeak did -- but though all economists agree that housing restrictions increase the price of housing, that doesn't mean that housing prices can continue to increase indefinitely above median income growth, as they have done in hot markets. People who make $60,000 a year cannot pay $4,000 a month on a mortgage, no matter how scarce housing is. Since zoning regulations in other areas generally prevent housing from being subdivided to let more people carry the mortgage burden, as has happened in New York, rationing has to take other forms than price appreciation, such as people moving out of the area.

Low mortgage rates have enabled people to assume larger debt burdens, but those are at an end, and for the past eighteen months or so, entry into the housing market has been supported by variable, rather than fixed rates. That means that as interest rates rise, not only will new entrants stop coming into the market, but previous entrants who were stretched to the limit meeting their payments at teaser rates will be forced out. That is likely to devastate the markets.

Finally, surveys done in hot areas show that psychology is playing a big part in decisions to buy. For example, a recent survey in Los Angeles showed that new buyers were expecting average price appreciation of 20% a year for the nexxt decade.

["..Part of the problem is that it is very difficult to know whether a price is right or not."]

...no, it's not difficult at all -- your own personal valuation of an item is sufficient to determine if it is the "right" price for you.

"Market Prices" are merely summations of such individual valuations.

A 'problem' arises only when you intend to sell an item to somebody else -- then you must make a much more difficult assesment ... of how other people value the item.

A free trading market & inherent pricing system make it much easier to assess the valuations by other people.

American housing is hindered by heavy government regulation & interference in the construction and transfer of housing -- severely distorting the fundamental supply & demand 'pricing' system.

Mis-pricing (e.g., bubbles) result.

the housing market in the US has been influenced by numerous government actions that both subsidize it and make it more expensive for decades and decades.

Moreover, most of the recently done studies that claim to demonstrate that government restrictions cause prices to go up use population density as a proxy for zoning and other restrictions. But that proxy could be reflecting many, many different variablees that may or may not have any thing to do with government.

So unless you can show a significant change in the actions by government in recent years to make housing more expensive, your claim that government actions cause the speculative bubble are unsubstantiated. Moreover, if housing prices do fall now without a similiar move by
government to remove one of the subsidizes or benefits that would be futher proof that government actions did not play a role in the bubble.

As long as we have had capitalism we have had bubble, crashes, manias and panics. They seem to be inherent to capitalism and do not appear to require government interference.

So unless you can show a significant change in the actions by government in recent years to make housing more expensive, your claim that government actions cause the speculative bubble are unsubstantiated.

Here in the Boston area, I believe the notion that local government actions have at least helped along the bubble is pretty uncontestable. Local government in these parts mostly means "one's neighbors". I think the eastern half of Massachusetts is only producing something like half the housing starts it did 20 years ago. Once upon a time municipal officials (again, one's neigbors) tended to view new housing as a welcome source of tax revenue, but they wized up and realized they were doing their sums wrong. The tendency of new home construction to attract families with children means school budgets (as well as other budgets) increase far beyond any new revenue brought in by the property tax. If one's neighbors are rational, they'll tend to give town approval to ofice developments and the odd small retail facility. But housing construction is increasingly frowned upon, and inevitably is met with complaints about traffic, and is sometimes stopped dead in its tracks, or sharply zoned downwards in scope (usually by minimum lot size requirements). One's neigbors, homeonwners themselves, are all the more rational for taking these actions, as they tend to increase house prices. And one's neighbors are increasingly zealous in their approval of the use of tax money to buy up undeveloped land, further reducing the possibilities for house building.

The net result of all this is "artificial" (i.e., government-induced) scarcity, which means house prices soar during periods of economic expansion, and this makes Boston and other similar blue metro areas much more "boom and bust" prone than Atlanta or St. Louis.

"What magical thing is going to happen in the future that justifies a doubling of price in five years?"

Easy. Massive, runaway inflation. At least, that's more likely than any of the alternatives. =)

What can one do in a housing bubble except wait it out if one does not own, and sell and rent if one does?

Assuming the bubble ever ends. When in the last fifteen years has the San Francisco Bay area (to pick a market I know well enough that I moved away to find affordable housing) NOT been dramatically overpriced by any traditional measure?

In the case of San Diego, I think it plausible, though I don't actually know the area well enough to know, that it's slowly tipping from being a "red" county to a "blue" county, it's also instituted a lot of growth-controlling regulation. If that is the case, then the recent runup in prices will eventually reach equilibrium at a new, higher level, and price inflation will slow to match other indicators.

In the San Francisco Bay Area, prices have not inreased quite so rapidly in the past year or so, as the boom in per-household income has slowed, and mortgage rates have risen. But house prices are sticky, because lots of people have a choice over whether and when they sell, so prices didn't drop much during the worst of the dot-com crash even though rents fell precipitously in some areas.

I'll take issue with Delano's comment that he right price is the one that's right for you. That's true when you're buying something individualized that you plan to keep - for example a piece of clothing or perhaps a gas-powered hot tub.
The problem is, this falls down with items that you will eventually need to resell - things like houses, and stock.
In those cases, you do need to pay attention to what others are paying and whether you think you're in the middle of a bubble.

When 1200 square feet on gentrifying Pearl St. in Denver starts at $800,000, housing is definitely overpriced. However, there's another reason that house values have jumped: The cost of building materials has doubled or even tripled in the past 10 years. This is partially due to government regulation: Believe it or not, they use helicopters to fly logs off the mountain here because it's so difficult to get a permit from the Forest Service to build a road; that's got to be expensive. It also seems to be partially due to heightened demand for materials resulting from all the damage done of late by hurricanes and other natural disasters (plywood can be hard to get when all the folks in Florida and along the gulf coast are decorating their windows with it). I hear we're also shipping an incredible amount of building material to Afghanistan and Iraq, and I'd bet that improving economies elsewhere in the world are increasing demand as well.

Still, IIRC the cost of materials and construction didn't figure into the price of that bungalow on Pearl St. It was featured in a recent DenverPost article because someone wanted to buy it to tear it down and build a McMansion -- they were willing to pay $800,000 for the bleedin' lot! An odd situation indeed.

The federal tax treatment for homes makes home ownership very attractive, and supposedly raises housing prices around 33% from what it would be without the mortgage rate deduction, property tax deduction, etc...

Toxic

I'm interested in the stat that claims the mortgage deduction increases the price of a home by 33 percent. I read a book that, in passing,claimsthevalue of same has diminished.

Well the theory goes that because of the interest mortgage deduction, the tax free sale of homes up to 1,000,000, etc... that the price rises becuase it allows more people to buy, and to buy bigger houses. Which of course raises prices both by increasing demand and increasing the quality and size of the homes. Low interest rates also play a role, since they also allow a buyer to buy a home that he couldn't afford otherwise.

Let's say a married couple has a gross income of 50000 (except for the mortgage interest). That's an initial tax burden of 9,203 in federal income taxes. They're in the 28% tax bracket. Let's say they buy a house and pay 600 dollars in interest on the mortgage payment of 900 a month. That amounts to $7200 in interest a year. They deduct that from their gross income. They're tax burden is now 7107. (trust me on the math) They save 2,096 a year. If you distribute that towards their payment, their effective monthly housing payment is 725.33. In other words, they can buy a house for less that it would cost to rent it. Also, any increase in value is tax free up to a millon as long as they stay there for two years. They can deduct the property taxes assessed against the house. It's a pretty sweet deal, and especially at the start of a mortgage, there would be even more interest and so they would save even more. The higher their tax bracket, the more they save. Someone who made 150,000 would save 2592 on the same mortgage, making their effective housing payment $684 a month.

So I don't see how it could lower market prices. It lowers the price for the individual--- but I suspect much of that savings results in higher prices in the market.

Spencer,

It seems to me that if you add pretty strong economic growth, a period of low interest rates, tax subsidies (housing must be one of the most tax advantaged assets around), and population growth to even moderately more restrictive regulation of new development you'll get some pretty strong price increases. Regulation isn't the only factor but it is an important one. I think it's difficult to argue that the regulatory environment hasn't made it more difficult to develop single family housing in the northeast and in California.

The article a few weeks back in the NYT Magazine about Toll Brothers documents some of the changes in the regulatory environment in NJ over the past 15-20 years if I recall correctly.

The insistence on seeing housing in financial investment terms sure makes things complicated for those of us who like being hip urbanites but don't earn endless sums of cash, eh wot, Jane Galt?

application cost insurance life low no

Odd, all the posts that mention price appreciation assume that the current owners are happy with the sudden run up in prices. Maybe I'm the oddball, but I'm not happy that my property taxes have increased 150% in the last 5 years simply because my new neighbors paid too much for the honor of living by me.

What magical thing is going to happen in the future that justifies a doubling of price in five years?

Doubling? Try tripling, here in OC.

Economic fundamentals -- increasing pressure on limited supply, lower interest rates, tax changes -- did have an effect on the price inflation of the past five years. They started the ball rolling.

What happened then was that speculative purchaser demand and an enabling lending industry proceeded to rocket prices into bubble territory. Once prices started rising year after year, rising prices became a self-fulfilling prophecy: They convinced millions of people that real estate is a no-lose investment (thus increasing potential demand) and caused banks to make insane exotic loans (option ARM, no-doc, 100% financing, etc.) confident that even if the homeowner didn't have any equity reserve at closing, he'd have 20% or more equity the next year. (The increasing securitization of mortgages also has much to do with this -- which adds yet another layer to the mess, given the mess with Fannie Mae's accounting.)

American investors, I believe, have become trained to stampede from one bubble to the next. Once hot-area real estate looked to be the Next Big Thing, money rushed in its direction.

A note: If tight housing supplies were the reason for price appreciation, then I wouldn't be able to rent a house for less than half what it would cost to finance the $1,000,000 price it would be listed at. (Or would have been listed at three months ago -- inventory here has shot up dramatically since the end of summer, and nothing's selling.) A true imbalance between non-speculative demand for housing and the supply would have had a roughly proportional impact on rents as on ownership costs.

Ultimately, the cumulative value of the housing stock sold in an area has to match the cumulative purchasing power of the potential buyers there. (We've avoided that reckoning for awhile thanks to instruments that artifically inflate people's purchasing power, such as no-doc loans and negative-amortization payment schedules -- but those things will come to a screeching halt once it's clear rapid price appreciation is a thing of the past.)

CuriousTexan -

Us Californians have it easy, thanks to Prop 13, lo these 27 years ago. Tax assessments cannot increase more than 2% per year, except when improvements are made or the property is sold. Improvements only increase the assessment by the cost of the improvments. My parents bought their current house in 1986; their assessed value is 45% higher than the price they paid, despite that they might be able to sell it for about three times the price they paid. Neighbors who bought a similar house recently will be paying twice or more the property taxes my parents are paying.

On the topic of markets, and how human perceptions impact trading...

When you get a chance, please look over my thought at:

* http://dardashti.blogspot.com/2005/11/value-investing-in-2005-is-not.html

...You might want to share these observations (both mine and the site's comments...) with your readers.

Best regards,
Shai Dardashti

===

Editor, Shai Dardashti on Grahamian Value
www.ShaiDardashti.com

PB writes: "If one's neighbors are rational, they'll tend to give town approval to ofice developments and the odd small retail facility. But housing construction is increasingly frowned upon, and inevitably is met with complaints about traffic, and is sometimes stopped dead in its tracks, or sharply zoned downwards in scope (usually by minimum lot size requirements). "

Ah, then you've missed the trend of towns favoring the construction of age-restricted developments.

Houses for empty nesters, 50+ only, no kids, but young enough that they get out and shop, and don't put much burden on the town's services for the elderly.

Winterspeak,

I'm a little sceptical about the housing futures you've referenced. The problem comes in with the reference entity. To develop a liquid market, it will need a decent reference entity that allows for standardized contracts. This implies using some sort of national index. Unfortunately, the use of a national index seems like it would introduce a lot of basis risk for hedging purposes. I can easily see the index underhedging markets like San Francisco, while overhedging markets like Peoria.

Any thoughts?

Bill:

Good question. The proposed financial instruments consist of Indices for Boston, Chicago,
Denver, Las Vegas, Los Angeles, Miami,
New York Commuter Area, San Diego,
San Francisco, Washington DC and
Composite Index of the 10 cities Cash Settlement. So, not everywhere, but a good start. Overall, I think people would be more interested in a regional index rather than a national one. But I don't think the reference entity is going to be the problem.

I *do* think the pricing of the financial instruments will be a problem. I think right now they plan to update the price once a quarter, and I don't think that will be often enough.

Winterspeak,

Thanks for the feedback. I should have followed the link beyond the first page. Sorry. Actually, I'm not so sure pricing will be a problem. CDX prices with a fairly narrow spread and individual contracts never get repriced.

Hi all - In regards to the suggestion that over-regulation has caused the San Diego housing runup, this just is not the case. The supply of housing has pretty well kept pace with growth in population over the past few years--and at this point (thanks to the bubble) new home supply is outpacing population growth.

Great site, btw.

rich

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