That looks kinda like a bubble, huh?

Real house prices since 1870

There are two basic factors that could cause such a spike: either it's a bubble, or fundamentals have changed. Both are probably in play here - speculation tends to be fueled by initial real gains. The main fundamental that comes to mind is the recent low interest rates, but there are probably more. As a homeowner, I'd hate to think we were in a bubble...but the graph is rather suspicious. It seems rather unlikely that fundamentals have chagned *that* much. On the other hand, its not like there are past bubbles on the graph (unlike the stock market) - if bubbles can happen, why not before now?

NYTimes article, reg required. Via OpenKnowledge.

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"As for those claiming

"As for those claiming we’re in a bubble, why not short housing? That’s a great thing about the market, if you know something is over-valued you can make a profit off of it by taking a short position with it."

Oh, there are people doing that--shorting housing stocks (TOL, RYL, BZH, KBH, CTX, PHM, etc.), buying put options and LEAPs, and even creating housing bubble hedge funds... and they're also selling off their long positions in housing, along with the insiders.

BTW, the _Financial Times_ just reported UK housing wealth declined by 60 billion pounds last quarter (though there's some less gloomy news in the last paragraph about the expected rate of home value declines--betting on 2.3% decline by March 2006 instead of 9% decline):
http://news.ft.com/cms/s/3af905d2-1116-11da-adc0-00000e2511c8.html

From the NYT

From the NYT article:

---
"Shiller is predicting the mountain goes into the sea," Robert I. Toll, the chief executive of Toll Brothers, a home builder, said in a recent interview, without having been asked about the economist. "He's selling himself."
---

Ironically, Robert Toll is also selling himself, or at least his shares in his company:
http://finance.yahoo.com/q/it?s=TOL

He's dumped a lot of stock since late June 2005, as has his brother Bruce; insiders have sold 5.6M shares in the last six months (most of that in the last two), and purchased none. TOL has been declining along with the other homebuilders since peaking in late July; it's about 19% off its 52-week high at the moment. Toll's no dummy.

I don't think there's much

I don't think there's much question at this point that there's a bubble, and that a lot of people (especially those speculating using negative amortizing, interest-only ARM loans) are going to lose their shirts. Condo prices in some markets (downtown San Diego, southern Florida) have shown some declines already. The UK and Australia seem to be somewhat ahead of the U.S. in terms of slowing rate of appreciation (and I think they've already seen some year-over-year price erosion).

This is not unprecedented--there were significant price declines in California in the early nineties; Japan's real estate prices have been declining for the last decade and are showing signs of possible recovery at long last. The Economist had a good article on a U.S. real estate bubble which may be found here (check out the last graph, which overlays U.S., UK, and Australian home prices 1995-2005 on top of Japan home prices 1980-2005): http://www.economist.com/finance/displayStory.cfm?story_id=4079027

There's a blog focusing on evidence of the housing bubble popping, at thehousingbubble2.blogspot.com. Ben Jones, who runs it, tends to be selective (biased towards "there is a bubble" reporting), but there's much useful information there if you can get past all of the comments from the financially ignorant.

Stephan: "The homes are real

Stephan: "The homes are real phyisical objects which we can easily inspect and analyse before we invest many hundreds of thousands of dollars in them."

Homes are real physical assets. So are companies. If you look at what is actually happening in many areas, there are speculators buying homes sight unseen, with no intent of ever living in them, simply because they believe they will be able to "flip" them with enormous appreciation in a very short amount of time. I bought my house in south Phoenix in 2001, when it was surrounded by orange groves. Those have all been filled in with housing developments, entire streets of which had "for rent" signs in front of them as soon as they were completed. There are now "for sale by owner" signs all over the place, and a lot of vacant property. And this is in the #1 city for population growth for the last year, that actually has growing demand for housing--but inventories are on the rise as they are being built much faster than demand. BTW, for more evidence of a housing bubble, look at the rise in homebuilder stocks (and the insider sales), as well as the financial filings of companies like Countrywide Home Loans (doing more loans--with an increasing number of high-risk loans, but making less money doing it). They're chasing bad loan risks because they don't expect to be left holding the bag--sound familiar?

Someone making less than $50,000 should not be able to get a $500,000 negative amortizing loan, yet there are lenders offering such things, and even offering no doc loans (no proof of income required). I've heard that option ARMs account for the majority of new home loans in California. It's clear that many of the people getting these loans don't understand them, and think "my interest rate can only change 2% a year" means "my monthly payment can only change 2% a year"--they'll be very surprised when they see their monthly payment jump by a double-digit percentage.

Matt:
"The advantage that the people in the Neg Amshave is that they didn’t treat their home as a store of wealth and if they get foreclosed upon their loss isn’t that great."

Do you advocate that they walk away if they end up underwater? (And Stephan--if people are prepared to walk away so readily, they aren't buying the home as a home, they're buying it as a speculative investment.) If they have a second mortgage or HELOC (which many people are doing to avoid PMI without putting any money down--they take out a first mortgage for 80% and a second for the remaining 20%), they can be on the hook for the difference (via deficiency judgment) between what the bank can sell the home for and what they owe. If people successfully walk away, then its the lenders holding the bag (probably holders of mortgage-backed securities getting hit the hardest).

IMHO, the main advantages of owning a home include having fixed living expenses, having it paid off by retirement to greatly reduce living expenses, and not dealing with a landlord. I disagree with your analysis--pulling equity out of a home is using a home as an ATM and a source of (but not store of) wealth, and in a speculative bubble, that's wealth that is likely to vaporize and leave a lot of people out in the cold when it does.

Stephan- This is not usually

Stephan-

This is not usually the case with the housing market, The homes are real phyisical objects which we can easily inspect and analyse before we invest many hundreds of thousands of dollars in them. Their price is sually based on the varied conditions of the local neighborhood or particular region. The value is more directly calculable and much more in step with the price. Thus, I doubt a “buddble” is the case.

No doubt this difference has an effect (I discuss it a bit in my above post) but I think the housing market is still susceptible to such bubbles for two reasons:

a. in the bubble regions of So Cal, it's estimated that speculative housing purchases may account for as much as 50% of the residential real estate transactions for the last few years- this sort of housing purchase is just as susceptible to rampant optimism as is stock investing.

b. The intermediaries in the transaction (brokers) have a tremendous incentive to "push" values for a home via the appraisal, especially during the appraisal and such values are factors in determining the subsequent sale price and subsequent appraisals.

Matt

Rental ptices and home

Rental ptices and home values cannot be expected to track proportionally independent of interest rates. Rental housing is a present good and largely dependent on current demand in the short term. Homes are primarily future goods, and must be discounted to the present, and their present value must be highly sensitive to variations in interest rates. In addition, to the extent that interest rates are low, the affordability of houses reduces the demand for rentals. All of these factors tend to push up home prices relative to rentals when interest rates are low.

that sounds like a reasonable assesment to me.

Matt, Rental ptices and home

Matt,

Rental ptices and home values cannot be expected to track proportionally independent of interest rates. Rental housing is a present good and largely dependent on current demand in the short term. Homes are primarily future goods, and must be discounted to the present, and their present value must be highly sensitive to variations in interest rates. In addition, to the extent that interest rates are low, the affordability of houses reduces the demand for rentals. All of these factors tend to push up home prices relative to rentals when interest rates are low.

Regards, Don

interesting... The bubble

interesting... The bubble is expected to be regional correct? So you may not be in danger unless you live in California. I think what makes it dangerous is the high level of debt that the country has, putting us at risk of a small catastrophe creating a wave of foreclosures which bursts the bubble. I kind of doubt that the bubble will be burst by pure rational value-reassesment, simple because of the nature of a house (the utilitarian function of it mitigating the panic factor to a degree.) What'd be more likely is the foreclosure effect. It's also worth noting that Home Values have far outpaced any increase in Rental prices in many of the boom regions of the US (like the CA coast), which is quite suspicious to me. It does seem like rental prices should increase by approximately the same factor in a non-bubble asset evaluation period. That's just speculation of course, but what isn't at this point?

Matt

Patri, Don't we see two

Patri,

Don't we see two bubbles in the near past, late 70s and late 80s? That jibes with my general recollection of real estate happenings, especially the collapse of land prices in the late 80s after the 1986 tax re-org.

I think what we're seeing here, is that if a twinkie reflects the usual state of the housing market, then what we have is a twinkie the size of manhattan forming. [/ghostbusters]

Low interest rates are not a

Low interest rates are not a necessarily permanent feature, and therefore cannot count as a changed fundamental as much as a transitory stimulus. While they could be around for a long time history hints that this will not be the case. Between the govt deficit, rising energy prices, growing demand in China, a Fed on alert, and other factors, interest rates are set to rise.

I am not registering at the

I am not registering at the New York Times, but I have to wonder a few things:
1. When he inflation adjusted it, did he use the CPI? The CPI uses house prices in its caluclation.
2. Are thouse housing prices, or payments for housing?

Mike, Absolutely the CPI

Mike,

Absolutely the CPI uses monthly housing payments in its calculation, but that isn't disconnected from the price of housing. It's still a circular calculation.

Also, reading this article, it sounds like they're trying to say that this guy is a market oracle because he said there was going to be a stock market bear cycle four years before it happened. Well I'm going to say that there is going to be an earthquake in California, if it happens four years from now, does that make me an earthquake oracle?

As for those claiming we're in a bubble, why not short housing? That's a great thing about the market, if you know something is over-valued you can make a profit off of it by taking a short position with it.

Im rather skeptical of this

Im rather skeptical of this bubble theory. In the stock market, bubbles occur easily largely due to the disconnection between stock prices and the underlying brick and mortar businesses value. Those who buy and sell stocks are often looking at them as pieces of paper that represent growing or declining numbers based on market trend. They forget the actual business that really sets value in the long run, simply becuase its not before their eyes. This is not usually the case with the housing market, The homes are real phyisical objects which we can easily inspect and analyse before we invest many hundreds of thousands of dollars in them. Their price is sually based on the varied conditions of the local neighborhood or particular region. The value is more directly calculable and much more in step with the price. Thus, I doubt a "buddble" is the case. Furthermore, if everyone is saying that there is a bubble then its usually not the case. Most stock bubbles, at least, occur just as their is greatEST optimism and nary a mention of overvaluation.

I don’t think there’s

I don’t think there’s much question at this point that there’s a bubble, and that a lot of people (especially those speculating using negative amortizing, interest-only ARM loans) are going to lose their shirts

this is an area of some contention, but I actually think the people in most danger are the people who've been treating their homes as a store of value and trying to pay extra every month on their 30 year 5.5. The advantage that the people in the Neg Amshave is that they didn't treat their home as a store of wealth and if they get foreclosed upon their loss isn't that great. I used to recommend that my clients in California stay at about 75-85% LTV, refinancing to stay liquid, and invest the proceeds from the Refi into an Index fund. Borrowing money at 5% and investing in something that returns 7% is a sound investment, and if things get bad and their house value goes upside down they won't be wiped out because they've stored value in something more stable and more accesible. I would never advocate a Neg Am loan, of course, but I don't think they're in a worse position than someone in LA who uses their house as their savings account.

Matt

Note on the graph that the

Note on the graph that the price appreciation appears to go north starting in 97 - which is when current tax law surrounding real estate gains went into effect. Basically, homeowners are now exempt from taxes for gains up to $250k, or $500k for a married couple.

This means, starting in 97, you could sell your house for a modest profit and pocket every cent - and of course roll it into your next house purchase. Like the reduced interest rates since 2002, this has had the effect of adding money to the bottom lines of homeowneres.

For further evidence that this is a key fundamental driving housing price appreciation, note that median prices are running away from affordability for first-time buyers. It's the existing homeowners who are taking this post-97 tax break and running the market upwards.

Dave Peterson: 1.Use

Dave Peterson:

1.Use bugmenot for this one and to anyone linking to the NYT, please use the NYT link generator so you readers don't have to go through the bother.

2. You made the same comment about housing prices and the CPI a few months ago, so I'll just link to my reply from then.

You can short the housing

You can short the housing market by shorting the stocks (or buying put options or LEAPs) of real-estate related companies (homebuilders, lenders like Countrywide and Accredited Home Lenders, REITS, etc.).

The short interest in homebuilders has grown substantially over the last few months (e.g., short interest in TOL has increased by 64% since last month).

the price rise in housing

the price rise in housing inversly mirrors the personal debt level charts. they're below or at zero. its a mania combined with socio-economic engineering(phony interest rates purposefully detached from true inflation) and it will end the same way all gov't experiments by do-gooders end. in tears. its ALL credit and money supply.

Jim - thanks for the

Jim - thanks for the agreement. I'm personally somewhat amenable to the arguments that we'll see lower stock returns in the 21st century, I just don't think one data point is an argument :).

Dave suggests: Shorting for home owners is direct: sell it and rent.

That is a small, unleveraged bet with very high transaction costs (the pain of moving, brokers fees, bank fees, etc), and thus does not contradict my claim about the difficulty of shorting housing. The real power of shorts to correct market inefficiencies comes when the smartest and most knowledgeable investors can throw tons of capital on the other side and force prices back in line. If there is a way to do that for houses, I haven't heard of it yet.

"Matt - your response

"Matt - your response “fair enough” to Jim’s comment “There’s no guarantee of 7% return–2005 doesn’t look like a great year for stock index funds so far (S&P 500 is down, total stock market is near zero).” was far too kind, Jim’s comment was not fair at all. It’s one thing to argue based on various complicated ways in which the future is different from the past that stock market returns will decrease. It’s another thing entirely to point to one data point of a high-variance variable as if it means anything at all. Talk about innumeracy!"

Criticism accepted; long-term, the stock market has been a better investment than real estate, by a substantial margin--and above 5% per annum as well.

Matt - your response “fair

Matt - your response “fair enough” to Jim’s comment “There’s no guarantee of 7% return–2005 doesn’t look like a great year for stock index funds so far (S&P 500 is down, total stock market is near zero).” was far too kind, Jim’s comment was not fair at all. It’s one thing to argue based on various complicated ways in which the future is different from the past that stock market returns will decrease. It’s another thing entirely to point to one data point of a high-variance variable as if it means anything at all. Talk about innumeracy!

you're right. No matter how much I invest I always feel like I'm missing some crucial piece of info, so all I was left with was that the savvy investors I had for clients certainly felt that they could consistently yield a better rate of return than the 5.5 average mortgage rate they were getting, and as such liked my proposal.

matt

"I used to recommend that my

"I used to recommend that my clients in California stay at about 75-85% LTV, refinancing to stay liquid, and invest the proceeds from the Refi into an Index fund. Borrowing money at 5% and investing in something that returns 7% is a sound investment ..."

Just to throw in a few more factors, in case anyone is thinking of using this strategy today:

1. The amount borrowed at 5% is larger than the amount being invested at 7%, so you're not really getting a 2% spread. (And unfortunately, most of the money people are taking out of home equity is being spent on consumer goods, not invested.)
2. This description omits fees, maintenance, and property taxes, which can be substantial.
3. A lot of people are using ARMs, so the interest rate on the debt will go up for them.
4. There's no guarantee of 7% return--2005 doesn't look like a great year for stock index funds so far (S&P 500 is down, total stock market is near zero).
5. A 25% increase in home value gets completely wiped out by a 20% decline in home value. (I've seen a lot of people discussing the percentage increases in value in their home in an innumerate way...)

Matt - I will throw out the

Matt - I will throw out the idea that rents will go down before prices go down if one assumes that the height of speculators manifests itself in the form of non-owner occupied properties. This group is trying to make the carry trade - rents pay the mortgage while the property appreciates at a greater rate. If there are enough of them and property values go beyond the reach of most buyers (even with IOs), this glut of rentals will benefit renters before and during pricing adjustments.

Tanner is right on and, in addition, although not a new law, interest paid is tax deductable on 2nd/Vacation homes.

While Stephen is right about the liquidity difference between real estate and stocks, any market can bubble if enough speculators are in it.

One of the biggest causes for the run up in real estate is that interest rates were held too low for too long. Yes, this means that if their is a real estate bubble burst, Alan Greenspan will have gotten it wrong. This should not be a big surprise because it is not the first time the Fed has messed things up.

I'm talking about the

I'm talking about the specific critics shorting housing. I'm weary of experts who don't put their money where their mouths are.

Shorting for home owners is

Shorting for home owners is direct: sell it and rent.

Garth - for those who got

Garth - for those who got long fixed loans, the low interest rates were a permanent feature in their buying decision. But its true that interest rates will change, and that will affect home prices.

Don - Yep, exactly, housing prices are very sensitive to interest rates.

Tanner - fascinating, I didn't know that the capital gains exclusion was so recent (I graduated college in 98), that does seem like a key fundamental. Not only rolling from house to house, but putting money into your house (remodelling or whatever) becomes a better deal, so there are marginal improvements that weren't worth making before that becoome worth making now. So houses get nicer and more expensive.

Jim & Matt had good replies to the "housing can't bubble like stocks" claim.

Dave - shorting housing is not straightforward, unlike stocks. The ways to do it are indirect (at least until Shiller has his wish and there are housing price derivatives being traded in liquid markets)

Matt - your response "fair enough" to Jim's comment "There’s no guarantee of 7% return–2005 doesn’t look like a great year for stock index funds so far (S&P 500 is down, total stock market is near zero)." was far too kind, Jim's comment was not fair at all. It's one thing to argue based on various complicated ways in which the future is different from the past that stock market returns will decrease. It's another thing entirely to point to one data point of a high-variance variable as if it means anything at all. Talk about innumeracy!

1. The amount borrowed at

1. The amount borrowed at 5% is larger than the amount being invested at 7%, so you’re not really getting a 2% spread. (And unfortunately, most of the money people are taking out of home equity is being spent on consumer goods, not invested.)
I'm discussing a cash-out refi in which the additional cash out is invested. It's usually the case that even a cash out refi will get you a lower rate, saving you money in an additional way. It is correct that the additional money you borrow is at a 5% rate, though.

2. This description omits fees, maintenance, and property taxes, which can be substantial.

property taxes shouldn't increase as a result of a higher balance on your home. Fees of course are worth considering- that's a problem that can't be solved in the abstract but is case by case. Nevertheless, I wouldn't always advocate buying a home and incurring these costs just to get the incestment potential (though a case could be made)- rather if a homeowner is at 65% LTV and could benefit from a refi. So maintenance and property taxes are already on the guy's plate.

3. A lot of people are using ARMs, so the interest rate on the debt will go up for them.

right, and one should never go with an ARM unless one is absolutely sure that they will be moving out their house within a period of 5 years or less (because 7 years ARMs don't save you much rate.)

4. There’s no guarantee of 7% return–2005 doesn’t look like a great year for stock index funds so far (S&P 500 is down, total stock market is near zero).
fair enough. The investors I worked with seemed confident they could produce a 6-8% return, and based on these estimates the home loan idea was smart.

5. A 25% increase in home value gets completely wiped out by a 20% decline in home value. (I’ve seen a lot of people discussing the percentage increases in value in their home in an innumerate way…)

sure, but this is an argument for the refi. If you get upside down and/or get foreclosed upon and you've been using your house to save money- you're done for. Having your house assets liquid provides a significant advantage of security.

Matt

That is a small, unleveraged

That is a small, unleveraged bet with very high transaction costs (the pain of moving, brokers fees, bank fees, etc), and thus does not contradict my claim about the difficulty of shorting housing.

But what's the payoff? This guy's graph seems to suggest that, adjusted for inflation, housing prices are 2x what they should be. A correction on a $200k house will bring it down $100k. Selling that and only renting would net you a nice profit if were right about the bubble burst. Sure, it's not a multi-million dollar deal, but you'd have a sweet ROE when it's all said and done.

Also, seeing how some people will trade anything, I wouldn't be surprised if you could find an investor who would pay near market value for your house and let you live in it and pay rent.

The real power of shorts to correct market inefficiencies comes when the smartest and most knowledgeable investors can throw tons of capital on the other side and force prices back in line. If there is a way to do that for houses, I haven’t heard of it yet.

You're right Patri, shorting houses isn't as easy as shorting stocks, but the point is that it can be done and that if we are in a bubble there is a profit to be made from taking the short position, even if only on your own house.

I almost forgot, there's a mortgage trading market. Owning mortgages is just like owning bonds in that when rates go up, prices go down. Plus their long maturity rate makes them very interest sensitive. If part of the bubble is the low interest rates, then shorting mortgages would work.

the problem with shorting

the problem with shorting bubble markets like the NASDAQ or the Nikkei in 89 is they are going to go twice as high as you can possibly believe ,where you just start laughing at the numbers, and you'll be stopped out long before the optimum short point. its a mania , and by definition, unpredictable, usually to the upside.

It's only a problem with

It's only a problem with shorting if you expect nothing but the best possible returns :)