That's More Like It

Submitted by Rich Toscano on July 13, 2006 - 9:37pm

Since I mentioned yesterday that I was surprised at the sanguine tone of the UT article on the median price drop, I must in fairness mention that (as suspected) they came out with an expanded and more gloomily-titled piece today.

While I'm here, I can't help but comment on a couple of sections from the article. This:

San Diego real estate agent Calvin Goad, who represents the Fleischmanns, says the region is experiencing a normal cycle of decline following a boom. “The prices are coming down right now, but it is a good time for the buyer to jump into the market,” he said. “San Diego historically does take a small drop in price, but then the market levels.” simply outrageous. The "normal cycle of decline" is pictured here:

When adjusted for wage growth, San Diego housing has given back all of its boom-time gains in both of the prior downturns. Wages are now rising at around 5% per annum. So assuming (as this gentleman apparently does) that this "cycle of decline" will follow prior patterns, the decline has a very long way to go, either in terms of duration, price, or some combination thereof. I am just astonished that, of all the possible rationales for buying now, someone would actually try to invoke prior downturns.

Second, I note that the article points out the following:

Single-family resale houses, more than half of the local housing market, showed a price gain of 1.8 percent over June of last year, DataQuick found. The median price last month in the category reached $565,000, a slight decline from May's record of $569,500.

The fact that single family home medians peaked last month may well become the new life raft with which the permabulls try to keep their theories afloat. I imagine that resale single family residences will suddenly become the only property type that is meaningful.

However, the Case-Shiller home price index, which tracks actual paired sales and thus reflects pricing power better than the median price, shows that so far resale single family home prices have yet to regain their November peak. So while they will no doubt try to find a way to drink this data pretty, there is really no question that prices are on the decline.

(category: )

Submitted by rrmarks on July 13, 2006 - 10:10pm.

The top of the climb on the roller coaster ride is a decidedly tranquil experience. Nice view at the top. What comes next is the "pucker up" moment. The race to the bottom is terrifying.

The UT came out from underneath the ether today. Their grasp of the obvious is very impressive.

Submitted by powayseller on July 14, 2006 - 5:59am.

I went ahead and forwarded your story to the U-T reporters. It strikes me as odd that WE are educating THEM. Isn't that backwards??

Submitted by Downtowner on July 14, 2006 - 8:43am.

Yes, the comment from Calvin Goad that "now is a great time for buyers to jump into the market" was particularly funny to me. This is like a ticket broker selling trips on the Titanic after it has hit the iceberg! When will the SD UT understand that quoting real estate agents as "market experts" is not objective or unbiased reporting?

Submitted by Lickitysplit on July 14, 2006 - 8:50am.

This is like a ticket broker selling trips on the Titanic after it has hit the iceberg!

lol... I used the exact same analogy yesterday when a good friend said her parents are in town this weekned and want to spend their time looking at real estate as retirement property.

Submitted by PD on July 14, 2006 - 9:00am.

Hey, I have a great deck chair for you. Afterall, can't you hear the band still playing?

Submitted by reanalyst on July 14, 2006 - 11:21am.

This has to be one of the most frightening graphs that I have ever seen. I don't own a home but it puts a pit in my stomach for those that do and especially those who bought near or at the top of the peak. I know, I know spare me the "they get what they deserve for being so stupid and/or greedy" comments. I think there are many who just had no idea and really bought into the thing because of all the hype, I almost bought into it at one time in 2002-2003 when I got bitten by the house bug, but thankfully things got a little soft that year and that's when I really began to wonder if this thing was sustainable. The market coming down now makes me feel better about my financial conservatism but I feel bad for many family members and friends, including a brother-in-law that just bought a home in Murrieta last month. He jumped on a $50,000 reduction. The neighborhood is still dark. He wonders if he got in to soon, all I can do now is reassure him that if he lives in it long enough, he should be ok. (He probably doesn't realize that I'm talking about somewhere around 10 years.)

I think this graph could be useful for predicting a bottom. What do you think?

-re analyst

Submitted by powayseller on July 14, 2006 - 11:29am.

I used this graph to predict a bottom of 50% off, and sold my house.

Submitted by CAwireman on July 14, 2006 - 11:58am.

What good commentary on the quote from Calvin Goad. I wish I'd posted it first.

Submitted by reanalyst on July 14, 2006 - 12:08pm.

Where does this graph come from? And what does it actually show? Median home price to median income? I'm trying to understand this graph better.

-re analyst

Submitted by powayseller on July 14, 2006 - 2:21pm.

Rich is very busy, so I'll expand on this. Housing prices are sustained by the fundamentals: wages. Historically, housing prices are a multiple of wages of an area, a different multiple for different cities. In SD, the multiple is higher due to the sunshine tax. I think it is around 6.

Now, our multiple is 9. To get back to the median of 6, wages must rise or home prices must fall, or a combination of both. The global economy has put downward pressure on wages, and it is unlikely that wages will rise more than 1% annually. Wages have been flat for over 5 years. Thus, it is more likely that housing prices must fall.

If you study the hundreds of asset bubbles around the world the past hundreds of years, they ALL revert to the mean. The most wellknown bubble is the tulipmania, where the Dutch paid up to $1 million in today's dollars for a single tulip bulb. Other bubbles were railroad stocks in the early 1900's, the Nifty Fifty in the 1950's, the Japan housing bubble (bigger than ours and crashed for 18 years and is just now recovering) the 1990's US stock market bubble, and now the global housing bubble (yes, it's global).

So the housing prices are higher than our wages can support, and people had to get exotic loans to afford houses. When these loans adjust, and payments go up 30-80%, borrowers will have to sell or be foreclosed, since they are maxed out on their mortgage payment at the introductory rate. No way can they handle the new rate. It was made possible by 1% federal funds rate. Mortgages were tied to this rate and the LIBOR, instead of the 30 year bond market.

This graph also shows you that historically, Sd housing prices were a certain multiple, 6, of median income. This is the median to which we will revert. Thus, to me, it shows a 50% price drop. If you think wages will grow a lot, then we could get a 30% price drop along with a big increase in wages.

Submitted by rrmarks on July 14, 2006 - 2:40pm.

That is exactly right. I recall the SD multiple was 7 from another thread by Rich but I could be mistaken. There is one other element in the mix. Time. Real estate is a very large cyclical and it always moves the same way. The run-up took years and the slide will take years. If something skyrockets quickly it falls the same way. Real Estate is the classic bell curve. We are at the beginning of the downward slope.

Growth in real wages also has an historical mean. Over the last 30 years they have grown about 4% per year. They have been flat for most of this decade. Assuming a resumption of historical wage growth (yeah right) over the next five years then the median home price will drop about 30% over the same period to restore the historical balance.

I think what is fundamentally different this time that has no historical precedent in prior market shifts is the impact of vast pools of mortgages with adjustable rates. This can change the borrower's situation overnight from uncomfortable to untenable.

Submitted by rankandfile on July 14, 2006 - 3:17pm.

I can't help but scratch my head at the lofty expectations that most sellers have these days. They see their mediocre home increase by $400k in 5 years and they are nearly in tears because they have had to reduce their selling price by $20k to entice (bait) buyers. Give me a break! I am tempted to tell all of these people to take their selling price, cut it in half, and then we can start talking.

Submitted by Downtowner on July 14, 2006 - 4:24pm.

Yes, I agree!  I sometimes get very upset/offended by how sellers still think they can get top $$.  I recently decided to sign up on "interest lists" for a couple of new high-rise developments (Sapphire Tower & Breeza) because I was curious to see if developers have started to get realistic with their pricing.  Well, to no one's surprise here, both sent price lists that were as if they had the only inventory on the market in the next 3 years!  I replied back that I could easily find 100's of listing priced at 20-30% less on the MLS that were of similar size, location, amenities and asked if they were going to adjust prices accordingly.  I was basically ignored, one acted as if I had never emailed and asked for my phone# so they could setup a meeting.  It will be very interesting to see what these new developments downtown do when prices continue to fall.     

Submitted by CA renter on July 14, 2006 - 5:14pm.

I was so upset about this part of the article, I also e-mailed Mr. Pierce. Here is my e-mail:
Mr. Pierce,

Thank you for your article about the slowing housing market. There is one glaring piece of misinformation, though, in the following paragraph:

“We are seeing an increase of inventories to normal levels, but it has dramatically changed the psychology of the market,” said Leslie Appleton-Young, chief economist for the California Association of Realtors. “Buyers have more properties to look at, more time to decide.

Inventory levels are nowhere near normal. They are well above the record highs experienced during the depths of the last downturn. According to some, they are above record levels even adjusted for population (increased since last downturn).

It would be interesting to examine why we have record inventory levels at the **beginning** of a downturn. Is this indicative of how this cycle will play out (much more extreme movements up and down)? Does this mean the price declines are hidden in the swollen inventory, and that the declines are much greater than most could possibly have expected?

Thank you for your attention in this matter.


Submitted by SD Realtor on July 14, 2006 - 5:38pm.

This site is so addicting...

The graph provided was one of the most useful tools I have seen. I have yet to see a tool that actually gave any quantitative number of the runup in such a simple display. What is debatable is where will the bottom be. Personally I do not think it will be back down at a multiple of 6/7 (Geez I hope not) but one never knows.

Earlier replies to this thread bear discussion. To be specific, the mainstream media ALWAYs interviews Dataquick analysts, CAR, NAR or SDAR officials, and even local brokers for thier spin on things. Occasionally they take snippets from UCLA economists of other members of academia and these are usually the more realistic answers. Of course these people frequently are painted in a paranoid light. I to would be happy to see more people like Rich or Will get interviewed. When will first called me a few months back I had so many stories of distress BACK THEN, I didn't know which to give to him. Should I have given him the young couple in a UC condo that was not selling at 25k BELOW the price they purchased in 2004? Should I give him the client a La Jolla Regents who sold for 80k LESS then she bought it for just 8 months ago? Should I give him the couple in Mira Mesa who had to move out of thier condo and in with thier parents as they couldn't keep up with thier ARM?

It saddens me to see the data manipulated... I really feel that the organizations (of which I am a member of!) would help break this haze that sellers have by reporting the data correctly. The bottom line is that if you price your house right, it will sell! I had a lady in Escondido and she got it right. She priced her home 10% below everyone else and her house sold in 2 weeks. She HAD to cuz she was moving but what the heck.

Food for thought:

1 - I RENT. Accumulate cash right now if you can. Renting will not kill you. Cash in a CD will most likely outperform alot (but not all) of the zip codes in town

2 - If you do buy, think about learning some of the facts about foreclosures, buyer in distress, notices of defaults and such. I know it is kind of a pain to do...I just had a buyer who signed up for RealtyTrac and they ended up getting a home 70k under the recent comps in a very nice neighborhood....

3 - If you do buy, don't be afraid to walk away. I promise you something as good or better will come along. Sometimes the best deals are the ones you don't make.

4 - DONT Speculate, at least not here in San Diego. Go to North Carolina or other hot markets in the USA. There are plenty of them out there. San Diego isn't one of them.

5 - If you do buy, make sure you can afford it, and be prepared to stay in your home for awhile. Make sure you find out what the seller paid for the home when they bought it. Make sure you have your realtor show you the comps for the neighborhood BEFORE you submit an offer. Also check out recently expireds, cancelleds, and withdrawns in the neighborhood.

6 - If you do buy ASK YOUR REALTOR FOR A CREDIT. He can take it out of his commission. If he says he cannot then that is not true. I do it all the time.

7 - Don't be afraid to look at recently expired, cancelled or withdrawn listings. Have your realtor call them up or send an unsolicited offer. You just never know.

8 - Even if you are looking at new properties from developers, don't be afraid to get an agent. The developer will not change the price on you. The agent will get a commission. See corollary 6 above and get yourself some of that cash.

Submitted by JWM in SD on July 14, 2006 - 7:25pm.

They get upset because a good many of them have pulled a lot of equity out of their home through refinancing and now owe far more than the original purchase price.

Submitted by powayseller on July 15, 2006 - 8:28am.

SD Realtor, here's another one that is a combination of another realtor's idea, and what happened to me to make me settle on a lower offer:

9 - Don't fall in love with one house. Write up 3 offers and put them in a desk. Take the first offer, at 10% - 20% below market price to Seller #1, say, "This is a firm and final offer and I have 2 other houses I am going to make an offer on if you counter". Give them 24 hours in the contract. If they counter, tell them, "I told you this is firm and final. If you insist to counter, we move on". They will cave. If not, go on to offer #2, and so on. You will get lucky on one of the three. The buyer has to decide on 3 houses before the first offer is written, so he is not emotionally attached to the outcome of any one.

The updated graph is much easier to read. Historically we are at a ratio of 7-9, and now at 14. Far to fall. Why shouldn't we go back to 7? What would prevent it? Why is this time different?

Submitted by Daniel on July 15, 2006 - 11:55am.


It could indeed fall that far, but it could stabilize higher as well. Long-term house prices, like stocks, depend primarily on 3 things: earnings (i.e. rents, which are usually proportional to salaries), earnings growth (i.e local rent or wage inflation), and interest rates. Someone can make some educated assumptions about rents, salaries, and their growth over time. But long-term interest rates are very hard to predict. Everybody thinks they're going up (twin deficits, inflation fears, etc), but they've been stubbornly low for awhile. Much lower than in decades past, which makes equilibrium asset prices higher. Stocks are still very expensive historically, primarily because of low long-term rates. So, as Rich says, there is "risk of a substantial price decline", but not a guarantee. If the entire world goes into recession, long-term rates drop to 3%, but, by some miracle, the SD economy chugs along at 10% growth, then local house prices would get a big boost. (Note: I said "miracle"; such a scenario is nothing more than a theoretical fantasy that I used to make my point).


Submitted by powayseller on July 15, 2006 - 12:51pm.

These interest rates were the lowest in our history, right? Before that, it was 5% in the 1960's. What would make them get that low again?

Wages have been flat, due to global trade. How can they rise? We have competition from China, where people work for $3/day. We buy more and more of our goods from China, and less from ourselves, because we cannot compete with their wages. These cheap goods have kept inflation low, but it cannot get any lower.

Peak oil is causing oil prices to really rise, and I doubt it will ever get below $70 again.

Housing prices do NOT depend on rents at all. Usually, rent and housing move inversely. Housing prices depend on wages and lax lending and interest rates. If you think this time is different, then you'd have to explain why. Have you ever heard of an asset bubble which started correcting, only to reverse course? Ever? I need only one example, please. I'd also like one example, just one, of an asset bubble that did not correct, but reached a permanently high plateau.

The excesses that create bubbles are not sustainable, so when they reverse, and psychology changes, the downfall gets going. The new psychology picks up steam, and the asset reverts to its mean value.

In this case, mean value is a multiple of 6 x earnings. If you want housing prices to stay high, you've got to bring up earnings. How to do that? The Fed is fighting goods inflation, and preventing wage inflation by raising interest rates. How can you fight the Fed?

Will the Fed reverse interest rates next year to stimulate? Maybe, maybe not. Not, if oil and commodities prices stay high, as is likely.

By next year, so many lenders will be in bankruptcy, that even if rates are back to 5%, you will need 20% down and prove your income. No more funny money loans. That ALONE will pop the bubble the rest of the way.

Investors will lose so much money in foreclosed ARMs, they will demand risk premiums for high risk loans. With the new lending standards, high prices CANNOT be sustained.

This is a landslide, and it cannot be stopped.

Submitted by Daniel on July 16, 2006 - 12:46pm.


I respectfully disagree with a few of the things you're saying, although I do agree with most of them. Before I start, let me say that I read this site and a few others (Ben's and Jim's blogs) fairly often, but I don't post very much. So I feel that I need to "introduce myself": like you, I'm a RE bear, like you, I rent, and, also probably like you, I am privileged to have a substantial liquid net worth. However, unlike you, I don't believe that a very deep downturn is certain. I think a downturn is likely, and there are substantial risks that it will be deep, but I don't believe that's a foregone conclusion. My view is somewhat similar to that of UCLA economists or with Don Kohn's: "homebuyers should not expect that all recent equity gains will endure". Some gains will be given back, but it's not yet clear how much.

I should also say that I don't think that "this time is different", or that we reached "a permanently high plateau". My statement is that, in the long run, it is very possible to have price/income ratios higher than the average over the past couple of decades (8, I think). Not as high as today (15), I never said that. Today is extreme, and the ratio will go down. But the long-term ratio may be higher than that in the 80s and 90s.

Again, this has to do with long-term rates. Let me assure you that nobody, neither you nor I, knows what long-term rates we'll have in the future. We had ~5% rates for several decades, then we had ~10% for decades, and we again have 5%. If someone KNEW where long rates were headed, that someone wouldn't bother with RE, he/she would make an absolute killing in the bond market. While it is wrong to assume that rates will stay at 5% forever, it is equally wrong to assume that they are destined to go back to 80s levels.

Regarding rents, our disagreement seems very wide, but perhaps we're talking about different things. I talk about long-term trends (decades), where rents are the main driver of house prices, and I'll explain why. You talk about the short-term, where lending standards and human psychology matter a lot. In the short term, rents and house prices can move differently, due to psychology, but this is just noise in the long-term trend. The truth is that rents matter a lot. If one could rent a nice house in SD for $50/month, nobody would buy. If one could rent one for $50,000/month, I would leverage myself to buy my entire neighborhood. Also, rents are more closely tied to house prices than incomes. To my knowledge, there is no city in the world that has very low rents and very high prices, or the other way around. But there are many cities with very high historical rent/income AND price/income ratios (Tokyo, Manhattan, Oslo), and some with very low historical ratios (Dallas, St Louis, etc). The reason is what you call the "sunshine tax", and what I prefer to call the "zoning tax". It means that people in cities constrained by geography or slow-growth policies pay a larger share of their paycheck towards housing (either rental or owned).

Finally, let me play a bit of devil's advocate on SD's market. Buried in Rich's graphs is an alarming trend for us bears: SD rents have increased at a very fast clip (6%) for a couple of decades. This is huge. A trend of fast-rising rents puts a solid floor under house prices. And this is not a one-time event, it's a pretty damn long-term trend. It says that SD is becoming more constrained (either by geography or policy), and that the long-term price/income equilibrium might be higher than in the past.

Again, let me say that I think prices will go down, and my hat is off to you for the timely sale of your property. We only disagree on the extent and likelihood of the downturn.

Submitted by powayseller on July 16, 2006 - 2:57pm.

I don't see the relationship between house prices and rents. Rents are dependent on income/wages, but house prices are also dependent on interest rates and lending policy.

Rents are 40% of CPI, so now that housing prices are so high and interest rates are rising, more people are turning to rents, driving up rents. So this trend will continue.

A reversion to the mean mean housing prices must revert to 7 times income. There is a 1% likelihood of income rising more than 4% annually, in my opinion. Why? Because of free trade, and the booming economies of Chindia (China and India). The SD economy has no prospects, and about70% of hiring in the past 5 years is construction, real estate, lending, retail and restaurants and other sectors benefitting from MEW. These jobs will mostly go away, and we will go back to 2001 employment levels in those sectors. Biotech is not bighere yet, you'd have to go to Thousand Oaks or North Carolina to be in the booming biotech towns. So, what are our wage prospects in San Diego? They are bleak, and wage growth is likely to be flat for many years to come.

I have no landlord or investor experience. I look forward to learning more about what you are saying. I don't understand your point, I am sorry.

I love a good debate, and I am grateful for the time you took to exchange your ideas with me. I hope I can stay open minded to new ideas, and not be so locked into my way of thinking. It is when we get locked in, that we get blindsided. So please don't apologize for disagreeing with me.

Submitted by reanalyst on July 17, 2006 - 4:21pm.

Thanks Rich, for updating the graph, I understood the logic behind it but not the numbers (you were right it was the percentages that were throwing me off). Love the site by the way and I saw your article in the LA Times, it's already floating around the net (being that San Diego has been the bellwhether for nation during this bubble), congrats.

I've been lurking on this site for about a month and a half now and have just started posting. Lifetime California resident, renter and SD resident for 4 years now. BA's in Economics and Political Science from UCSD. I've been working as a Real Estate Analyst and Land Search Specialist for the past year. Although I love working in real estate, I've decided to make a career change (At least for the time being). I've begun to realize just how deeply the financial and housing bubbles are going to cut. It's nice to have like-minded individuals to bounce ideas off of, and it helps me to realize that I'm not imagining it all. Good to be here.

-re analyst

Submitted by edna_mode on July 18, 2006 - 3:43pm.

_Against the Gods: The Remarkable Story of Risk_ (Peter L. Bernstein) is an excellent readable book about the history of risk. I believe it is pertinent to the discussion between Daniel and powayseller. "Clouds of vagueness" pervade our ability to make predictions and choices; specifically, while reversion to the mean does occur, 1) it may take a lot longer than one thinks (for example, flipping a coin and getting heads 50 times in a row does not change the odds that my immediate next throw still is independent of the previous 50 and thus, I still have a 1:2 chance that that specific throw will come up heads, the Law of Large Numbers notwithstanding); and 2) sometimes fundamental circumstances really do change the mean to a new metastable state. For example, just because the mean for SD price/wages has been 7 is not any guarantee that a disequilibrium has not occurred recently (hidden during the huge runup) that may not cause the new mean to be a different number. When we add the data that we will collect over the next 10 years to the Professor's plot, we might get a linear regression that passes the "fat pencil test" where the mean is 5.5 or 9.2.

It all depends on how fat your pencil is...

Submitted by rrmarks on July 18, 2006 - 3:51pm.

Well put Edna. Navigating in this market is essentially like driving your car through the rear view mirror. You still don't know what is around the next corner.

Submitted by powayseller on July 18, 2006 - 5:25pm.

A study about the last 400 bubbles, found that EVERY one corrected to the mean. I will start a thread about this later today. People ALWAYS think it is different this time for reason xyz, but it is not. Think of a bubble like a pendulum, which cannot stay at the right; it must swing back. It is a law of nature for excesses to correct. "For every action there is an equal and opposite reaction" is a physics prinicple, which applies as well to financial markets.

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