Sunday, May 6, 2018

House prices: hard to believe currently, but they do go down at times

Real estate prices continues to march unabated since the the crash of 2008 - 2012. Many cities (SF Bay area, Seattle) have already crossed the pre-2007 highs (by a lot). San Francisco median price is 2x that of 2007 highs.  Just the equity gains made by residents in SF bay area and Seattle are more than average full time worker salaries. Some of this looks unsustainable. Prices look inflated and there's risk off behavior that assumes that house prices continue going up. Examples such as one shown here indicate that some house prices don't cover even carrying costs (interest + property tax). Is Fear of missing out (FOMO) causing these high prices? 

I don't claim to know how or when prices might get corrected. But now would be a good time to look at prior housing crashes to remember that housing does not always go up. There's no permanent high plateau in finance, and things go in cycles. Some of the risks which caused house price drops in the past may re-appear, or they may not. Or new risks could emerge that no one thought about, mainly because it sounds crazy until it happens. For example see this awesome post from Morgan Housel

This post is also inspired by Nassim Taleb's Russian roulette analogy for real life and investing. Paraphrasing Taleb - Reality is like Russian Roulette with 1000 chambers. Just because 999 times there's no bullet, we forgot that there's one bullet still there. It might be useful to consider that one bullet while making real estate buying decisions at current elevated prices. This is not to say that same situation repeats, but its worth noting all the possible outcomes including house price drops.

Examples from Jim Grant's Mr Market Miscalculates: 

Kansas Farm Land bubble in 1880

Kansas farm land reached bubble price of $4000/ acre in today’s money in 1880s and is currently only at $800/ sq ft.

First came the frenzy. Newspaper articles from 1880s explained it as lack of land in Kansas territory, east coast lenders couldn’t wait to lend more to get higher yields, and agents sold Kansas as fertile land with adequate rainfall.  The rainfall data cited was from the good years and not the norm, and rainfall dropped after new people arrived to farm the land. What followed was familiar bust - farm incomes dropped, farmers could not keep up with debt payments and lost farms, many moved out of the area, and lenders lost a lot of money. 

Additional reading: Mr Market Miscalculates, essay on “In Kansas We Busted”

Long Term Price for 45 Beacon St, Boston 

Sale Prices are from Kiley in June 1941 edition of The Bulletin of the Business Historical Society
Here’s the historical price for 45 Beacon St
1859    $135K  (Sale Price) 
1853    $91K    (Sale Price) 
1929    $400K  (Sale Price) 
1940    $55K    (Sale Price) 
2000   $2.9M   (city of Boston appraisal)
2006   $6.2M   (city of Boston appraisal)

There was 86% markdown from 1929 to 1940, and 114% markup from 2000 to 2006. 

 Maui real estate bubble (1990)

In 1988-90, 36 two acre lots sold for average $1.8M each due to Japanese frenzied buying.
In 1998, these lots sold for $600K - $800K each - and this was after a recent rebound.

House price drop during Great Depression

House prices dropped a lot in both early 1930s and 1940s as cars disrupted the life of cities and Great Depression reduced demand. Demand for Commercial real estate in downtowns also dropped as more population moved to the suburbs.

House price from Shiller
1930  -4.3%
1931  -8.2%
1932  -10.5%
1933  -3.8%

Houston bubble (1983)

Between 1983 and 1988, median house prices fell by 23% due to collapse of oil prices, resulting drop in jobs in the area and net outward migrations.

Southern California bubble burst

Between 1990 and 1995, avg house prices dropped by 21% due to post Cold war reduction in defense outlays.

John Kenneth Galbraith - Great Florida Real Estate Boom (from A Short History of Financial Euphoria) 

Until 1920, sky seemed the limit for property in the growing American city. But then came the automobile, the suburbs, 1929 crash, the ensuing Depression, falloff in immigration and rising burden of real estate taxes.

There was optimism with having Republican president Coolidge, attraction of Florida climate, and use of leverage and only 10% downpayment. As speculation got underway in 1924-25, prices could double in matter of weeks. Choice “beachfront” lots could actually be 10-15 miles away from the beach. Charles Ponzi sold a subdivision “near Jacksonville” when it was infact 65 miles away. In 1926, the market collapsed due to lack of new buyers needed to sustain the upward trend. Powerful hurricane left many homeless. There was futile rush to get out and prices crashed. 

San Jose house prices 2006 - 2012:  

Because of the dot-com crash, San Jose lost 17 percent of its jobs between 2001 and 2004. In the same period, office vacancy rates increased from 3 to 30 percent. Yet, between the beginning of 2001 and the end of 2004, home prices increased by more than 20 percent. The rise in prices in the face of declining demand can be attributed to speculation— that is, people buying homes as sources of income rather than for shelter. Exacerbating this was the ease of credit. Based on Shiller Index, San Jose house prices drop 26% from 2006 peak to 2012 bottom

Japan housing market crash starting 1992

Mr. Nakashima, a Tokyo city government employee who was then 36, took out a loan for almost the entire $400,000 price of a cramped four-bedroom apartment. With property values rising at double-digit rates, he would easily earn back the loan and then some when he decided to sell.

Or so he thought. Not long after he bought the apartment, Japan's property market collapsed. Today (2005), the apartment is worth half what he paid. (After falling prices, there were few takers for far away suburbs because Tokyo became more affordable)

Mr. Nakajima said he had barely missed being stuck out there himself. In 1991, he was looking at a 100-square-meter apartment (1,080 square feet) for about $600,000 about two hours outside Tokyo. He said his wife stopped him. Six years later, he spent the same amount to buy a more spacious house in a downtown neighborhood. "Maybe my wife should be the economist," he said.

At the market's peak in 1991, all the land in Japan, a country the size of California, was worth about $18 trillion, or almost four times the value of all property in the United States at the time. Then came the crashes in both stocks and property, after the Japanese central bank moved too aggressively to raise interest rates. Both markets spiraled downward as investors sold stocks to cover losses in the land market, and vice versa, plunging prices into a 14-year trough, from which they are only now starting to recover.

In the 1980's, Professor Noguchi said, the frenzy in Japan reached such extremes that companies tried to outbid one another even for land of little or no use. At the peak, an empty three-square-meter parcel (about 32 square feet) in a corner of the Ginza shopping district in Tokyo sold for $600,000, even though it was too small to build on.

London house price crash of 1989 

According to Nationwide, a UK mortgage lender, the average London home was selling for just under £98,000 in the summer of 1989. Prices then fell by one-third and didn’t top £100,000 for nine years. Cumulative inflation over the same period was well over 50 per cent. London housing in the late 1980s was a disastrous investment.

Toronto House price crash of 1990

The cause was rising interest rates. The early 1990s housing crash followed the late 1980s housing boom, which was driven by an over-heating economy allied with the consequences of financial liberalisation. Specifically, in April 1988 an interest rate cut to curb the pound’s ascent against the deutschemark boosted the housing market. By the second half of 1988, however, interest rates were raised aggressively to dampen inflationary pressures. The base rate touched 7.5 per cent in mid 1988. In 1989 it was increased to 15 per cent. Many affordable mortgages in 1988 thus became unaffordable in 1989.

The downturn lasted for 6 years and many buyers walked away from a deal after the downturn started.People forced to sell had to accept 1991 deflated prices. For instance, Stinson real estate recently sold a penthouse for $299,000 - a couple of years ago it would have reaped $450,000 to $495,000.

There was story of elderly man buying 3 condos with his $300K retirement and losing it.A similar repeat story from 2018 was a CIBC bank teller buying a second condo and renting it out to previous owner of the condo 

Many of the people who suffered losses during the real-estate slump of the past two years stretched themselves too thin and purchased properties they could not afford” - Brad Lamb, Dec 21, 1991

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