Some Thoughts on Housing - The 4 Forces

urbandigs bullish? say it aint so

The most interesting point I find is mortgage rates. It's obvious that they really can't go down. If Fed Funds stays at zero for too long, it must mean we are continuing aon deflationary path. If it moves up, then asset values could get hurt. It seems to me like a catch 22 for real estate.

I think that most buyers chose a home based on affordability, and if rates go up, it just means that prices will need to go down so that the payments are equal to what would have been payed under the previous scenario. It seems to me, assumming this is true, that there are advantages to waiting including the following:

- less risk of loss
- lower cost basis for taxes, and thus lower taxes (not sure how this applies in apartments)

I would be interested to hear your thoughts on waiting for the higher rates to come considering the potential to have lower taxes or other factors that I have neglected to realize.

Anon - I agree. We do have a huge shadow inventory. Some estimates peg it at 7M nation wide. Unemployment is still rising and usually lags the end of a recession by about 18 months before it peaks and lets not forget all the points Noah is talking about in his articel about all the artificial puppet work done by the govt, which are all scheduled to end in March/April of next year. I think the key is to quantifythe following:
what happens if unemployment hits ~11% with the fed MBS purchase program only running at half its current pace and no more home buyers tax credit, as I think it will be a hard sell for a third time although our govt makes bad decisions all the time. Now lets remember, moratorium will be running out on foreclosed properties. How much further downward pressure on pricing is there. Lets remember, credit is still contracting and it appears it will contract an additional ~1.5-2T. I think this the the million dollar question.

first anon - lol. well I am bullish when there are reasons to be bullish and bearish when there are reasons to be bearish. adaptability one way or another is a good freedom as the world changes.

in this case, yes its the most bullish tone I have had in 3 years for hardest hit markets given the unique environment right now. cant time it perfectly, but given what I see out there, now is as good a time as there was in the past 3 years or so to buy in hardest hit markets

Anonymous - well sounds like a market timer to me, when considering waiting for lower prices as a result of higher rates. Nothing wrong with that but you may lose 2 other forces - the govt tax credit + the pipeline foreclosure pressure that continues to hurt sellers that need to move property. Granted, the latter will likely take at least another 12-18 months to get to a point where inventory may be nearing that 6-7mth absorption medium...with shadow inventory, I think its close to a year now.

Anyway, to answer your question, if I had a lot of cash and planned to finance less than 50% of the purchase, then yes I would continue to be picky & patient. But most are not in that camp and pressures are still out there on sellers, so they may hit your bid now where they may not be as pressured in say 1-2 years when rates might be 100 bps higher.

Is it a speculative play or a home to live in for x number of years? Its nice to options, record low rates, govt tax credits, and pressure on sell side right at the time you find your perfect home. if that is the case, I wouldnt wait, because net net, if prices are lower, one of the forces will likely work against you.

this is my thoughts, and many likely will disagree

It's so funny, Noah - it all depends the lens with which you read this: as I was reading it, I was thinking it had a significant bearish slant (because of the temporary nature of the forces at work) but I can now hear the quasi-bullish tone that anon referred to.

Great post and topic!

yes that is something I think many people are not yet prepared for: that is a higher interest rate world.

its a tough topic to tackle as nobody is trying to time the market perfectly, which is impossible given the local nature of real estate. I just think this is a unique time for buyers given the reasons mentioned.

this reality is temporary. so i guess lets fly with it while its here. higher rates, higher taxes, no tax credits, fallout from pulling forward demand, peaking unemployment, etc.. will make up another period in the world at some point - the question is when and how bad does it get?

You know, I've been thinking of taking out a FHA (raised to the mid-$700k's) loan to get a new house/apt, sub-let it, get a HELOC on it, and then parking the money in a place w/a fat interest rate spread compared to the US.

Witness Australia's RBA where they hiked rates today to 3.75%. If money markets are offering .06-.08% returns then I can make more overseas by borrowing at low rates (ok I won't qualify for the .1% Bernanke gives the primary dealers but there are other abnormal returns possible in alternate vehicles).

I will also be banking on the continued devaluation of the dollar vis a vis this carry trade.

Alternately, I can go "all in" on otm GLD calls.

Correction on the FHA loan limit. Who would've guessed the NYC maximum mortgage would be low 6 figures!

https://entp.hud.gov/idapp/html/hicostlook.cfm

Noah, no comments on the Treasury saying that if banks don't make mortgage modifications permanent that there will be "consequences?" It was a Bloomberg article not too long ago.

MeekSheep - here's what I found on the consequence front in terms of Treasury comments, which include "sanctions and monetary penalties":

http://news.businessweek.com/article.asp?documentKey=1376-KTXT0F0D9L38-5

these loan mod programs have been proven to be a failure in transparency and result. we dont know what real redefault rate is, and what percent of mods were permanent.

however, i think this is just one of many fear tactics politicians will used to get re-elected or for other agendas. its been going on for years now.

i wonder what consequences they really mean? the consequences I see are ones of natural market reactions to the uber manipulation that has occurred to stem the crisis and the positions taken globally that will move markets when something 'changes'

doubtful they will put in penalties at this point in the recap game. they are trying to rebuild these banks, and work out the issues. the penalties, the regulations, the lawsuits, the taxes, the restrictions, that all comes in the years down the road! the payback period

Thanks. I was wondering what the hell they were thinking when I read that article. Glad to hear you guys saying it won't happen.

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Noah, I am sure many of your readers (especially the stubbornly bearish sideline sitters) would appreciate your take on the drastic differences in rent vs. own pricing right now. Those of us renting (with bucks in the bank) still can't begin to contemplate a purchase--especially in the Manhattan market--while it's so darn cheap to rent. With unemployment steady--or more likely rising--it's hard to imagine rents experiencing much inflation. Surely this phenomenon would have an effect on sales?

Otto - ugh, i hate doing those! no but seriously, the best way I can describe is that Manhattan needs its own unique buy vs rent equation otherwise there would be no trades. This market, I dont care how you slice it, is faster, bigger, and has more buyer exposure than almost every other local market (including other major cities) in this country

we cant use a typical 15x monthly rent formula. Something needs to be tweaked

Noah,

This is a great blog but with all due respect on the rent versus buy issue, there's no reasoning behind your explanation.

Once you start saying -- this area is special -- you're on the slippery slope.

It makes no sense to buy something you can rent for half to a third of the (all in) cost of ownership. The ONLY conceivable reason for that kind of spread is if the owners (buyers) believe they'll make a lot of money via ownership. And, just try telling someone who owns the price will be lucky to go nowhere for a decade. They'll look at you like they looked at me in 1999 / 2000 when I said the NASDAQ was going to be down a decade hence.

Either rents have to rise (massively) or prices have to come down...or go nowhere for a long, long time.

As a broker (of anything), it doesn't make sense for you (or any broker) to harp on this but it is the (very) likely outcome. If Manhattan rents were twice as high as they are, prices wouldn't have to come down but they aren't going to double any time soon.

anon - thats ok, you can give criticisms to any of my comments. My point is, if you use the normal buy vs rent equation that applies to many local markets out there, you would hardly EVER justify a sales price here in manhattan.

Case in point. I bought my unit, 245 E 93rd, 2M, for 500K in 2002. I rented it out in 2004 for 3250. I rented it out again in 2005 for 3350. I sold it in 2006 for 935K. How the heck does the buy vs rent math work?

If you take the 15x annual rent metric, that many people use to figure out whether a market is under or overvalued in terms of where prices are headed to equalize, my apt should have sold for about 600K. But the open market priced it at 935K and it was 1 yr prior to the peak of the market?

You take a number of sales and you will find the same thing. Something is off anon!

Hey, I didt write a piece on it and this is one reason why I dont. I simply answered a commenters question.

I dont care what all the people against me say, when it comes to rationalizing WHY this market is so overvalued. It continues to trade this way, year after year after year...not the case in other markets though. Other markets corrected to a point where prices got low enough so that you can rent out at a profit and it makes sense. In those markets I am not arguing. But this market, something is different. Manhattan I mean.

Those that submit a bid using a rent equation will likely find that they are never getting a bite, and almost always will find the property ends up trading at a level way above their rent metric. So, how do you explain this? That the market is overpriced and will be until it isnt anymore?

Noah,

What do you think drives the disparity between renting/owning. Are buyers overly optimistic about appreciation? Are they so rich that they just don't care? Are they afraid of dealing with scummy landlords? Is it just so cool to own? It is truly interesting that the market behaves this way.

I'm sure you've done the analysis, so when was the last time that Manhattan prices and rents seemed to coincide on a multiple or cash flow basis. What kind of correlation is there between rental and sale prices. Is the premium consistent?

anon - its a great question and I really dont know the answer in terms of 'when' it may have made more sense before it disconnected

this market has elements to it that not many markets have..i wont go into them here because then people mis interpret that manhattan is not a market, but rather its own animal that is immune to market forces. now I dont believe that manhattan is immune, but it is its own animal.

Ill try to see if the data I have goes back far enough to answer some of these questions

Anonymous- why is it so important that the rent vs own disparity be explained? It would be interesting if it were a sudden phenomenon, but it's not so interesting if the disparity has been going on for years and continues to.

There was a topic here a little while back dedicated to the debate, with a huge follow-up discussion. The only conclusion that could be drawn after many points of view is that the decision to buy or rent is highly subjective- and influenced by many factors, fixed term investment strategy only one of them.

Noah -
I missed the whole rent v. buy debate.. but here are my two cents. Manhattan doesn't need a "special" price to rent equation. Price vs. rent wasn't this out of whack in the mid-late 90's - see Goldman's January 2009 research. The price to rent ratio is probably my favorite metric to use as rents remove the speculative aspect and just reflect incomes and demand to live in a certain location. During a speculative bubble the price to rent ratio gets out of whack, as we have seen. It will return to normal as people's expectations about price appreciation fall - or perhaps as the people with higher expectations are exhausted from the market. In any case, people won't continue indefinitely to expect price appreciation that will make up the the difference between buying and renting. Any emotional argument about the benefits of owning was the same in 95-99, and is thus invalid. Add to this the fact that rents are falling significantly and the picture does not look pretty.

This adjustment isn't going to happen overnight as real estate prices (in Manhattan in particular) are quite sticky. What I take issue with is that you seem to imply that the Manhattan market will always have a screwy price to rent ratio. You can't just ignore the data to the contrary and focus on the last decade, during which there was a well-documented speculative bubble in housing.

Also, the current tailwinds behind house prices (tax credit, 4.7% mortgages) will not last forever. They are a good argument AGAINST buying now - even if prices don't fall despite them this winter as I'm convinced they will - because if you have to sell in 3-5 years when they presumably will no longer exist, prices will adjust down accordingly and then you're underwater.

Andrew - great points. Hard to time the market perfectly and 3-5 years out is a long time, so many things can happen. But you make valid points and for most part, I agree. My thoughts on the confluence of four forces, is more for buyers who look at buying a home to live in and plan to live in and wanting to secure both a good deal, a great rate, a govt gift, and an environment where options are good and pressure still on sellers. That is temporary.

But to your price/rent comment, I didnt even want to touch another buy vs rent debate. Im renting. That tells you something. I owned, I sold, and now Im renting.

But the typical equations that people use just dont work here. They just dont make sense. They didnt in 2000, they didnt in 2003, they didnt at peak in 2007, and they still dont know after a 20% adjustment down.

when you say, "It will return to normal", well, what is NORMAL? I dont have the data to find this out.

Its not that we need a special price to rent equation because this market is immune, we need a special price to rent equation because the equation used for markets like Miami, Phoenix, LA, etc. just dont make sense here! If they did, the market would have adjusted down 45-50%, not 20%, and sales would not be happening at levels they are in past 6 months with such a limited correction given severity of the crisis.

consider manhattan an outlier I guess if we look at the equation as a scale and plot local markets on different segments of the scale, manhattan would be at the top, maybe its a 20x annual rent? I dont know.

If 2M, my unit got 3450/mth, $100 more than in 2005, and I sold for 935K, that equates to a 22x annual rent multiple. So, did I do good or did the buyer do really bad? Or does the market have more downside to go to get to that 15x number?

Lets say it gets 3600/mth today, which means its only worth $648,000 and is overpriced for any trade above that.

My point is, those submitting a bid ONLY on a stiff price/buy equation, which is usually something around 15x annual rent, they will find a big disconnect to where they see real value, and where trades actually occur. We can explain the difference Im sure in 20 different ways

Hey guys...Good discussion.

First point, all the posters under "anon" are not the same person (as you likely know). I posted the question above about the slippery slope.

Second: I found this blog searching Google (a while back) for Manhattan bubble as I was trying to learn more about the market before I moved here earlier in the year. Therefore, I like the idea that we can revisit this idea occasionally. That said, I realize why it may be an unpleasant topic and not so good for business -- I mean that without any hint of irony.

Third: The reason the rent vs. buy calculus "matters" is because it is the best indication of whether the market remains overpriced. All kinds of justifications can be used to explain why the market has exploded in price over the last decade...to whit: prices were low 10 years ago, interest rates have dropped, more and more people want to live in NYC as crime has improved, there are buyers from around the world and the dollar keeps dropping, etc., etc.

HOWEVER, what can't be "explained away" is the FACT that the spread between the cost to own and the cost to rent similar (or identical) properties is still massively wide. Thus, this fact implies that those of us who "feel" that prices are way out of whack are much more likely correct than those who "feel" that prices are sensible because "everyone wants to live here".

If you are a first time buyer -- say coming in from a new city -- and you can rent a place for $5000 a month (all in cost) or you can buy a similar place with a monthly (after mort. interest deduction but also after property taxes, maintenance, insurance and opportunity cost [and lost interest or returns] of the downpayment) for $9000 to $11,000 per month, ON AVERAGE people would only opt for the second choice if they are implicity convinced they are going to make a lot of money by owning versus "throwing money away" renting.

The irony of the catch phrase above "throwing money away renting" is that UNLESS THERE IS LARGE AND CONTINUING sustained price appreciation, the people throwing money away (when the rent to buy ratio is where it is) are the buyers.

Why don't people realize this?

1) Until recently, all price action indicated that people making the argument I am making were idiots. (Just like all people who argued that tech stocks were in a massive bubble in 1998 looked like complete fools as the entire NASDAQ doubled again by early 2000.)

2) People "want" to own (I know I do) and therefore they want their desire to be rewarded.

3) People waiting to buy are terrified that they'll wait too long and prices will start to move away from them again thus a lot of fence sitters buy as soon as prices stop dropping. They do this based on the previous decade of reinforcement that prices go up and sometimes go up very quickly.

4) The real estate industry is transaction based. No successful broker is going to constantly dissuade clients or potential clients that their desire to own is foolhardy. I am of the opinion that NONE of the "blame" for the bubble rests with brokers. Any broker (of anything) who tells their clients what they DON'T want to hear over and over again doesn't work for long. It is a losing strategy.

Sorry for the long-winded post but as I continue to review the situation here, I cannot come to any other conclusion that prices are still way too high. If that is correct, it doesn't mean that prices come crashing down....there are a lot of ways this bubble (if it is one) can deflate over another 4 to 8 years without causing massive pain.

Former Seller,

The reason the rent v. own disparity should be explained is to better understand why market action diverts from financial fundamentals. It may not matter to you, but if I was to determine whether today's prices are sustainable, I would want to know what factors dictate them and whether they have staying power. That's why I had my follow-up questions regarding the history of the price/rent ratio, correlation, and whether the premium of owning has some kind of stable charactaristic, or is simply random.

If other poster's contention that the mid to late 90's price/rent ratios were more consistant with other city's markets, it implies that post-bubble prices have a good chance of returning to fundamentals absent any new factor that would permanently shift the nature of the market over the last decade. Or could the price premium just be some transient phenomenon that was based on the surplus of cheap capital and the benefits thereof being concentrated in the compensation of Wall Street? That's what I'd like to get a better handle on, and it matters if you think like a cash flow investor when you buy assets.

anon2, it's a fair point that it can be useful to ask why market action diverted from fundamentals over the past decade, but only to a degree- that's just my opinion.

There are a lot of whys to ask about this period: why did hummers become the new status cars in NYC where they're unwieldy to drive in city streets and there's no place to off-road? Why did rich celebrities like Ed McMahon and Nicolas Cage buy expensive real estate- with credit- only to face foreclosure after the burst? Why do people pay for bottled water that's no better than what they get for free from their tap?

Again, I think there is some merit for looking into why markets drift from fundamentals. But to me, the most important thing to observe is what's actually happening. You can argue that buying is a poor value proposition right now but the fact is, the market has been fairly liquid. People are buying at prices far above the rent equivalent, in a poor economy while unemployment has been rising. We hear of bidding wars. I sound bullish but I consider myself agnostic; I don't sweat market movements either way right now. I realize that the very first comment made (by anon) on this topic is probably tongue in cheek, but the sentiment does seem to be reflected in some of the the questions and observations that follow, which seem to be asking Noah to be bearish- as if getting him to agree would cause the rent / own disparity to magically correct itself and drive prices down.

It may be worth your while to go through back through the UD archives to about this time last year (really, take a look). It was a big market pooh-pooh party, with many of the regulars here using macro fundamentals to explain why there would be total armageddon by summer '09, with owners being happy to dump their manhattan RE at $500/psf. Someone forgot to tell the people that have been buying.

Former Seller,

I am not trying to wish a bear market, but just trying to get better understanding of the market behavior over a long time period as looking at only recent data is, in my opinion, sophomoric. Just because there are a few bidding wars out there and the market has picked up today doesn't tell me much about the more distant future. In fact, focusing on just today is the exact error that led many into some of the worst decisions of the boom.

Many markets divert from fundamentals. Oil did, then crashed. Tech stocks did, then crashed. Debt markets did. There is hundreds of years of history on this in all sorts of markets. Generally, these markets find their fundamentals in the long run. Is real estate in NY different for some reason? What was the previous normal over the last 50-100 years? What has changed since then? All worth considering. Maybe NYC always trades at a premium to rent, but maybe that premium has been pretty constant over the last few decades before the boom. I'm not saying where it needs to go, but I want to know what the historical relationship was and how tightly correlated it was.

Also, your examples of Nick Cage and bottled water were nothing other than straw man setups. The real issue is why should anyone with a long-term outlook choose to focus on today's activity over historical behavior?

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