real estate questions....

[CamusEatsSumTum]

I think someone questioned you publicly here before, and I think its a good idea because the posters here are more intelligent here than in other sections of this website.

My first question has to do with inflation in real estate prices and this so-called bubble.

Has there previously been a real estate crash that we can study?

How exactly are real estate prices set, similar to stocks, that a house is worth as much as someone will pay for it, so for there to be a crash, several people would have to lower the price of the house they are selling.

Ive read that recently several investors have entered the real estate market which is responsible for the boom: Why would these investors decide to sell at a lower price, as opposed to just holding their appreciating asset and renting it out?

How can you judge whether a property is at a good price? Is it in relation to the amount it would cost to rent a similar property. How do you figure the rent of a property? Is it a percentage of a properties total value?

sorry if these questions are too vague or stupid or broad based.

if you have any book recommendations that would be great.

[deathtoau]

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My first question has to do with inflation in real estate prices and this so-called bubble.

Has there previously been a real estate crash that we can study?

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Japan in the past couple of decades. The real estate bubble there destroyed their whole economy and created one of the longest prolonged recessions since the Great Depression. They still haven't fully recovered.

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How exactly are real estate prices set, similar to stocks, that a house is worth as much as someone will pay for it, so for there to be a crash, several people would have to lower the price of the house they are selling.

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It is a matter of supply and demand. People can set their property value at what ever they want to, but it only sells if there is a buyer willing to meet the seller’s price. If there is a vast oversupply of houses on the market, then the prices would fall because buyers have more options and can hold out for a better deal.

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Why would these investors decide to sell at a lower price, as opposed to just holding their appreciating asset and renting it out?

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Most real estate investors as well as home buyers are leveraged up to their eyeballs. Between short term ARM mortgages and interest-only loans, the monthly payments can explode higher when interest rates return to the typical levels. These higher monthly payments are going to lead to a rash of property owners going into default which will result in a large number of foreclosures which will result in a glut of homes on the market etc. etc. etc. The end result will be the collapse of the real estate bubble just like the collapse of the dot com bubble.

The real bet now is figuring out when not if the crash will come.

[midas]

Camus

In the early 90's the loose credit standards of the S&L's cause a real estate bubble which burst in the early 90's taking down several banks.

Buyers and sellers set the price of real estate.

Real estate bubbles also occur when investors drive up the prices of real estate without actually occupying the building. I believe this is happening in Las Vegas right now. Investors get into trouble when they can't afford to carry the cost of the investment (taxes, interest, insurance) and are forced to sell cheap or are forclosed by banks who then sell cheap. Usually in a real estate bubbles the cost of buying is much greater than the cost of renting.

A property is a good price if it trades at or near recent comparables but these prices can vary widely just like stocks. A safe real estate investment thesis is to buy where land is scarce (ocean front, dense suburbs) and income levels are high (NY, LA , Boston and SF)

[RYL]

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I think someone questioned you publicly here before, and I think its a good idea because the posters here are more intelligent here than in other sections of this website.

My first question has to do with inflation in real estate prices and this so-called bubble.

Has there previously been a real estate crash that we can study?

How exactly are real estate prices set, similar to stocks, that a house is worth as much as someone will pay for it, so for there to be a crash, several people would have to lower the price of the house they are selling.

Ive read that recently several investors have entered the real estate market which is responsible for the boom: Why would these investors decide to sell at a lower price, as opposed to just holding their appreciating asset and renting it out?

How can you judge whether a property is at a good price? Is it in relation to the amount it would cost to rent a similar property. How do you figure the rent of a property? Is it a percentage of a properties total value?

sorry if these questions are too vague or stupid or broad based.

if you have any book recommendations that would be great.

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Hey... I was gonna ask these questions!!! /images/graemlins/smile.gif /images/graemlins/cool.gif /images/graemlins/grin.gif

[DesertCat]

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Most real estate investors as well as home buyers are leveraged up to their eyeballs. Between short term ARM mortgages and interest-only loans, the monthly payments can explode higher when interest rates return to the typical levels. These higher monthly payments are going to lead to a rash of property owners going into default which will result in a large number of foreclosures which will result in a glut of homes on the market etc. etc. etc. The end result will be the collapse of the real estate bubble just like the collapse of the dot com bubble.


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There is a great article in Fortune this month about the real estate bubble. It quotes one "investor" who owns a bunch of houses, but is only renting a few of them since he's planning to flip. He's already got major negative cash flow (something like $5,000 per month), and says if prices go down he's just going to hold on to them and wait until the rebound (he figures a year or two!).

This guy seems to have relatively deep pockets from some big wins but most real estate investors don't. They can only hold on so long before they or the bank dumps their properties at cut rate prices. And if the market takes five years to recover (late 80's, early 90's California), even Mr. Deep Pockets is up a brown creek with no paddle.

[crazy canuck]

There was a very good article in Economist last year about real estate bubbles (forgot which month). They mention that one way to price real estate is by summing up the future discounted rent. This is identical to valuing a stock based on future discounted earnings. So based on this, the article concluded that real estate is overvalued.

The article also mentions that people are more reluctant to dump their property if it drops in value compared to a stock. So there is a possibility that the bubble will not burst but instead there will be a gradual decrease in price over many years.

It is also mentioned that the real estate market is less efficient financial markets (forgot the exact reason tho).

[laserboy]

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My first question has to do with inflation in real estate prices and this so-called bubble.

Has there previously been a real estate crash that we can study?


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Real estate prices in some areas of Japan have fallen over 90% since the early '90s. Toward the end of the mania, people were actually taking out 100 year "legacy" mortgages to get into houses. Of course we have now one-upped them here in California through use of interest-only loans (which were used in over 60% of home sales here last year) and negative amortization loans.

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Ive read that recently several investors have entered the real estate market which is responsible for the boom: Why would these investors decide to sell at a lower price, as opposed to just holding their appreciating asset and renting it out?


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A "homeowner" could be forced to sell under a number of circumstances. For example, relocation or job loss. One of the primary drivers of the Southern California housing crash of the early '90s was the meltdown of the aerospace industry which left many people unemployed and unable to make their housing payments. Keep in mind that, in bubble areas such as Las Vegas and Orange County, the majority of jobs that have been created over the last 5 years have been in the real estate industry. A downturn in housing will be exacerbated by massive job losses in the real estate industry.

Homeowners who have overextended themselves could also be forced to sell once their ARMs lapse into fixed rate mortgages or when interest rates rise. There was an article in the WSJ a few days ago detailing how an ARM holder's monthly payments could double once their ARM terms lapsed and if interest rates were to rise a mere 2 percentage points.

Also, if housing prices dip significantly enough, a number of people will just walk away from their homes and let the banks forclose. Most new homebuyers in California buy homes with zero or very little money down and many are using interst only loans. These people have very little equity in their homes. If it gets to a point where they still owe $600K on a house that is now worth $500K, abandoning the home and letting the bank forcloes becomes the more attractive option. This was prevalent in past housing crashes in Southern California and Texas.

Now in a healthy housing market, yes, a homeowner would be able to rent out the property for positive cashflow while the market recovered. But a rental property in todays market does not generate positive cash flow because home prices and rents are so out of whack with each other. I rent a two bedroom apartment in Southern California for less than $1500/month. To buy and maintain an equivalent condo in this area would cost over twice as much per month. If I were to buy putting no money down, as many people are doing, it would cost even more. So in addition to price depreciation, homeowners would also be getting hosed on monthly cashflow.

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How can you judge whether a property is at a good price? Is it in relation to the amount it would cost to rent a similar property. How do you figure the rent of a property? Is it a percentage of a properties total value?


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Home prices and rents are dictated by the market. When purchasing an investment property, you should consider metrics like capitalization rate and price/rent just as you would consider price/earnings in a stock. In a healthy market a decnt capitalization rate would be 10%+. In my area you would be lucky to get 5% on a residential property. 5% a complete joke. People are taking massive losses on cash flow only because they believe that some sucker will pay them a higher price for the house somewhere down the line. It's basically a gigantic Ponzi scheme.

[Carl_William]

I agree with essentially everything you in your post except:

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It's basically a gigantic Ponzi scheme.

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"gigantic" is an excellent adjective; but "Ponzi scheme," connotes criminal intent. "Giantic musical chair game" or "greater fool" would be a better way to describe the game.


People running Ponzi-schemes" have can go to jail, but the real estate market bubbles are just greater fool games.

[laserboy]

If I were in charge, sending home refinancing spam would be a crime punishable by death. /images/graemlins/grin.gif

But you are correct. The people most responsible for the real estate bubble will walk away with millions laughing their way to the bank. Fannie Mae's CEO for instance. It was a great scam while it lasted.

[Dan Mezick]

RE prices crashed in 1987 approx. 30% and did not recover in any meaningful until around 1998. 30% off with 10 years to recover is your basic risk based on that as a baseline.

A trend in motion tends to stay in motion. Folks have been naysaying RE for over 5 years now. Any RE crash will certainly have huge macro effects and kill the US economy.

This RE crash scenario is a highly unlikely scenario; a more likely scneario is no appreciation for 3-7 years.

[imported_bingobazza]

You do tend to get a few of warning signs that real estate is overvalued, but as with all bubbles, the prices can keep going up anyway until a substantial minority realises that the game is over, for now.

My most dependable indicators are the relative value of property to local average incomes, (over 5.5 is bad)accounting for local wage inflation, the number of first time buyers entering the market, (less than 25% is bad) and the prospective relationship between maximum geared rental properties and rental incomes using 1 and 2 year treasury bond yeilds (less than 100% is bad). Average property selling times can also be useful, as can banks tightening of lending criteria.

When the grounds of Emperors palace in Tokyo was valued at more than the entire state of California in the Japanese boom, the warning signs were pretty clear. Having said that, I would definitely buy it today if I could.

Bingo

[adios]

Hedgestreet (http://www.hedgestreet.com)

Check this site out. I'll tell you what though, when seemingly the most popular buzzwords about something are bubble and crash I'm fairly certain that it won't happen at least not soon. This is purely a qualitative analysis I admit. I remember when the hype about Japan was at it's zenith, I can't remember too much hype about real estate bubbles in Japan or the over valuation of the Japaneese stock market.

I think there are four factors affecting real estate prices alot, not necessarily in the order of importance.

One is of course the supply of desirable housing in desirable areas.

Second is the favored tax status of housing. Ray has stated that home owners should basically consider selling much more frequently than they do since so much of their profit is tax free. Of course the deductability of interest expenses help as well.

Third and this one is really a big factor IMO is that there is tremendous liquidity in the mortgage market i.e. there is a lot of money available for people that want to borrow money for a real estate. The mortgage backed secuirty market (MBS) is bigger than the treasury market and there are all kinds of bonds rated from AAA to junk that appeal to investors of all risk tolerance levels. Personally I trust the rating of MBS more than I trust the ratings of corporates.

Fourth is that interest rates are generally speaking low from a historical perspective.

I've read some horror stories about people who bought expensive real estate in SoCal where they had the price of their x million dollar home cut in half when builders came and built en masse. I'm sure there are disasters waiting to happen. Also all the things about the economy that people mentioned are relevant. I frequently go to open houses in the area where I live and can't believe what people are selling their houses for and getting. I mean I walk in, look around and see a lot of projects most of the time. So I understand a lot of the concern about prices as well. I'd also like to say that 30 year fixed mortgages and 15 year fixed mortgages don't suit everyones needs and I/O ARM type loans actually meet certain buyers needs very well.

[STG]

Where is the best place in the southwest to invest in income property, I would love to retire there? I missed an opportunity a few years back to by some property in Las Vegas that would have doubled, and I love that area. But that area is just going crazy with housing prices. Is there anywhere in the southwest that is reasonable? I am looking for something around $150,000 that is not a dump.

[laserboy]

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Having said that, I would definitely buy it today if I could.

Bingo

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Real estate appears to be vastly overvalued by every one of the metrics you just mentioned. Your investment guru Warren Buffett just sold the Laguna Beach home he has owned for decades claiming that real estate in now ridiculously overvalued. What more do you need to convince you of a bubble?

[ScottTheFish]

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Having said that, I would definitely buy it today if I could.

Bingo

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Real estate appears to be vastly overvalued by every one of the metrics you just mentioned. Your investment guru Warren Buffett just sold the Laguna Beach home he has owned for decades claiming that real estate in now ridiculously overvalued. What more do you need to convince you of a bubble?

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real estate is very regional. Just because it is way overvalued in Laguna Beach, CA (which I don't doubt it is), doesn't mean it is overvalued in other places.

Buffett still has vast RE holdings, BTW.

[imported_bingobazza]

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Having said that, I would definitely buy it today if I could.

Bingo

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Real estate appears to be vastly overvalued by every one of the metrics you just mentioned. Your investment guru Warren Buffett just sold the Laguna Beach home he has owned for decades claiming that real estate in now ridiculously overvalued. What more do you need to convince you of a bubble?

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Yip, he is a guru. I was talking about Japan tho...I would buy there. I think the US is in for several years of low growth to let the fundamentals catch up...cant see a bust though, just unpromising returns. I pass on US property for now.

[NoTalent]

I think you can say there is a real estate bubble in California when 1/75 people have a real estate license...

http://quickfacts.census.gov/qfd/states/06000.html
and
http://www.dre.ca.gov/stats04_05.htm
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