[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.