We’re old hands at following the housing market. While the rest of the media proclaimed a “robust recovery” in California real estate, we’ve looked past the hype and called a spade a spade. Or, in this case, an unsustainable mini-bubble.
The mainstream is finally catching up with us. Fitch ratings just released a report stating several U.S. cities are nearing bubble-year home price peaks. Fitch considers incomes, rents and mortgage rates to determine the sustainability of home prices. Based on these metrics, Fitch estimates homes are overvalued by 17% nationwide.
Most of the cities experiencing housing price peaks are in California. San Francisco prices, for instance, have increased 20% year-over-year. San Francisco and San Jose are on track to set home price records in the next six months — Oakland, San Diego and Los Angeles are not far behind.
And where has all this asset price inflation come from? According to Fitch:
[R]ecent home price gains appear to be the product of rising investment sales and practices such as ‘flipping’ (buying and selling a home within a short time). All-cash sales have risen dramatically since last year and are now at nearly 50%. Cash sales are often indicative of investor behavior so the concern is that home price increases are being driven more through speculative buying than from increasing demand. . .
What’s worse is that prices continue to rise along with interest rates. The coincidence of rising prices and rising rates is an anomaly that will not last for long. It’s only occurred recently due to the proportion of cash deals to total sales volume.
As prices inevitably decline in these inflated California markets it’s important to keep in mind that the drop marks a return to sustainability. The consequences of the coming price disinflation will not be widely felt. Speculators will bear the brunt of the correction – which is only fair, considering how fervently they leveraged their cash offers to outbid middle-class end users. Well, speculators, what can we say? We tried to warn you.
So, while prices will fall, this is good news for a market that needs more real demand from end-users.
It has been my observation having invested in and following home prices for the last 40 years that there appears to be a 10 year price cycle with about 7 years of rapid price appreciation at an annual rate that is somewhat higher than it should be ( such as 10% a year instead of a sustainable 7%) and where home prices double—-which always triggers a “correction” lasting about 3 years where prices drop back to where they should be ( if they had appreciated at lower long term average sustainable rate ( like 7% per year ). Then the cycle repeats itself.
There is a lesson to be learned here in that the real estate market repeats itself, over and over and over. One simply has to acccpt the fact that during the up price cycle prices always appreciate too fast and one has to accept that this always leads to a correction. What is really important here is the fact that over the long term home prices keep doubling ,and then doubling again, and then doubling yet again.
So one year into an recovery one should accept as part ofd the normal market cycle that prices will have appreciated in the previous year at a faster annual rate than what is the average and a sustainable rate over the long term. But that if one decides to stay out of the market because of this market reality then the market will pass him by and he will miss out on the next doubling of home prices over the next 10 years.
Investing in real estate is NOT a short term investment but is a long term investment.
Using leverage, it’s pretty darn easy and almost a sure thing, to make a 400% return capital investment over a 10 year long term. Of course there is no sure short term profit and prices can and will correct and decline some years on their way up.
I purchased my home in California in 1980 for $300,000 with $100,000 cash down ( 3 to 1 leverage) and its now worth $2,500,000. Figure my annual rate of return ( profit) on my $100,000 investment. (20% a year).
The overall home might have appreciated at an average annual rate of 7% a year. ( yes some years it went up 20% , and some years the value dropped, but the whole point of this story is: “over the long term so what if there is a mini bubble along the way?”
Prices rise, but is that a result of true increased value, or simply a reflection of the overall decline in the dollar, as the govt. becomes more and more monolithic in our lives, and shamelessly uses debt and borrowing to sustain it hideous ways.
Home Ownership can be good for many, but often, the lenders, insurance companies, taxes, suck so heavily on the freedom teat, that the end result is a fancy form of renting.
John. This publication is echoing your point. Since being a subscriber, I’ve tracked First Tuesday’s record on this issue and it has been, as far as I can tell, the only publication honestly predicting and defining the difference between an artificial RE market and an organic one. Yes, CA has been in a 12-14 year cycle since post WW2, which is why our current run up doesn’t wash with any real historical markers. Like you I’ve bought and sold RE based on this cycle and will cash out big time in 2018-2023. One of the most rewarding insights that I’ve given my children, friends, and clients, ( I’m a Realtor) is this 14 year cycle phenomenon.