I think the real estate market may have finally peaked

[BigPete]

Originally Posted by al_bundy

How does a middle class family making $150,000 a year afford a $600,000 home in california if they are first time buyers?

Actually, 4x doesn't seem that bad to me ... lower the salary to $75k - $100k and then I'll agree with you.

[X]

Originally Posted by al_bundy

affordability

at current low rates it should be nothing for a middle class family to buy a home on a fixed rate loan. Why are so many people getting IO loans?

How does a middle class family making $150,000 a year afford a $600,000 home in california if they are first time buyers?

Let's assume they put down 10%, or $60,000. That leave $540,000 to finance.

Here are two alternatives...

An interest-only loan for a minimum of 5 years at, let's say 5.25%. That means payments of $28,350. Chicken feed, considering it's fully tax deductible.

A fully amortized 30-year loan at 5.5% means annual payments of $36,793. Again, most of that amount will be deductible as interest in the first 5 years. Over $29,500 is deductible the first year, $25,000 is still deductible in year 10.

In fact $600,000 is just about the maximum that lenders recommend for a $150,000 income.

[grrrah]

First time buyers arent the ones that typically buying the $600k homes. we are buying the 300k condos

the guys buying the 600k homes are the ones that bought the 150k condos, and sold it to us for 300k and used the profits as a down. or they work for google.

[ukywyldcat]

Originally Posted by al_bundy

I think that prices may have finally peaked and there will be a small correction or several years of a flat housing market. I think the mania and euphoria is finally over.

Question: Why finally? Are you one of those people who are bitter that they have waited so long they are priced out? I hope not.

When I run an open house on one of my rentals, most visitors are "kick the tire" types who are obviously feeling the pain of their own stupidity. They waited when prices went up and kept waiting, waiving their fist in the air about how stupid it all is while vowing to swoop in and get a bargain-priced palace from some sucker who lost it all. These same people have been telling the same miserable story for years, and that story has served them no purpose. They love to come to the open house and try to make me as miserable as they are. They bash my plans and offer to buy at a ridiculously low price. They waste my time and I cannot stand them. (I keep needles handy for the most annoying ones)

Anyway, I can count my blessings for people like that. I lovingly refer to these losers as "tenants".


But back to my question...why are you so set that it has finally peaked? I don't think it has, but it has definitely slowed. I honestly don't care if it does, but I'm poised to buy if it begins to drop. Hell, I'm poised to buy if it keeps rising. I really don't give a damn.

Oh, I almost forgot. Those people who crash my open house. Quite often they are married couples. One spouse really wants to buy or rent a nicer unit than they have. The other, usually the man, wants to stay put. He is the dumb one of the two, keeping them in the rut they are in. Anyway, the man uses my open house to do two things. Remind his wife that they cannot afford to buy and to show her again just how far $600K goes, and that the $600K 1500 sq. ft. 2/2.5 home is ridiculous, and that next year they can get it for $300K when the world collapses and he is ready execute the shrewd move he has been contemplating for 5 years. The second reason to show her the rental is to remind her that their $1400 rental condo is where they should stay, because it is big compared to the newer $2500/month rental units that are half the size.

[DodgingCars]

I'll talk to you skeptics in a year and we'll see whos right.

[X]

Originally Posted by DodgingCars

I'll talk to you skeptics in a year and we'll see whos right.

You mean the ones who are still living in the home they bought that might have gone down in value a little? Or the ones who still won't be able to buy a home even if it has? Or the ones who are living in the home that has gone up a lot in value? Or the ones who were suddenly able to buy a home because the values plunged 50%?

[Sloth911]

Housing Bubble:

Prices in the market continue to rise until the median two-family income in an area can no longer support the current monthly cost of the home (princiapl/interest). As long as the rates stay low, buyers can afford more principal - and the prices of homes will rise until that monthly payment is more than 30% of the median two family income. 30% is the rough debt/income ratio that banks use to figure out how much house you can afford.

In "hot" areas like NY/CA people are getting interest only mortgages - and their maximum montly payment is based on interest alone - allowing these people to afford "twice" the house of a conventional mortage. Granted, they are building no equity.

I doubt the housing bubble will burst. The prices may slowly cool off and stop increasing (when rates go up) but housing prices will NOT burst like the internet stocks did. Why? Cause homes are real property and hold real value that is unlike that value that was placed on interent stocks.

The people who will see the "bursting" will be people who buy the high-end homes that cost 2-3 times the value of the median home in their area.

==========

Originally Posted by grrrah

I put $0 down, and have to pay the dreaded PMI. Within a year, hoping the bubble doesn't burst too bad, I will have the 20% equity,

If you have good credit this is EXACTLY what people should do if the only reason they haven't bought a house is no funds for the downpayment.

I bought my house in Jun 2003 w/ 0% down. In fact, just like on TV, I got "cash at closing" my interest rate was high at 6.125% w/ PMI built in and a 20 year mortgage.

In the Dec 2004 I refinanced my home based on the new appraised value (meeting the 20% equity requirement) and I got a 15 year mortgage at 4.75%.

======================

Several of my friends have been "saving" for a house over the last 2-3 years and have nothing to show for it. The homes cost $50k more now and they still need to save more money.

People scoff at the idea of not putting 20% down and getting a 30 year mortgage because that is what their parents do/did and they can't think/research for themselves. I tried to help my friends see the "light" and they think I am crazy.

======================

Another very, very populat alternative is doing an 80/20 mortgage where 80% is in a conventional mortgage and 20% is in a HELOC that you can use to cover the down payment.

[BadlyDrawnBoy]

Originally Posted by X

You mean the ones who are still living in the home they bought that might have gone down in value a little? Or the ones who still won't be able to buy a home even if it has? Or the ones who are living in the home that has gone up a lot in value? Or the ones who were suddenly able to buy a home because the values plunged 50%?

Ooh Ooh, I'm in one of those categories.

This is a great thread.

[DodgingCars]

Originally Posted by X

You mean the ones who are still living in the home they bought that might have gone down in value a little? Or the ones who still won't be able to buy a home even if it has? Or the ones who are living in the home that has gone up a lot in value? Or the ones who were suddenly able to buy a home because the values plunged 50%?

Well considering this thread is about a possible bubble and there seems to be 2 views: we're in one or we're not, and I've taken the position that we are....

ummm.. you figure it out.

[DodgingCars]

Originally Posted by jasonr114

Housing Bubble:
I doubt the housing bubble will burst. The prices may slowly cool off and stop increasing (when rates go up) but housing prices will NOT burst like the internet stocks did. Why? Cause homes are real property and hold real value that is unlike that value that was placed on interent stocks.

Maybe not a burst like the stock market, but I could see a quick cooling... Maybe not a burse, what a quick deflation. Califonia had something similar in in the early 90s.

[kvrdave]

Originally Posted by ukywyldcat

Anyway, I can count my blessings for people like that. I lovingly refer to these losers as "tenants".

DAMN!!! I actually think there are plenty of good reasons to rent rather than buy (but not in my situation), and tend to look at my tenants as neighbors.

[X]

Originally Posted by DodgingCars

Maybe not a burst like the stock market, but I could see a quick cooling... Maybe not a burse, what a quick deflation. Califonia had something similar in in the early 90s.

Yes. My house went down about 11% at that time (I know because I had it appraised during the height and the slump). Everybody was in shock. Didn't matter much to me because I wasn't selling then.

During that year or so it wiped out about the previous 2 years of appreciation. Since then it's gone up 3 to 4 times the value it dropped down to.

[al_bundy]

Originally Posted by jasonr114

Housing Bubble:

Prices in the market continue to rise until the median two-family income in an area can no longer support the current monthly cost of the home (princiapl/interest). As long as the rates stay low, buyers can afford more principal - and the prices of homes will rise until that monthly payment is more than 30% of the median two family income. 30% is the rough debt/income ratio that banks use to figure out how much house you can afford.

In "hot" areas like NY/CA people are getting interest only mortgages - and their maximum montly payment is based on interest alone - allowing these people to afford "twice" the house of a conventional mortage. Granted, they are building no equity.

I doubt the housing bubble will burst. The prices may slowly cool off and stop increasing (when rates go up) but housing prices will NOT burst like the internet stocks did. Why? Cause homes are real property and hold real value that is unlike that value that was placed on interent stocks.

The people who will see the "bursting" will be people who buy the high-end homes that cost 2-3 times the value of the median home in their area.

==========



If you have good credit this is EXACTLY what people should do if the only reason they haven't bought a house is no funds for the downpayment.

I bought my house in Jun 2003 w/ 0% down. In fact, just like on TV, I got "cash at closing" my interest rate was high at 6.125% w/ PMI built in and a 20 year mortgage.

In the Dec 2004 I refinanced my home based on the new appraised value (meeting the 20% equity requirement) and I got a 15 year mortgage at 4.75%.

======================

Several of my friends have been "saving" for a house over the last 2-3 years and have nothing to show for it. The homes cost $50k more now and they still need to save more money.

People scoff at the idea of not putting 20% down and getting a 30 year mortgage because that is what their parents do/did and they can't think/research for themselves. I tried to help my friends see the "light" and they think I am crazy.

======================

Another very, very populat alternative is doing an 80/20 mortgage where 80% is in a conventional mortgage and 20% is in a HELOC that you can use to cover the down payment.

very few people are getting IO mortagages at least in NYC. A lot of condo/coop HOA's won't let you buy into the building if you do so via a IO mortgage. Most coop boards require that you put 10% to 20% down as well.

Most housing in NYC is coop apartments. The custom is that you give 10% of the selling price at contract as earnest money and the rest at closing. And the coop boards do a full investigation on you and won't let you buy in unless you are OK financially. All those stories about people paying $1 million for an apartment, they have enough cash in the bank after closing to pay their bills for 6 months if they lose their job.

[BigPete]

In reality, isn't it simply the price of the land that is skyrocketing? Won't the same $250k allow you to build the same kick-ass house as it would have 5 years ago, provided you already have a place to put it?

[orangerory]

I think the people who think there is a bubble that has burst (or will soon) or that everything has peaked - are those people who never "got in" and are sorry about it.

Those people who don't feel that there is a bubble (like me) are people who own more than one property, have made significant gains on their properties and are confident that they will make more.

I think that the reality is that things will slow down - but prices aren't going to drop. At least in my area (Wash. DC) - the job market is strong, rates are still reasonable (and will remain so for quite some time), and we're still nowhere near the prices of NYC or San Fran.

Anyway - I have heard people complaining about the "bubble" for 5 years - well, they sat back and waited and other folks got in on the action and made a killing. Keep complaining, keep waiting - you're not going to see a crash and you will never own.

[The Bus]

Originally Posted by jasonr114

Housing Bubble:

Prices in the market continue to rise until the median two-family income in an area can no longer support the current monthly cost of the home (princiapl/interest). As long as the rates stay low, buyers can afford more principal - and the prices of homes will rise until that monthly payment is more than 30% of the median two family income. 30% is the rough debt/income
ratio that banks use to figure out how much house you can afford. In "hot" areas like NY/CA people are getting interest only mortgages - and their maximum montly payment is based on interest alone - allowing these people to afford "twice" the house of a conventional mortage. Granted, they are building no equity.

[SNIP]

Another very, very populat alternative is doing an 80/20 mortgage where 80% is in a conventional mortgage and 20% is in a HELOC that you can use to cover the down payment.

Some points are pedantic, but as a whole, this part of the message is incorrect.

First off, the ratio most banks use is 36%, although some will allow up to 45% or even 50%. (Or more, but those are specialty cases).

Second, interest only lets you afford anywhere from 10% to 30% more house, not quite twice, assuming you're not counting the period when you start paying back principal.

And third, yes, they are very much building equity. Remember:

Sales Price - Amount Owed = Equity

Even if the amount owed remains the same, increases in price will mean you gain equity. If sales prices drop (even moderately), having a regularly-amortizing loan is not going to protect you from equity loss. A 30-year mortgage gets paid down only by about 1% in the first year. If
nominal house prices were to remain stagnant, it would take five years to pay down the mortgage by 7%, which is the point where you are almost guaranteed to not come out upside-down.

Finally, an 80/20 does not need to be with a HELOC. It can be done with 30-, 20-, 15-, or 10-year fixed mortgages, with ARMs, with HELOCs, and/or with Interest Only.

What I do know is this: house price increases cannot greatly outpace wages for any significant period of time. If this rise continues, at some point, we are either need to be earning a lot more, or the pricing will cool off.


What is Likely to Happen...



Consider this: say we enter a period of (comparatively) rapid inflation. Let's say inflation is suddenly at 7%, which is high, but not alarming. Assume wages increase at 9% on average. Now interest rates are much higher (back to the "normal" 7 to 10%), making houses effectively 25-50% more costly (in terms of monthly interest payments for new home buyers). This puts a damper on house prices, which now only increase 5.5% or so a year (their long-term average).

Let's say this continues for about three years.

What has happened to the REAL price of a home in DVD Town? Let's find out, assuming this begins in 2006.¹ All figures are estimates of current indices, I'm not going to waste time to make this currently accurate since accuracy is not my focus. Anyways, let's take a look at DVD Town.

DVD Town, USA

2005
Inflation: 3.0%
Wage Increase: 3.0%
Housing Increase: 15%
Mortgage Rate: 6.25%

Which results in...
Median wage: $40,000
Median house price: $200,000
Monthly P&I housing costs²: $1231 or $1169
House Price to Wage ratio: 5.0
Housing Cost to Wage (monthly) ratio³: 36.9%


Let's see what happens later...


2006
Inflation: 7.0%
Wage Increase: 9%
Housing Increase: 5.5%
Mortgage Rate: 8.75%

Which results in...
Median wage: $43,600
Median house price: $211,000
Monthly P&I housing costs²: $1659 or $1576
House Price to Wage ratio: 4.8
Housing Cost to Wage (monthly) ratio³: 45.6%


And then...


2007
Inflation: 7.0%
Wage Increase: 9%
Housing Increase: 5.5%
Mortgage Rate: 7.5%

Which results in...
Median wage: $47,500
Median house price: $222,000
Monthly P&I housing costs²: $1552 or $1474
House Price to Wage ratio: 4.7
Housing Cost to Wage (monthly) ratio³: 39.2%


And finally...


2008
Inflation: 7.0%
Wage Increase: 9%
Housing Increase: 5.5%
Mortgage Rate: 7.5%

Which results in...
Median wage: $52,000
Median house price: $234,000
Monthly P&I housing costs²: $1636 or $1554
House Price to Wage ratio: 4.5
Housing Cost to Wage (monthly) ratio³: 43.2%


Adjusting for wages:

2008 (in 2005 earned dollars)
Median wage: $40,000
Median house price: $178,000
Monthly P&I housing cost²: $1250 or $1187
House Price to Wage ratio: 4.45
Housing Cost to Wage (monthly) ratio³: 37.5%


____________________________________________________


Results...

• Homeowners who bought in 2005 have enjoyed a 17% nominal increase in their homes. If you bought a median-priced home, you made $34,000 in equity.
• Wage-adjusted house prices dropped 11% since 2005, or roughly 3.8% per year.
• For 100% or 95% financing, monthly house payments have not become more or less affordable for someone who waited it out.
• For homeowners who bought in 2005, the monthly payments that were $1231 are now effectively much more affordable since their wages rose from $40,000 to $52,000 per year.
• If first-time buyers who decided to "wait it out" saved $300 per month, by 2008 they could have a 5% down-payment.

So, in summary...


-- Houses will not become stratospherically unaffordable.

-- The wage- and inflation-adjusted price of houses may drop without an effect on the perceived value of the home.

-- Houses can be higher in price AND more affordable, even when rates rise.


____________________________________________________

¹ I am NOT predicting these exact numbers, I am simply using this as an example to illustrate my point.

² The first number is for 100% financing. The second number is for 95% financing. These are the more popular options for first-time homebuyers, since many don't have large down payments. For brevity, we assume rates are the same.

³ This ratio figures compares the 100% financing option only.

[ukywyldcat]

Originally Posted by The Bus

[*] If first-time buyers who decided to "wait it out" saved $300 per month, by 2008 they could have a 5% down-payment.

As usual, a great overall post. I found this tidbit amusing. Another example that backs my theory that saving up for something in any long term plan is for suckers. If I can't save for something and have it by the end of the week - maybe the end of the month...I'm either not going to be interested or I'll find another way.

[kvrdave]

Originally Posted by BigPete

In reality, isn't it simply the price of the land that is skyrocketing? Won't the same $250k allow you to build the same kick-ass house as it would have 5 years ago, provided you already have a place to put it?

Sort of. Lots of building materials have gone up significantly. Codes generally become more complex over time which contribute to a higher price. And municipal hook up fees tend to go up quite a bit as well. But the land probably is over half of it.

[The Bus]

Land is land. I know that's a trite response, but it is what it is. If you're to follow the "Three Rules of Real Estate" (location, location, location), then that's all that matters. It's also the main catalyst for why a 4-bedroom ranch home sells for $135,000 in South Carolina and $980,000 in California.

However, kvrdave is right, in that other costs do change. Not only do the costs of material change (and certain ones can change quickly from year to year), but you also have the cost of labor (which has been effectively stagnant recently), and the cost of convenience of available labor. If the economy is slow and the housing market is slow, you can probably build a house to-suit for very little compared to trying to get a good builder during busy times.

Here are some costs of homes to be built in this area, not counting the site. These are estimates of appraisals, so take them with a grain of salt. They're all in Delaware, which, as a market, ranks slightly above average in house values. I'd imagine construction costs (not counting hook ups, taxes, etc.) would be similar across the country IF these appraisers are right.

BIG DISCLAIMER: I'm not a contractor, or a real estate agent, or a handyman, or an appraiser, so I can't tell you if this is right or not. This is just the info I have. This info covers the past two years, so I am just putting this up as a novelty:

$290,000 - 2,900 ft.² 2-story home, 4 Bed, 2.5 Bath, finished basement, 2 car garage, deck
$250,000 - 2,600 ft.² 2-story home, 4 Bed, 2.5 Bath, finished basement, 2 car garage
$235,000 - 1,450 ft.² 2-story home, 3 Bed, 2.5 Bath, finished basement, 2 car garage, patio & porch
$230,000 - 1,900 ft.² 2-story home, 4 Bed, 2.5 Bath, finished basement, 1 car garage, deck
$180,000 - 1,800 ft.² 1-unit twin-home, 3 Bed, 2.5 bath, finished basement, 1 car garage, covered porch
$175,000 - 1,600 ft.² 2-story home, 3 Bed, 2.5 Bath, finished basement, 1 car garage, deck
$170,000 - 1,000 ft.² ranch home, 3 Bed, 1 Bath, finished basement, patio/sun room
$170,000 - 1,300 ft.² 2-story home, 3 Bed, 1 Bath, finished basement, 2 car garage, deck & open porch
$160,000 - 1,600 ft.² 2-story home, 3 Bed, 2.5 Bath, finished basement, 2 car garage
$145,000 - 1,800 ft.² end-unit townhome, 3 Bed, 2.5 Bath, no basement, 1 car garage
$140,000 - 1,800 ft.² split-level home, 3 Bed, 1.5 Bath, finished basement, 1 car garage, deck
$130,000 - 1,200 ft.² ranch home, 3 Bed, 2 Bath, no basement, 1 car det. garage
$105,000 - 1,200 ft.² townhouse, 3 Bed, 1.5 Bath, finished basement

(All these are colonial-type houses, with wood frames, brick/siding exteriors, nothing fancy, just the typical stuff here in the East/Mid-Atlantic/New England).


Site/land values for these properties ranged from $25,000 to over $100,000. For the most part, these prices are in line with each other, and it tells us that properties that sell for $600,000 or more and have features similar to the ones in the list above have a large percentage of their value in the land. The land is what is getting so pricy, not the actual costs of building the site.

The problem with just buying land at first is that you usually need a lot more down than for a house (typically anywhere from 10 to 30% down). You might be able to buy a site for $150,000, but you will still need a hell of a lot of money, and now ALL your investment is exposed to risk as opposed to a house where at least some of the value is inherent in the structure.

Then again, if you are savvy, go ahead and buy large plots of land, subdivide them, and sell them piecemeal. I know a lot of people that have turned $10,000 into $50,000 or more over time, but they are shrewd investors.

[mllefoo]

We were told by the title company as we were signing our documents yesterday that just about 90% of the loans she sees are I/O ARMs. She was impressed we have a loan where we pay on the principle as well as interest, but we had to jump through hoops to get the loan we did. I didn't want an I/O because I'd like to build some equity, and I don't plan on moving out of my digs for a while.

The real estate market in the SF Bay Area will occasionally flatten, but it never goes down. We will be able to make a decent profit on our place in six or seven years, but unlike a lot of people who buy around here, I'm not doing this to invest. I'm buying a place so I have a place to live.

[mllefoo]

My husband brought up an interesting point: I/O loans were popular just before the stock market crash in '29.

[jiggawhat]

I'm a RE agent in california and I can tell you that the one thing keeping prices so high is simply Supply and Demand. Rates are low, so people are induced into buying at any cost. The one thing that does scare me is that there are so many interest only loans happening. Most of these folks don't realize that the interest only period last for a couple years, then when the period ends and they find out they have to pay both interest and principal. Usually the payment doubles and most of them simply can't afford the payments and forced to sell.The amount of I/O loans was relatively small in 2002 but now it's almost 50%, which is ridiculous.

[X]

Originally Posted by jiggawhat

I'm a RE agent in california and I can tell you that the one thing keeping prices so high is simply Supply and Demand. Rates are low, so people are induced into buying at any cost. The one thing that does scare me is that there are so many interest only loans happening. Most of these folks don't realize that the interest only period last for a couple years, then when the period ends and they find out they have to pay both interest and principal. Usually the payment doubles and most of them simply can't afford the payments and forced to sell.The amount of I/O loans was relatively small in 2002 but now it's almost 50%, which is ridiculous.

But you need to consider the time periods you're talking about here.

Interest-only loans are generally interest-only for the first 5 years. Somebody taking out that type of loan now won't have to worry about their payment going up until mid-2010. And at that time they can just refinance again, either interest-only or conventional, if interest rates/payments are more favorable at that time. Five years is a good amount of time to increase your income via raises, job switching, or inflation as well.

For the people who already have a few years on an interest-only, they can refinance now at extremely favorable rates to extend their low payments until 2010.

In addition, I think I read that the average amount of time a home is owned by someone is less than 5 years in California.

So I don't see this type of loan popping the bubble for many years, if there even is one.

[kvrdave]

Agree big time. I also don't understand the attraction people have to ARMs currently. I know the story of "I don't plan on being here longer than X years" etc. but why bother with an ARM when regular rates are incredibly low? Plans and situations change, and some people will get hurt by the ARM as well. Those suckers can shoot up a fair amount.

[jiggawhat]

Originally Posted by X

But you need to consider the time periods you're talking about here.

Interest-only loans are generally interest-only for the first 5 years. Somebody taking out that type of loan now won't have to worry about their payment going up until mid-2010. And at that time they can just refinance again, either interest-only or conventional, if interest rates/payments are more favorable at that time. Five years is a good amount of time to increase your income via raises, job switching, or inflation as well.

For the people who already have a few years on an interest-only, they can refinance now at extremely favorable rates to extend their low payments until 2010.

In addition, I think I read that the average amount of time a home is owned by someone is less than 5 years in California.

So I don't see this type of loan popping the bubble for many years, if there even is one.

The loans I've been seeing lately are only interest only for 2 years.