Wednesday, November 7, 2007

30-50% fall in 6-10 years?

Back on September 4th I began a look at housing prices and income trends, seeking an estimate of likely price fall. Then on September 29th I added Santa Monica income levels. Finaly on October 27th I found a good fit between the Los Angeles S&P/Case-Shiller index and north-of-Montana lot value prices.

Here I'll put these all together. Above is the Los Angeles S&P/Case-Shiller index, which we know has closely fit Santa Monica prices as represented by low-end north-of-Montana, combined with a linear extrapolation of Santa Monica median household income. This suggests for prices could fall 40% in 8 years to return to their historic relationship to income. Now let's push the model in both directions. I scaled the income line by eye to the price curve. For a worse case (above), I dropped the income line by 10% and shortened the drop duration to 6 years, resulting in a 50% fall estimate. Going the other direction, I raised the income line 10% and extended the duration to 10 years, more of a "soft landing" but still a 30% fall. So a likely 30-50% fall in 6-10 years, consistent with others' projections.


Anonymous said...

point of curiosity: did SM property values realign with median incomes the last time RE market went down? i.e. in the eary nineties?

Anonymous said...

p.s. or were they in sync with median incomes during that downturn?

Anonymous said...

Wow - advanced science.

Consider adding p-values to
your predictions :-)

tony almonte said...

i'll bite? what is a p-value? property value? i can only guess from the tone of your message, and i admit that email tends to take on a tone of its reader, that you are dismissive of the effort from westside. if so, please explain.

rosebud said...

Hey Westside – first, thanks for the front page reprint!

A lot of great points on the boards… For the graphs, I respectfully question the value of the Median Household Income. More valuable in this case could be Average Family Income or Per Capita Income, which both track closer to the huge upswing we’ve seen in SM, particularly Northern SM (which is where they’re most relevant). For instance, while MHI was up 41% between ’90 and ’00, PCI was up 48%.

That’s nothing though… from 2000 to 2005, Per Capita was up another 29%! Very relevant considering the low volumes of units we’re (still) looking at. Another good data point is that people making more than $200,000 went from next to nothing in 1990 to more than 3400 people in 2000. Safe to say that with the increase in PCI, this has gone up even more substantially of late.

There was a comment about rich people all sending their kids to private schools, ergo the quality of schools didn’t factor into this discussion… think the same poster said that the schools were good, but not great. The best school in the district is in Northern SM, which is in the top 1.5% of all elem schools in the state. Top 1.5% is great not good. I’ve said it before, this is a huge factor when deciding where to buy for those that have kids or are thinking about it. With the top private schools costing 3k per month, per child, a family with 2 kids can afford nearly $1MM more on a mortgage by sending kids to the great public schools. Even if you feel you need to send them to a private high school, you rack up significant savings beforehand. The rich pay for their kids’ education out of the same account that they pay their mortgage.

Good points with the lifestyle posts (sidewalks, etc.) too. This is buffeted by the fact that the majority of 90402 listings are now coming from the canyon… i.e. for folks in the great neighborhoods who enjoy all of the posted benefits there’s not a lot of pressure/reason to leave. For the other changes from 2000 to now, check out the repost while it’s still on the front page (thanks again for that, Westside, very objective). Apologies for the long post.

Anonymous said...

thank you very much

there seem to be very very few people living in the "walk streets" section of 90402 that are deciding to put their homes up for sale.

you are correct on that account.

Wow, i never thought of the savings from sending kids to public school - if private school costs 30 thousand bucks per kid, that is indeed 60 thousand a year, enough to take on an extra million of mortgage debt.

hfguy said...

The -40% scenario is closer to what Goldman Sachs expects. Other econometric models reach the same conclusion. They track individual zip codes on the Westside and inflate home pricing by shelter costs (rental equivalents), building costs, population and per capita income growth. The only thing missing from such economic approaches to valuing housing are paradigm shifts in housing finance and buyer psychology. Both forces are fleeting but can be viciously powerful over several years.

Exotic leverage, coupled with better information (high speed internet), improved transaction speeds and sales volumes. This sustained the illusion of liquidity in what is fundamentally an illiquid, hard asset market. Excitement in trading bids up prices, similar to what happened when retail investors got their PCs with internet stock brokerage in the 1990s.

A difference is that the PaliMonicaVistaWood housing bubble will deflate more slowly than the NASDAQ, which took only 2.5 years to fall from from its apex in Mar 2000 to its nadir in Oct 2002.
Another difference is that the tech stock investor lost 100% of her equity investment. The PaliMonicaVistaWood home owner will lose equity times her leverage ratio. Horrible (in terms of what that cash could have done) but immaterial so long as she can still float $12k a month for PITI for a teardown in NoMoLand.

Westside Bubble said...

Anon 11:37, it looks more like property values crossed income on the way down and again heading back up. Scaling income to prices is a subjective element in my analysis; I started with income crossing at the beginning of Case-Shiller, then did a range 10% up and down from there.

I had few data points for Santa Monica median income, but annual for the Los Angeles-Long Beach-Santa Ana MSA in my first cut at this. The latter was still pretty linear.

Rosebud, do you have Santa Monica mean and/or per-capita income numbers handy for this time span? If so, I'll post additional graphs to compare.

I think I noted before, the value of good schools north of Montana and its relative unaffordability date back over two decades, yet its prices still fell in the 1990s.

Thanks, everyone, for the good conversation here! Obviously I'm a bear now, but am seeking the best information for all of us considering whether to buy soon vs. wait for a fall-off.

Ann said...

i don't think prices will fall that much, and not because your data analysis (affordability) doesn't make sense. There are too many other random factors to consider, such as inflation and psychology. I could be wrong, of course. That's why this whole endeavor is so interesting.

Anonymous said...

I think the concensus on this board is that Westside prices will come down. Ie that prices will be lower in one year than they are today.

Ok i respect that.

Let's look at this from the perspective of a spec builder.

Let's say today the teardowns in 90402 on 7500 sq feet are 1.7 million
so he buys the teardown, slaps up the 4500 square foot house (maximum allowed by the zoning)
and on the day it is completed he is all in for $350 a square foot * 4500square feet or 1.6 mil plus the 1.7 he paid for the land so total he's got 3.3 in.

In order to pay the interest on the money he has borrowed to do this and earn any sort of payment for his time and energy expended, he has to sell it for what? I mean be direct with me - in the above scenario, he has to sell it for what $$$ Ammt to break even, and what $$$$$ ammt in order for him to look back and be happy he went through this hassle?

I mean assume for a minute that one or two of the guys doing high end specs are rational reasonable nice people. If you see one of them today, November 2007 buying a teardown for 1.7, what do you think is going through his mind? what is he thinking

i want to understand

thank you

Westside Bubble said...

he has to sell it for what $$$ Ammt to break even, and what $$$$$ ammt in order for him to look back and be happy he went through this hassle? ... what do you think is going through his mind? what is he thinking

That there is developing a glut of houses asking $4-5M? If he sells, he's done well; if not, ouch!

Oldest is 333 14th, listed since 6/29/07, now reduced 6% to $4.6M. Four others jointed it more recently.

Anonymous said...

The developers are not entitlted to make a profit or even break even. If they put up too many McMansions and the market is saturated with these monstrosities, they are only "worth" what the market dictates--the market could care less what the developer spent on making the McMansion.

People that add up all of the costs that the developer put into building the spec mansion and then say, "This is what this house is worth" don't understand capitalism.

The McMansion is worth what someone is willing to pay and in the case of the Westside, a lot of developers put up these wannabee mansions and they expected that there would be people to buy them.

Guess what? Traditionally if a wealthy person wanted a custom home, they hire an architect and then they design and build it to their specifications. A person who can afford a $4,000,000 house would be an idiot to buy one of these McMansions when they could go to an architect and get a house that was built exactly to their wishes and requirements.

DG said...


Very interesting info. Can you share the source of the data? Thanks for participating in the discussion.

allsouledout said...

"People that add up all of the costs that the developer put into building the spec mansion and then say, "This is what this house is worth" don't understand capitalism."

EXACTLY, thank you.

Kind of like when people were (and still are) using Zillow value to justify their listing price. The new tactic in listings is to say a place is "lower than recent comparable sales". YOU THINK!?!? I mean, I don't fault people for using marketing spin, but come on ...

What's something "worth"? What someone will pay for it, that's what ...

Anonymous said...

I am so glad that several posters have mentioned the 90402. I agree completely that whatever news is discussed on this board, we should all be mindful that it will not affect the 90402. Why?

First, because the houses in that zip are NORTH of Montana, unlike the houses in other zip codes. Therefore, the economic principles that at first glance seem universal cannot apply. 90402 is not a spreadsheet, it's a dream, one that everybody wants at any cost.

Second, because not only do people in affordable areas dream of moving to the 90402, but people living in other areas do too, including the Palisades. So it will not be subject to the declines you see in Inland Empire, Malibu, etc.

I think that RE prices will drop 30-40% in most parts of LA, West LA will drop a more modest 20-30% (higher end of that for the condos), and 90402 will also slow down, it can't go down but it will only go up maybe 5-10% a year until the market bottoms out.

Anonymous said...

While I agree in principle in the direction of the correction, there is an implicit assumption of income deflation in your charts, which
may not be obvious to most people

You project increases in income as a straight line.

This implies a decreasing rate of income growth over time.
In other words, a fixed increase in $ per tear, is a smaller and smaller percentage increase.

This implies that income GROWTH is decreasing.

Your implicit assumption in your projections is that incomes will continue to deflate.

This ignores inflation.

History shows that inflation happens.

WarChestSM said...

"90402 will also slow down, it can't go down but it will only go up maybe 5-10% a year until the market bottoms out."

If it can't go down, then why has this blog been able to show so many examples of 90402 properties cutting prices and languishing on the market. The data seems to suggest that this zip code has already fallen more than a few percent.

The $2.2 million tear downs of yesterday are now marketed as $2.0 million "starter homes".

Anonymous said...

You didn't detect even a slight bit of sarcasm in that post based on these comments!?

"First, because the houses in that zip are NORTH of Montana, unlike the houses in other zip codes. Therefore, the economic principles that at first glance seem universal cannot apply. 90402 is not a spreadsheet, it's a dream, one that everybody wants at any cost."

WarChestSM said...

Sorry, I guess I was gullible and took it at face value. It seems early enough in the cycle and there are still enough 90402 "believers" that seeing a comment like that (and having somone actually mean it) would not surprise me.

Also, it helps when people choose a name so that they can be identified (there are too many anons to count...)

rosebud said...

Good point on income growth. We definitely shouldn't project linearly... but also can't use median. If a dozen people move in making $1MM, and a dozen move in that are unemployed, the median doesn't move. Since we're talking about just a couple dozen homes...

For the data:

1980 per capita: 13,149
1990 per capita: 29,150
2000 per capita: 42,874
2005 per capita: 55,218

Source for this is the US census. Sources for other items include the city and Rand.

I buy the increased DOM, Warchest, but would be interested to see some of the sales examples. Some of the ones posted here have shown many homes still going for over (steep) asking prices. I think every year we see tear-downs ebb and flow within some range...

But speaking of languishing... the La Mesa property didn't seem to. Is that a function of an underpriced home ($5.5MM), statistical outlier, strengthening market for certain property types? What do you think?

ed wood said...

Looks like 704 15th fell out of escrow.

Previously referenced here