The Housing Bubble began in the Bay Area around 1996. That’s when home prices starting growing faster than inflation and faster than rents. By the late 90′s, people really took notice. By 2002, the movement took hold. By 2004, housing mania had become a full-blown religion.
Many things that were accepted as true in the bubble-times are no longer so . But for a generation that came of age during the bubble, these bubble-truths are the only real estate truths we know. Tearing them down is to tear at the core of our economic value system, directly challenging the reasons we’ve chosen to live the lives that we have. Losing one’s religion is a painful process.
A Necessary Education
“We need to go through this in order to get through this.” – Todd Harrison
And that’s the difference: knowing the answer is different that learning the answer. Learning is a process, a rewiring of our minds that helps us look at things differently moving forward. We might now know that housing prices don’t always go up, but we haven’t really learned it yet in a way that will change our behavior in the coming decades.
As the housing bust is about to enter it’s second phase, the education process will resume with full-force. When housing finally does bottom, perhaps 3-4 years from now, we will have learned – just as children of the Great Depression and children of the Vietnam eras – a new set of core values and beliefs going forward.
Here are 10 things we know, but have not yet learned:
1. Home prices do not always go up.
Okay…maybe we’ve learned this one.
2. Home prices do not go up faster than inflation.
Home prices do not outpace inflation over time. In the short-term there can be bubbles, but the long-term cost of shelter cannot go up more than someone’s ability to pay for it. Consider this chart of home prices since 1890, adjusted for inflation. You can clearly see that home prices do no better.
3. Investing is different than speculating.
Long-term value lies in the forced-savings of slowly paying down the principal over time, coupled with the benefits of rents that should pace inflation.
Expectations of anything less is speculating, not investing.
4. Wherever you live is not different.
There is no real estate decoupling. A higher-priced area is worth more, on a relative basis, than a nearby lower-priced one. But the relationship is still relative. If the lower-priced area sees an increase in demand, rising prices there will push up the entry-level prices in the higher-priced community. And vise-versa. And in reverse, which is happening now.
These adjustments take time…years in fact. But all market are effected by each other.
5. There is nothing wrong with renting.
Renters are not second-class citizens. They enjoy more mobility, less risk, and more liquidity. Across the Bay Area and most of the country, renters are also saving money each month.
If someone is going to be in the same house for decades, and slowly pay off the loan, and the price-to-rent ratio made sense at the time of purchase, then buying makes sense. Otherwise, renting is often the smartest, most financially-prudent decision a would-be homeowner can make.
6. You probably can’t afford to live in that big fancy house.
During the boom, anyone with a pulse could live in a big, new, fancy house. The man with the Mercedes said you were “qualified”…so it must have been true!
But, actually affording a home is different than qualifying for one, even with today’s stricter standards.
Affordability means different things in different income brackets. Here is one reasonable metric to consider: Home prices, in any given area, have historically averaged about 3.5 times that area’s median income. What you can afford is probably no more than perhaps 4 times your annual income. For some context, San Jose median prices reached about 13 times the median income during the peak of the boom.
And, if you need to use a product other than a 30-year fixed mortgage, you probably can’t afford it.
Consider this as well: if your home equity cannot be counted on as your retirement plan, you’ll probably need to save more money each month than you do now.
7. The mortgage interest deduction isn’t that big of a deal.
The extra costs of ownership (property taxes, special assessments, home repairs, maintenance) and transactional costs (transfer taxes, real estate commissions, loan fees, escrow fees, etc.) more than offset any perceived monthly savings.
8. Bigger isn’t inherently better.
Over the last 60 years, the size of our homes has grown while the size of our families have shrunk. During the boom, things got even more out of control.
But, big houses cost more to clean, heat, cool, furnish, and maintain. That’s a lot of time, money, and energy that could be put to more productive or fun uses elsewhere.
There’s probably only so much house that we really need, and the rest is for showing-off and storing all our stuff (most of which, we probably don’t need either).
9. Newer and fancier isn’t inherently better.
The remodeling and building trends of the boom years, convinced consumers that new fake-wood floors were better than old real ones, that everyone needs a fancy bathroom, and that any decent kitchen must have granite counters. This is utter hogwash.
Authenticity is the key to style and grace. Some homes just feel good…and the vibe usually because the house is comfortable being what it is. By contrast, many remodeled homes feel awkward and uncomfortable, perhaps because the house is trying to be more than it is. Keeping-up-with-the Jones”s is not a comfortable or healthy thing for people or homes to endure.
The eras of excess – the 80′s business boom, the 90′s tech boom, and the 2000′s housing boom – have trained generations of Americans to be great consumers. But now the Age of Austerity is here. Frugality is the new black. Social mood is shifting to where conspicuous consumption is scorned rather than celebrated and simple living is back in style.
10. Building and remodeling with “Green” materials often isn’t “Green” at all.
There is a newer community of 20 or so homes built near where I live in the East Bay, made up of 4,000+ sq. ft. “Green” homes. This oxymoron represents the peak insanity of the housing bubble and green consumerism.
The simple fact remains most green consuming isn’t as green as not consuming at all. Tossing your old TV to get a more energy-efficient one still puts an old TV in a landfill. Usually the most “green” thing we can do to our homes is just leave them how they are.
Sure, there are great new technologies (like solar power) and promising trends (like xeriscaping), but eco-friendly consuming is usually not as eco-friendly as no consuming…or simply consuming less.
June 7, 2010 at 3:32 pm
Great article man. I think people are SLOWLY starting to get it. I keep coming across more “mainstream” outlets that are finally starting to present housing in the manner you have.
June 7, 2010 at 5:00 pm
Thanks Chris. I think the mainstream media is “learning” too.
June 8, 2010 at 4:27 am
Greg – Sobering thoughts, but spot on. Many in the housing industry have never experienced a truly ‘normal’ market, and those of us who were around in the 80′s were too easily led into believing that the ‘new reality’ might be permanent. It was short-sighted of us all. Thanks for the reality check; knowing what to reasonably expect of the market is the first step in planning a successful strategy to meet it.
June 8, 2010 at 9:00 am
Yves Smith wrote and interesting piece this today about the oxymoron of “green consumerism” – it goes along nicely with my point 10.
“Why has the public so meekly accepted planned obsolescence? All sort of products, from cars to consumer durables to consumer electronics used to have much longer average lives in service. More frequent trade ins/ups seem to have been foisted upon consumers by playing on status-seeking and a desire for novelty. Yes, some new gadgets really do offer better and different functionality, but consider how many things you discard that are perfectly usable…”
http://www.nakedcapitalism.com/2010/06/green-consumerism-largely-a-myth.html
June 8, 2010 at 8:24 pm
Your article would be much more convincing if you checked your spelling and grammar.
June 8, 2010 at 10:02 pm
“Green” construction is just a new way to make money. I would agree that leaving things as they are is usually the most green choice. My family’s 1927 lake house has an original GE light bulb – and it still works. The quarter sawn oak floors, gumwood trim and hardwood windows are nice too; and they are in great shape. However, it also has a lot of other things which set off a litany of “does not meet code” with any tradesman who crosses the threshhold.
The kitchen, which was cheaply remodeled by my mother in the 60s, now needs attention and I find myself thinking that it was really a much better kitchen when my grandmother had it. It was a state of the art kitchen for 1927 and those quality materials were far better than the stuff my mother put in. It once had an enormous double soapstone sink and drain board. The stove was a black cast iron monster,with 2 ovens and 8 burners; big enough to cook for a large family. Why do most stoves nowadays not have a warming shelf? The refrigerator was a double door with the motor in the basement. There were no cabinets, only a few shelves and a big table; but there were( and still are) two large pantries, one a walk-in with 8 running feet of cabinets on each side for china &glass, and the other a bit smaller for food storage. I would actually prefer the 1927 kitchen, but then I actually cook.
Newer is not always better, nor is “green” always either economical or energy efficient. It was a travesty that all those cars in the “cash for clunkers” program were destroyed. I know of many people who got rid of cars much better than anything anyone in my family drives….but we are cheap Yankees who hang onto stuff, including paid-for assets. You have to ask yourself “why is the government so willing to give credits and money if I do what they want me to do?” Is it really smart to get on the treadmill?
June 8, 2010 at 10:50 pm
My exact same sentiments. A little spell checking and grammar check goes a long way for readers to believe.
June 9, 2010 at 12:58 am
Yes, check your spelling. For example:
“And that’s the difference: knowing the answer is different that learning the answer.” <- WRONG
THAT should be THAN….see the "N"
There are a few other misspellings below that.
June 9, 2010 at 2:27 am
Fantastic article!!! I hung a copy of it on my living room wall for all my naive neighbors to view when they visit.
June 9, 2010 at 4:40 am
Great comment, Pamela. I couldn’t possibly agree more. I closed on my own escrow in April on a 1935 farm house; when I was looking for the past 2 years, I wasn’t interested in any 3,000 square foot monstrosity built within the past 10 years, or anything that had been remodeled recently (I detest granite counter tops and the whole ‘Flip This House’ mentality of gloss over substance). I’ll take old, sturdy construction any day – and did.
June 9, 2010 at 8:23 am
FYI, solar power isn’t “new.” Granola eating hippies have been preaching the wonders of it for years. (There was talk during the Carter administration about putting solar panels on the roof of the White House!) Industry insiders I know (chemical engineers, power engineers), tell me otherwise.
Photovoltaic cells are still amazingly environmentally destructive and inefficient. Like the “new” technology of windmills, they take decades to make up for the energy that goes into their manufacture. This is because the cells still use silicon which is basically glass as a base and that takes a lot of energy to refine. Then there’s the harsh chemicals that are required to etch and build the semiconductors. Finally, altering the voltage generated by the cells and storing it for off-peak use consumers the electricity and creates their own environmental issues.
There’s been attempts to make two other more direct solar power generation plants. One is based upon directing solar power into a generator using oil as a heat transfer medium. As we all know based upon recent news, oil can be a hazardous substance. In this case, an experimental solar power plant exploded. The other idea is to build a large greenhouse to capture the heat and direct it into a chimney where a rotor resides. The problem with that is that it requires a lot of real estate and high construction startup costs.
Of course, this is all assuming that these technologies are so well made that they last the decades required to pay back their energy and financial startup costs.
June 9, 2010 at 8:24 am
Thanks for catching that! It’s been a busy last 24 hours…my apologies to the grammar police.
June 9, 2010 at 1:35 pm
Great list. We’ll learn eventually, but I bet it will take at least 5 more years for the lessons to sink in.
My only quibble is I don’t think “Home prices do not go up faster than inflation” is accurate. I would expect prices to go up more or less with household incomes, which for most of the post-WWII era outpaced inflation, especially when women started adding to the family income in droves. Certainly the land-value component would rise with the economic output of an area.
I became suspicious of the longer term Case-Shiller data when somebody actually dug up some data points on what Bay Area houses were selling for in the 40′s, and compared them to what those same houses are fetching now. Their prices have grown more than inflation by about a factor of 3, and I doubt retrofits can account for much of that.
June 9, 2010 at 1:41 pm
Mark,
The chart is home prices adjusted for inflation and the yellow line seems to be a fairly constant, level reading.
June 9, 2010 at 2:54 pm
Great article. How come CAR hasn’t kicked you out of their club for your heresy yet?
To follow on to Mark’s comments, I think he’s both right and wrong. If I recall correctly, the entry of women into household earnings was a keep-level maneuver, not a gain. I’d be interested in seeing data showing otherwise. But as to Bay Area housing prices (as opposed to national), those did indeed outpace inflation — until now. All you have to do is look at housing prices between 1970 and 1980 here compared to the rest of the country. And Prop 13 keeps prices artificially high because it offers a disincentive to sell, thus reducing supply.
Consumer Reports had an excellent article many years ago showing that basic items such as a newspaper or a loaf of bread have not changed price if measured in how long it takes to pay for them by average wage. Mid-priced electronics have come down tremendously; for example stereo equipment costs less now than it did in 1960 pricing (let alone adjusting for inflation). Large-ticket items have tripled, after adjusting for inflation. The examples they gave were homes and college educations. In view of your recent piece, I thought you’d appreciate that.
I think they should revisit that article and give 2010 pricing as homes are returning to earth but college is leaving the atmosphere.
June 9, 2010 at 7:38 pm
“And Prop 13 keeps prices artificially high because it offers a disincentive to sell, thus reducing supply.”
Agreed. Prop 13 has helped make housing more expensive in CA than other states.
Nice to see you here madhaus.
June 10, 2010 at 6:31 am
excellent points, I agree with all…I will just point out for example in # 10 that you use words that are pure realtor-speak “There is a newer community of 20 or so homes …”. Translated into reality-speak this would be “There is a newer development of 20 or so houses…”
community and home are loaded words that realtors use to appeal to peoples nesting instincts. Language does matter!
June 10, 2010 at 8:21 am
Suggesting that “community” implies some sort of overly-positive sales spin?
When a development is completed and all of the homes are sold and lived-in, isn’t “community” a fair word? Once active development is finished, should we still call it a “development”? For how many years?
Just curious…I do appreciate the feedback!
June 10, 2010 at 8:33 am
You’re welcome. They definitely are learning…or at least reporting more accurately. Here is an article from marketwatch – http://www.marketwatch.com/story/the-housing-market-recession-is-not-over-2010-06-09
I’ve seen more and more of these creep out now that the tax credit has expired. Prior to that, i couldn’t find any realistic assessment outside of blogs like this one.
June 10, 2010 at 1:17 pm
I live in a typical cul-de-sac neighborhood, 15-20 years old, and only know the immediate neighbors. My fault, I haven’t been here long and don’t work with them. To me a community implies lots of people who live near each other, and interact regularly via work, social activities etc. maybe even several generations of people. A bunch of adjacent houses with people living in them doesn’t necessarily qualify, no matter how old – I think the community is the social environment, not the built one. I also think subconsciously a lot of people have this view and new developments are often marketed as communities with this “Norman Rockwell” image in mind. Hope this clarifies.
June 14, 2010 at 8:04 am
Great post Greg. I’m so glad Housing Storm found me. It’s nice hearing from people with “common sense” and a sense of reality.
People just need to realize, contrary to the boom culture, that the objective of purchasing a home is to establish a long term place to live, not just for an “investment.”
June 14, 2010 at 8:18 am
I like the comment about the CAR kicking you out for heresy. It is so much the attitude of the disillusioned.
I recently had the president of my local board come and have a “special talk” with me after numerous complaints by local Realtors, because of the “negative attitude” I was shedding about the real estate market.
The local newspaper here quoted my blog, where I stated some stats and facts. In the post I predicted that my small local market would see a record high number of listings this year.
http://loganhomes.info/2010/02/number-of-logan-homes-for-sale-alarmingly-high/
Basically, I was instructed by the local board president that I was too defer all comments and inquiries to the media, to him, because he had “special” NAR training on how to handle media.
June 22, 2010 at 4:49 am
Great Post…It has been years in the making but I think the government financials are the biggest Ponzi Scheme the world has ever seen. The housing market needs to be kept afloat in order to keep the entire scheme going. If one of the pieces falls it is all over. Sad to say but we can thank our elected officials and really us for re-electing these crooks over and over again. I am really not cynical but I am extremely smart and have common sense.
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