Some are still commenting on my last post, “Erica predicts your news headlines for 2007.” The most common comment I’ve heard from homeowners is that they’re afraid I might be right, but they hope that I’m wrong.

Since hope is a very poor investment strategy, let me reiterate what is prudent if you are a homeowner:

1) Consider this. Are you willing to stay in your house for at least 10 more years? If you are, fine. Stay put… and wait out the coming bust. But you better be 100% sure you can either stay there for 10 years yourself or rent it out at a profit.

2) If you do not wish to stay at your current place, put it on the market NOW. Do not wait even a single month longer. Find a comparable house on the market and price yours 10% below it. You should receive offers if you have the lowest-priced house in your range.

3) Assuming you can sell your house, take the money and bankroll it (Fed funds or short-term CDs are good “safe” investments right now; they’re currently pulling in about 5.5%, which is much more than you’ll make on your house in the next 6 years.) The stock market is all over the place and I do not recommend most stocks as a long-term investment vehicle right now. Then rent. And plan to rent until 2010 or 2011.

You don’t have much time left (months, not years) to sell your house if you wish to sell. Bay Area prices have hit their peak and are starting to drop. This is echoed all over the country. San Francisco median year-over-year prices are already dropping. The East Bay is dropping radically. San Mateo County seems to be holding a bit more value; this will likely be the county that gets hit least in the Bay Area. If you can get out now, pull the trigger, price 10% below comps, and get out.

Historically, keep two factors in mind. 1) The “0” years are, historically, some of the worst years our economy has had in its history. 1930 — depression. 1980 — 18% interest rates. 2000 — I shouldn’t even have to remind you how much stocks got hammered. 2010 is going to suck, and suck hard. Jobs will be cut. Companies will go out of business. There won’t be as many “bubble” parties here in the Bay Area, and venture capital will be harder to find. Avoid problems NOW by paying off ALL of your debt (that means cars and houses, too, not just credit cards!) and curtailing spending. Make sure to have at least 6 months’ cash reserves on hand in a low-risk investment vehicle such as a CD. 2) Housing is cyclical, so we can judge how hard we are going to get hit by previous booms.

How long do you have to rent before it’s a good time to buy a house? Let’s take a look at this chart of the 1980’s real estate bubble to give us a feel for how the current bubble will end.

1985-1986 (2002-2003): Housing is booming, inventory is low.

1987 (2004): Housing still booming, prices increasing, inventories low.
1988 (2005): People start to question the boom. Realtors assure us the boom will continue. Houses aren’t like stocks, after all.
1989 (2006): Prices are very expensive; affordability an issue. Sales slow and prices drop. Mention of risky loan types.

Hmm, that’s right now. The Bay Area is still hitting record-high prices, although sales are down more than 30% from last year. What’s next?

1990 (2007): Prices take a serious plunge. One article claims that housing booms are a bad thing and we should hope prices stay low. Increasing mortgage rates are blamed for the bust. The word “recession” is mentioned. Gloom and doom.

That’s next year. How many times do you think you will hear the words “looming recession” next year? More than you want to, that’s for sure…

1991 (2008): A “dead cat bounce”? Some folks wondering if the bust has bottomed out or not. Sales are abysmal (e.g., -42%). Other parts of the country showing some signs of recovery.

2008 is when you might tell me that I was wrong about all of this and that we’re starting to recover. WRONG. 2008 will NOT be the bottom. Remember, we still have our “0” year ahead of us.

1992 (2009): No one is buying; housing is an investment that no one will touch. Desperate political efforts being made to encourage house buying. Rock bottom prices and lower mortgage rates encourage some purchasing. The year ends with some buying. Another “dead cat bounce”? It’s not clear.

Another dismal year for housing. But business spending will likely pick up in the 2008-2009 timeframe. There will be signs that the economy might be recovering. But we haven’t hit our “dead year” yet.

1993 (2010): It’s definitely a buyer’s market. Some people are saddened by the fact that current prices are 50% of what they were in the 1980’s. The housing bust in Southern California is clearly negatively impacting the California economy and the national economy at large. Sellers are desperate to sell (and some people taking extreme measures like putting huge “for sale” signs on their lawns for passing planes to see). Folks who waited out the boom to buy at the bottom are being handsomely rewarded for their patience. Proof-positive of the contrarian investing style — be greedy when everyone is fearful and fearful when everyone is greedy. The “slump” may be ending.

2010 will be the year to buy a house… if you can. Take those cash reserves and head into the market with gusto. Ignore your friends telling you you’re crazy and the inevitable stories of “I lost 50% of my home’s value.” Use fundamentals (rent times 200) and if the numbers work (look for a 150-175 number times rent to really know it’s a buyer’s market), jump in with both feet.

1994 (2011): Housing begins its comeback. People who had the intelligence to wait for the bottom are buying now at great values. Even rising mortgage rates are not shaking the recovery.
1995 (2012): Some parts of the Southland are recovering others are not. People with “negative equity” are in despair.

2011 and 2012 will be the beginning of real sustained growth in the economy. Housing will show some signs of coming back from the dead. Businesses will again hire. This time, the economy will put things in the right gear and move forward. You will not see much in the way of equity gain on your newfound house, but you bought it to live in and hold, right? Right? (Or you bought it to rent out and the fundamentals make sense. Either way, you’re in a great position.)

1996 (2013): A tentative recovery is still in the making.

Some others are beginning to buy houses now. Some don’t think you’re so crazy to have bought in the bleak pit of late 2010.

1997 (2014): Finally, housing has recovered.

And if you bought in 2003-2004, your house is worth approximately 75% of what you paid for it then. I hope you have a nice equity cushion!
…But if you bought in late 2010, your house is worth perhaps 110% of what you paid for it… and you paid less than anyone else did.

I hope I’m still writing a blog in 2014 so I can come back and see if I was right and how this bubble stacked up against a previous one. So far, it’s played out right as those “in the know” expected. I hope you, too, can invest wisely and do well in the housing market.

I’ll throw a housewarming party in late 2010. You’re invited. 🙂

It’s pretty interesting to me that the financial news sector has such a disconnect from the regular news sector. I read about many things in the financial news that most people have no clue about. These things will only make the regular news when they start to affect people, not just markets. Therefore, I’m stepping out on a limb to predict your news headlines for 2007 based on what the financial news sector is saying today. I firmly believe that all of these will become front-page news headlines (some for days and days, until you get sick of reading them) in 2007 — or possibly late 2006. Here we go:

The real estate boom is over. Toast. Dead. Done with. That’s already starting to hit the mainstream news. But the really interesting news is the shocking stories that will appear once the largest real estate bubble we’ve ever had turns into the largest real estate bust we’ve ever had, and it’s a bust that will likely send our country into a spiraling recession.

Let’s start with Florida. Florida will turn into a complete disaster area in the next year… if not by hurricanes, then by ridiculous overbuilding, oversupply, and glut of condos. That old joke, “Why are Florida condos like STDs? Because you are stuck with both for the rest of your life.” will resurface. The ridiculous price of hurricane/wind insurance (even inland!) will result in a lot of Florida condos (and some houses) that will not be able to be sold at any price.

Other markets that you’ll see break in 2007 include San Diego, Las Vegas, and Phoenix. All of these markets have been overbuilt so much that price declines of 50% or more by 2011 are likely. Here are some inventory numbers from Phoenix. Available homes for sale, May 2005: ~5,000. Available homes for sale, July 2006: ~55,000. Vegas is just as bad, with greedy developers snatching up everything within 5 miles of the strip to build condo towers on, and investors who will not be able to bail out of the condos they bought at overinflated prices. San Diego has 3,500+ condos that are being built right now. (Folks, $300,000 for a San Diego condo is soon going to seem as ridiculous as buying dot-com stock for hundreds of dollars a share. Bookmark these links for a good, hearty laugh in 5 years.)

The other thing you’ll start to see surface that is directly related to overbuilding of houses and condos is developer lawsuits. Pretty soon, some of the “investors” that bought condos at ridiculous prices and realize they can’t sell for even 70% of what they bought the condos for will start suing the developer. Claims? Anything from shoddy construction (oh, and you’ll find some nightmarishly bad construction on some of these condo units…they were slapped together at the peak of the market as quickly as they could be) to false promises regarding a return on investment that never materialized.

Let’s take a look at realtors, mortgage brokers, and the others who make their living in the real estate market. Did you know that 70% of the jobs created post-dot-com-boom in California are NOT in high tech, but in real estate? How about the fact that there is one Realtor(R) for every 55 people in California? At least half of these people will be out of work by 2011. Also, mortgage brokers and mortgage lenders will go out of business fairly quickly (perhaps aided by more lawsuits from angry buyers that were sold false promises.)

Here’s what may be the worst headline in 2007. Fannie Mae earned $10 BILLION less than they stated in their 2004 earnings report. What does that mean for us? Fannie Mae and Freddie Mac are two of the largest holders of mortgages in the country. They are allowed to borrow money at interest rates lower than any private company due to the assumption that they will be bailed out by the U.S. government if they go under. The problem is that this implicit (NOT explicit — Fannie/Freddie loans do have a disclaimer stating that the government does not guarantee their loans) assumption has allowed corruption to reign supreme. Earnings were ridiculously overstated. Then the executive management paid themselves huge bonuses based on the fraudulent earnings. This has “Enron” written all over it.

If the government does end up needing to bail out Fannie or Freddie due to massive corruption imploding them, our U.S. dollar will tank relative to other currencies. The dollar has remained strong because foreign investors keep pumping their money into the American economy. If a real estate bust and/or a Fannie or Freddie bailout happens, foreign investors will seek other countries to increase investment in, further sending the dollar down. Note this recent article regarding the dollar, which has the following quote:

“The dollar will no longer enjoy the benefit of consistently rising interest rate yields and will now have to compete on U.S. economic performance alone.”

U.S. economic performance is likely going to be very poor over the next 5 years — and perhaps longer. If you want to make money on this, bet on the dollar to be weak and hold a long position. Buy currencies of countries you think investors will want to invest in. You will come out ahead.

Finally, let’s head back to the local real estate scene. Here in the Bay Area, inventory has increased, but prices have remained fairly steady. With 30% more homes on the market this year than last year, and houses taking longer and longer to sell, the next move is a price drop. And drop they will. Prices have been disconnected from fundamentals for years now. (Read that link for an excellent, in-depth description of why the current housing market in the Bay Area is unsustainable.) But if you want the quick run-down, here are a few facts:

• Housing supply in the Bay Area, per person, is significantly larger now than it was in 1999. Normal laws of supply and demand state that prices should have gone down from their 1999 levels. They have not.
• Developers are still building condos, condos, condos. Have you been to Emeryville lately? And they are building thousands more condos near Jack London Square in Oakland…a quick drive or BART ride to San Francisco.
• Population has been decreasing here since 1999. One friend of mine is sure that San Francisco real estate prices will remain at their current bubbilicious levels due to population growth. It’s not his fault he’s been sucked into this myth; it’s the same line we’ve all been fed by Realtors(R) and others who make their living selling houses. I’m sorry to say that this is a myth. The population of San Francisco was larger in 1950 than it is now!

• 1950 San Francisco population: 775,357
• 2005 San Francisco population: 739,426
• Uh-oh.

I predict at least a 35% decline in housing prices (overall, average) from 2005 prices for the Bay Area by 2011. The hardest-hit areas will be outlying areas that rely on commuters to make the numbers work. As commuters see gas prices go up, up, up, the advantages of paying less for a house decrease. Sacramento will be hit extremely hard due to too many single-family homes being built. Tracy will be hit hard. Places that will be hit less are places close to where people work and/or close to public transportation other than buses. For instance, houses close to BART stations should retain more value than those where you must drive a car to get anywhere.

Condos will be hit worse than houses. There are more condos being built right now, but more people desire single-family homes. Those looking to “move up” from a condo to a SFH (single-family home) may find themselves trapped in a condo that is worth less than when they bought it — if they bought it later than 2001.

So when does the real estate bust finally end? It’s hard to say, but you can use this guide as a rule of thumb. Take the rent that you would be paying for an equivalent place and multiply by 200. If the house you are looking at costs less than that, it’s probably a good deal. Doing the math on the place I live in now, we find the magic number to be $570,000. My landlord paid $625,000 for the place in 2004. It is now worth approximately $800,000 (if he could find someone to buy at that price — duplexes are not hugely popular here.) A 35% decline over the current “high-water” $800,000 price puts the duplex at roughly worth $520,000.

This duplex sold for $325,000 in 2000.

This is why 35% price declines are not unreasonable. $325,000 in 2000 to $520,000 in 2010 is a 62.5% price gain in 10 years, or 6.25% per year, which is still over the historical average for the Bay Area. That means by the time we overshoot the bottom in 2011 or 2012, it could well be that this duplex would be valued at only $450,000…or less.

And time goes inexorably on…

Note: This post was pulled over from another site where I used to blog and has been reproduced here. Originally posted online on September 10, 2003.

In one of my previous journal entries, Liora made a comment that I’ve been meaning to reply to for a while. She said, “The interest rates pretty much mandate it such that renting is just dumb. Rent is throwing money away.”

This is absolutely true for most of the country. It’s absolutely NOT true for the Bay Area (hence the alternate title.)

Before we go on, I should mention a few things:
1) I rent;
2) I believe that housing prices in the Bay Area will drop about 10% (or perhaps more) in the next 3-5 years.

Why? Read on.

I just signed a 1-year lease for a 2BR/1.5BA condo for $1475 a month. This is the reason why I leased. (Note: link now dead.)

That is a link to a similar condo in Pacifica… a 2BR/1.5 bath, just like I have, and of the same vintage (built in 1972). They are asking $342,500 for it. This means that with a $68,500 down payment, I’d have to pay $1675 a month to own it.

Stop and think about this for a minute. Supposedly, the whole point of owning is that you aren’t “throwing your money away” (i.e. a mortgage payment should be cheaper than renting the equivalent property), but I could put $70,000 down on this condo and have nothing to show for it except a larger mortgage payment than I would pay in rent. A housing price devaluation of 10% or more could completely wipe out any equity that I would have in the house after only a year or so of owning it. As many people learned with the stock market, it’s extremely dangerous to always count on your investments to go up (like many people assumed both now with housing and in 1998-1999 with the stock market.) A lot of wealth was completely wiped out in 2000-2001 with the stock market devaluation. Imagine what any housing price devaluation will do to people who have saved up $50,000 or more to make a down payment, only to watch their equity disappear as housing prices face the same adjustment the stock market did.

Why will housing prices drop? To put it bluntly, they have to. Renting cannot forever be cheaper than owning, or people who buy investment properties will be out of work. People cannot afford to keep bleeding cash on investment properties like they are now. Plus, once interest rates go back up, those first-time home buyers who have been saturating the home-buying market right now will no longer be interested in buying. Thus, housing demand will drop, supply will keep going up (as builders keep building new houses and condos), and prices on houses will start to fall. And they will fall more than most people will expect. I’m forecasting an overall drop of 10%. It could be more, or it could take 5 years to hit 10%. But it will happen. This will wipe out a lot of equity for a LOT of people.

Renting vs. owning is a huge sticking point for me. I would love to own property. I could probably afford to own property in the Midwest. And I probably would own at this point if I lived in the Midwest. But in the Bay Area, it’s not justifiable to own when you look at the numbers.

I’d rather take $68,500 and invest it into my company… that way, whatever return I get on it is directly influenced by me and how well I do sales. I know I can take that $68,500, put it into Simpli, and turn it into a revenue generator of $10,000 a month or more. There is no way I could do the same thing with a house. And that is why I rent.