BSBJ Article Response
This week's Big Sky Business Journal has an article on housing. This is the first major housing update since the BSBJ's September article, which I critiqued near the bottom of this blog.
Unlike the September article, which only quoted many local Realtors, the new article contains a contrarian voice.. me! There are also some good quotes from Paul Polzin. Read it and see what you think. Thanks to Evelyn for an interesting article, and for quoting me.
I have two responses that I would like to post here.
Rents set to skyrocket?
In response to my assertion that the price/rent ratio is out of line with historic norms, here's what real estate agent Howard Sumner has to say:
That there is a huge disparity between the current rental rates and mortgage payments, is not something with which Sumner would disagree. His figures show a disparity of about $650 a month.
But, that means only one thing to Sumner: "People will be shocked at the increases in rent over the next 90 days". The "softening" in the rental market, Sumner attributed to a jump in the number of multi-family units that has been built in the recent pass.
Sumner recognizes that this disparity is a problem. That's a good start. But instead of believing, like I do, that housing is overvalued, he claims that renters will see shocking rises over the next few months. This claim is made with no data to back it up.
Barring a major shortage of rental units, rents are generally determined by local wages. There can be no speculation or risky loans . Rental rates can only be as high as people can afford. This is why the price/rent ratio is so crucial. While rents tend to steadily track wage growth, house prices can fluctuate much more and get out of line with fundamentals.
We really need to get some data on rental vacancies. I'll see what I can do. In the meantime, I did some quick looking into the Billings Gazette print archives. I looked at single family home rentals in print Gazette classifieds from 2003 through 2007. For each year, I looked at the last Friday in February. Here are the numbers I found:
If indeed rents were set to skyrocket, you would expect very tight supply. Instead, we see a fairly large number of houses for rent. The number is pretty much in line with what we've seen for the last few years.
Interestingly, several of the houses for rent are advertised as brand new and never lived in. Because there's so much inventory for sale out there, many units are being rented out since thay cannot sell. This is especially true in the condo market. Most downtown condos are for lease as well as for sale. Many other condo projects around town are having trouble selling, and are going up for rent. There are a lot of vacant units out there.
I don't see where Sumner gets his idea that the price/rent problem is going to be solved by rising rents. Unless he provides some hard data on why rental rates are going to have "shocking" rises, I'll be skeptical until I see it.
Have interest rates kept housing affordable?
Later in the article, Sumner takes on my claim that housing is unaffordable. Here's the exchange:
But affordability is exactly the problem with the price of housing, claims Armknecht. He stated, "Billings house price index, published by the Office of Federal Housing Enterprise Oversight shows house prices up 50 percent in the last five years. Most estimates show wage inflation to be around 15 percent during that time. Home prices have risen so fast that incomes can no longer support them."
Sumner's numbers indicate quite the opposite, much even to his surprise, he said. With the average price of a home climbing from $114,000 in 1999 to 180,000 in 2005, it may indeed appear that house prices are out stripping the average buyers ability to buy. But consumer purchasing power has been advancing at the same time, said Sumner. The median family income in Billings increased 18 percent, while interest rates dropped 20 percent from 1999 to 2004. A homeowner who could afford a $141,129 in 1999 could afford a $195,374 home in 2004.
I believe that Sumner's analysis is muddled, misleading, and sidesteps my point. Based on the phrase "Sumner's numbers indicate quite the opposite", he needs to show that my statement "Home prices have risen so fast that incomes can no longer support them" is incorrect.
To do so, he says that consumer purchasing power increased. Since wages have trended upwards and interest rates generally downward, he is correct. However, he conveniently only looks at the years 1999 through 2004, ignoring the trends and data since then.
I will assume that "consumer purchasing power" is a function of wages, prices, and interest rates.
Interest rates are at the crux of his argument. Rates dropped from over 8% in 2000 to below 5.5% in 2003. This did make housing more affordable. But what happened since then? Interest rates were fairly flat, then started ticking upwards. Did prices slow after 2004? No, they roared through more huge increases in 2005 and 2006.
Sumner suggests that housing took off because of low interest rates. I believe that prices shot up because of other speculative factors. The continued price increases in 2005 and 2006 in the face of modest wage inflation and rising interest rates support my view.
Here's a table with some figures:
There are lots of numbers here, but bear with me. Let me explain the columns. First column is the year. Second column is the average sale price in Billings for that year (source: Prudential Floberg Realtors). Third column is the average interest rate for a 30-year mortgage for that year (source: Estimate from Investech.com research). Fourth column is the income needed to afford the average sale price, using the year's interest rate (source: Billings Association of Realtors on-line calculator assuming 0 down, 1% property tax, and 0.5% insurance). Finally, the fifth column has each income adjusted back to 1999 dollars by taking into account 3.5% wage inflation per year.
That's a lot of numbers, but the most important column is the final one. This should be a good measure of "consumer purchasing power" since it accounts for both wages and interest rates. If in fact houses are as affordable now as in 1999, then numbers in the final column should be fairly flat. Instead, we see that the income needed to buy the average house was 21% higher in 2006 than in 1999, even when factoring in lower rates and wage inflation.
Housing is still unaffordable, even with lower interest rates. I don't think "Sumner's numbers indicate quite the opposite" at all. What do you think?
Look for my next housing video here sometime next month (April)
First, I don't mean this to sound harsh, but it seems to me you are not very open to any feedback that contradicts what you have to say. Sumner makes some very good points that I think are valid. At the same time I can see that they are slanted, but so are yours. I think there is a better middle ground. In all of this I think Polzin is the most correct. Housing will flatten out a bit for a year, but it won't "bust." Economic conditions outside the housing market will not let it bust. Like it or not Montana will grow, it's the way the world works. Historically housing prices rise faster than wages do. It would take a massive sell off of homes to cause a big bust. That won't happen. Why would you sell a home you purchased 3 years ago for $150,000 for $100,000? Unless you are moving away for better work, you wouldn't. We do not have a huge migration of people leaving the state (among home owners, a lot of college grads are, but they do not own homes). Most, not all, but most home owners in Billings have a stable job. It’s doesn’t mean something couldn’t happen that would change that, but at the current time there is no specific economic sector supplying higher paying job’s that is at major risk. Truth actually points to the opposite; which is why even if home prices flatten out, they won’t stay that way for long.
I read the Big Sky Business Journal article last week but now it seems to be taken off-line. It read like a political smear add, no supporting data with a bunch of innuendo and assumption.
To me the recent problems with lenders and the housing market is common sense. The industry employed unsustainable practices to inflate earnings, they used un-ethical techniques and now they're seeing the aftermath of that. The real estate pros have no one to blame for their problems but themselves.
For some reason the truth always gets attacked like this when it points out un-ethical practices in business.
Keep up the good work Doug.
I think Sumner's agenda is obvious and you are a spokesman for reality.
All these places that are for rent/lease where the payment is so ridiculously high - it's obvious the owners are desperate for someone else to make their "exotic" mortgage payment. What is going to happen when their loan resets and they have to raise rents even more? How will they justify this to their renter? How many of these houses will go into foreclosure anyway, forcing renters out? How many landlords (who never intended to be landlords to begin with) will neglect the upkeep on their rentals because they are stretched beyond belief financially and only went into this to "flip" houses that now aren't selling? This is going to be a nightmare...
I've seen 4 foreclosures in my neighborhood in the last year, 2 more are in pre-foreclosure on my street right now.
How would Sumner spin that?
Ok, the web site was just down or something it's still on-line. I re-read the article a little closer and I have to say for a just a "GIS tech" you certainly have the real estate pros giving a great deal attention to your analysis. It appears you might understand housing market indicators better then they do and they know it.
First Anonymous-- I'm open to pretty much any feedback. I'm even open to feedback that contradicts my ideas. However, I require that anyone who wants to be taken seriously back up their ideas with good, solid facts. That's why I present hard facts and hard data in this post. Do you see something wrong with my analysis? Then call me on it. Show me the data or logic that contradict my position, then I'll definitely be open to it.
By the way, I consider this all to be good-natured, open debate. Of course you don't sound harsh. I felt that the truth wasn't being reported in the traditional media, so I started this blog and video series. My main beef was that *they* didn't seem open to contradicting feedback. I'm all for good conversation and debate. Keep it coming. Thanks for writing.
My thoughts on some of your points:
Economic conditions will not let it bust? Are you sure about that? It's true that the oil bust caused the last housing crash here. That's unlikely to happen again. But I suggest that you do some serious reading on the current state of overheated markets in Florida and California. They're finding out something interesting. Housing there is going bust even though the general economy seemed to be stable and robust. It's not that a major economic disaster occurred to crash the housing market. Instead, housing just became so unaffordable that it collapsed in on itself.
I know, I know, the Cali and Florida markets got a lot more irrational than the Billings market. I'm not suggesting that we'll follow them exactly. I am suggesting that housing can still bust even with a seemingly healthy economy. We've seen an unprecedented boom that has resulted in unaffordable housing. If people can't afford houses, then the current price level cannot be sustained for long. Simple as that.
Even steadily increasing population (less than 1% a year in Yellowstone County, according to the Census Bureau) does not mean house prices rising to infinity. If there are no high wages, there can be no sustained high house prices.
And speaking of wages, I would challenge your idea that house prices have risen faster than wages. Common sense shows this to be impossible as a long term trend. Here's an exaggerated example. Suppose that this year, houses sell for 1x the median annual income. Suppose that every decade, house prices increase by 50% relative to wages. So in 10 years, houses are selling for 1.5x annual income. 20 years, we're at 2.25x annual income. That's still cheap. In 30 years, we're at 3.4x annual income. About normal. 40 years, now it's 5 times annual income. Houses are now very hard for the average family to afford. Eventually there's a breaking point. Prices can't increase relative to wages forever. At some point your first-time buyers are going to dwindle because they just can't afford to buy a house! Once that segment of the market goes away, look out. Nothing else in the market can be supported. Prices must always return to a point where they are in line with wages. And that may even mean price declines.
You always hear housing called an appreciating asset. And it generally is, in nominal terms. But Yale economist Shiller did some compelling research suggesting that, in real terms (adjusted for inflation), house prices have been flat through history. There are ups and downs, but the general trend is-- flat. Or it has been until the recent mania. This seems to line up with my simplistic example in the previous paragraph. Housing cannot go up forever, in real terms, because eventually everyone would be priced out. Check out this graph of Shiller data from the New York Times:
Shiller price graph
You said: "It would take a massive sell off of homes to cause a big bust". I say, not necessarily, at least not at first. Let me present a scenario. Suppose that, almost simultaneously, the following things happen: 1) First-time buyer demand drops because housing has become unaffordable, 2) Exotic loans get severely curtailed due to a national credit crunch, 3) Years of overbuilding finally result in a pileup of spec home and existing home inventory. With these factors working together, prices drop slightly for a year or two. Now what's gone from the market? Psychology. The idea that housing is a gold mine that always goes up 6-10% a year. What does that mean? Fewer people buying housing for speculation or short-term "investment." That means even lower demand, and higher supply because of people trying to unload their second/third/fourth homes. Result? Prices drop even more. Maybe it even looks like a "massive sell off." When does it end? When people start looking at houses as places to live instead of a quick-money investment. When prices are supported by wages. When buying and renting are comparable in price, as they always have been.
The paragraph above is not a prediction, just speculation about how an overheated market could see major price drops over the course of a few years.
Why would you sell your home for less than you paid for it? Unfortunately, sellers don't dictate the sale price. The market does. Maybe you did pay $150k for the place three years ago. Buyers don't care. All they care about is that prices have dropped, thanks to oversupply, and that there are comparable houses all around for $135k. So are you going to take that $132k offer and just get out, or are you going to wait around and pay carrying costs in hope that the market will go back up?
It's true that Billings has modest levels of inmigation. Still, there are always people that "need" to sell. If life were predictable, then homebuying wouldn't be a risk. It's often the unexpected things that cause people to need to unload the house: Layoff, job transfer, divorce, medical emergency. Others just leave the state for whatever reason. At some point, they need to sell, and they need to sell at market price. At times that will mean selling for less than they paid. That's life in a free market economy.
You said: "At the current time there is no specific economic sector supplying higher paying job’s that is at major risk". Fair enough. But I don't believe there are a whole lot of sectors supplying many high-paying jobs, period! That's my whole point. We don't have the wages. The only explanation I can find for these last few years is that the market may have been propped up by silly loans and speculation.
If that's the case, then are you sure that the entire real-estate industry would not fall under the category of an "economic sectory supplying higher paying jobs that is at major risk"?
As always, thanks for voicing your dissenting view.
Here's a quote from the SF Chronicle to back up my comments about California housing collapsing without any external economic problems:
"But Thornberg, the Beacon consultant, said that the First American analysis fails to take into account the relationship between the housing market and the economy as a whole. Defaults are rising at a time when the job market is stable, a highly unusual occurrence."
Source: Study expects 1.1 million foreclosures
To the second Anon, here's an interesting quote from Schopenhauer regarding truth: "All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."
Firt anonymous, you had beter take a hard look at japan. After the bubbel economy of the 1980's began to deflate, in about six or seven years, poperty price droped about 60%, in many areas the drop is still going on. they called this " price distruction". Japan is still the second larges economy in the world, and home many sucsesful firms such as Toyota.
Doug,
I fund the writer of the Big Sky Bi Journal to e a bit dense. He infers that smart growth policies make housing more expensive. What they actually do is make where you live desirable. Thus raising prices.
BTW, I am a planner and I have visited Billings and many smartgrowth communities so I speak with some authority.
I spoke to you previously about my wife's sister in Billings whose neighborhood you showed at the end of your last video. She still has not sold it. One price reduction of $10k in over 6 months.
Hi Doug,
Just saw your Doom comment from a couple of days ago pointing back here. We are a motley crew, aren't we! Just for the record, I'm a burned out fifty-something former IT worker and Canadian Dept of National Defence bureaucrat from Halifax. We had an internal defence policy portal going and I got started sometime in '05 looking at the affordability of the wars (by the way, they're not affordable), discovered the weirdness in Fannie Mae's structured finance, and couldn't stop myself.
Perhaps freedom from group-think is just very, very rare, and that accounts for how few of us notice the obvious.
Doug,
I really enjoyed your videos and look forward to your next ones.
I live in Missoula. Any chance you could investigate and report on the situation up here? I think it's much the same, though with higher average prices and even more realtor hype about this being a place where prices will never fall.
I have been watching the market to buy my first home. But Montana law makes it very hard to figure out what's going on. In other states, selling prices are public record. Here they're not. And with property taxes reassessed only every 6 years, there's really no way to know what the market is doing unless you hook up with a realtor. At least that's my impression. Is that right? How did you come up with sale price figures in your videos? What would you advise buyers to do to find that info on their own?
Thanks again, and please do a Missoula or state-wide follow up to your great work in Billings!