Saturday, July 02, 2005

Walking away

Thought on the house bubble
Surprisingly, we were all in the process of either moving or getting a second home, and we all had decided to rent. They both live in the hot Southern California markets and find that renting is far more affordable than buying. In essence, we were all going short housing prices. As it turns out, I found a way to hedge my bet.

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"...It's fascinating that the zeal for homeownership has pulled people out of rentals so that rents in many areas are falling as house prices soar. This, however, doesn't bother those who buy extra houses as investments, and 9% of total mortgages in the first four months of this year were taken out by investors, up from 6% in 2001. They, too, figure they'll flip these houses quickly at big profits, so low rental income in the meanwhile is of little concern. Neither does the fact that single-family rental vacancies topped 9% at the end of 2004."

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But investors are nothing if not optimistic. The LA Times, in a recent survey, reports that local homeowners expect to see housing prices rise by 22% annually for the next ten years. Now this is a group, while admirably optimistic, that clearly didn't pay attention in math class. Compounding at 22% a year for ten years is an 800% appreciation, doubling every 3.27 years. 22% doesn't sound like much. Let's just project today into the long term future. Not doing the math, they do not realize that means homes would have to go up in value 8 times! But such is the nature of bubbles. That is why it is called "irrational exuberance."

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First of all, there are clearly bubbles in some areas of the country. That being said, the average home is still affordable by the average person, according to the housing affordability index. But not in the bubble areas. Only 17% of the US can qualify for a mortgage on a median priced home in California. In certain areas it is much worse. This is not surprising for certain wealthy enclaves, but this is for an entire state!

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