City-Data Forum "Right Price Equation? (foreclosure, 5%, mortgage rates, mortgage)
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08-13-2008, 09:22 PM
 Location: Olympus Mons, Mars 5,678 posts, read 8,594,408 times Reputation: 5778

Quote:
 Originally Posted by chuck22b Of course if you pick and choose the lowest P/I ratio in the 20 year period and choose the lowest income (2005), and use median price from a difference source... things would come out differently. You previously stated 2.5-3 P/I as the "historic" relationship (which I went ahead and looked up from the Harvard Joint center for Housing Studies) . I took Median Income and Price from city-data, and took a historical average pre bubble < 2000 P/I ratio. So, I was trying to be "unbiased" in my calculations. But obviously if you take the lowest P/I and discount "inflation"/increase in wages but don't care about inflation in home values... etc. you can make things look worse. Also, we're talking about Mission Viejo here which should have a higher P/I than the average for LA metro area. So using 4.5X P/I is still conservative. Secondly, the 95k can be derived from looking at the difference between 2005 and 2000 (90k-78k = 12k and divided by 2 would give 6k or ~95k in 2008). -chuck22b
Well, you can skew the data to come up with any scenario. If you say I am selectively using certain data to my advantage then I say you are doing the same. Why should Mission Viejo have a higher P/I ratio? How did you come to that conclusion? You're basically saying that people in Mission Viejo spend a higher percentage of their income on housing. That is just bizzare. Do you think people in Newport Beach spend a higher percentage of their income on housing, no...they just have a higher income!

Your inference on income is flawed. Real income (inflation adjusted) has been declining since 2000, just search google for some references on this. People have not noticed this because CREDIT has picked up the difference. The cost of living has gone up and the middle class is increasingly struggling, you hear this everywhere.... in print and on TV, do you think all this is fabricated?

Also estimated income? get real. When is the last time you thought any estimate was right? Gary Watts estimated 20% appreciation this year. Yes, that was an estimate as well.

The Harvard whatever...the source of your price/income ratios is just one source. Don't believe it as gospel just because it is from Havard U. Those are the guys who wrote that home prices are going to stabilize last year, instead they have dropped 21% in Los Angeles. Perhaps I can find their ridiculous report somewhere on the web. If you look at price declines, all the indexes i.e. OFHEO, NAR, Shiller etc. have WIDE variances due to the way they calculate. We don't know what Harvard is using as a source for income or how they are categorizing it. I'm not saying a 4.5 ratio for LA would be surprising and my assumption of 3.0 would be wrong but even if you take 4.5X income, the peak was at 10X income and your theories are still don't add up because a fall from 10X to 4.5X is 55%.

Also remember that historic lending ratios are 28% front end and 36% back end ratio. Just use those to compute a PITI+HOA for a \$95k income. That will give you \$2200 max payment. Using 10% down, at a 7% interest rate gives you only a house cost of \$360,000.

So, using historic qualification guidelines this income would qualify for only a \$360k house. Given the current credit situation do you think these lending ratios are going UP? I don't think so.

There are many variables in this market that are putting immense downward pressure on prices. Your approach to just take 10 yrs of data and add 4% adjustment per year and arrive at some conclusion is just naive.

ANYWAY, opinions on where the bottom is are so many and so different that I've realized it is just pointless. Everyone sees the situation through their own prisms and gathers their own data from selective sources to prove their point. So the only thing to do is to wait and see what actually happens

Last edited by k374; 08-13-2008 at 09:41 PM..

08-13-2008, 10:21 PM
 Location: Wouldn't you like to know? 9,114 posts, read 15,670,466 times Reputation: 3695
Quote:
 Originally Posted by k374 I'm not saying a 4.5 ratio for LA would be surprising and my assumption of 3.0 would be wrong but even if you take 4.5X income, the peak was at 10X income and your theories are still don't add up because a fall from 10X to 4.5X is 55%.
Prices have fallen 20-30% in the LA Market from Peak to trough so far. You don't think prices can go another 20%?

Quote:
 Originally Posted by k374 There are many variables in this market that are putting immense downward pressure on prices. Your approach to just take 10 yrs of data and add 4% adjustment per year and arrive at some conclusion is just naive..

His basis is really not naive, it actually makes alot of sense. No one is saying that prices should be EXACTLY what the formula states. No one said that and you shouldn't argue that. The point is history has shown us that home apprection over a 100 yrs or so tend to follow w/or slightly above inflation.

With a majority of sales in markets like yours and the Phoenix's of the world ending up as bought back by banks. Add the fact we have ever tightening lending standards & a plethera of inventory left to clean out, don't be so confident that this is over by any means.

LA is around '04 levels and still have a ways to go...

08-13-2008, 11:08 PM
 377 posts, read 1,543,760 times Reputation: 201
I agree with K374. The op was asking if his formula can somewhat "right" price a house and the formula is too simplified and doesn't take into account several variables, such as interest rates, unemployment, job growth, income levels, property taxes, inventory of homes, foreclosures, etc. It's nice to look back in time to see what happened, but you need to predict "forward" all of these variables (plus more) and then put them into a very, very complicated formula to derive home prices. If it was as easy as a one line formula, everyone would be on the same page and could predict the bottom of the market. But don't give up... because if you do come up with the formula.... you'll be richer than rich.

08-13-2008, 11:11 PM
 Location: Olympus Mons, Mars 5,678 posts, read 8,594,408 times Reputation: 5778
Coupon, I AM saying that prices have to go down lots more. HE is saying that it's over because according to his measures current prices make sense.

08-14-2008, 03:36 AM
 Location: Los Angeles Area 3,306 posts, read 3,453,044 times Reputation: 592
Quote:
 Say a house was 200k in 2001. In 2008 the nominal price should be at 200 * (1.04)^7 = 263k.
Why make up a figure when the data is available? The inflation adjusted price in this case is about \$247k.

Quote:
 Using the Case-Schiller Report... Los Angeles historically has a 5.77% annual appreciation (average since 1987).
How did you determine this?

Quote:
 So, historically speaking, houses appreciate faster than inflation rate as also seen in the Census Data since the 1940s.
The Census data shows no such thing. It merely reports on the changes in median house prices, not how much a house has appreciated. The median house in 1940 was dramatically different than today. Not only are they much smaller (at least in California), but they lack many of the features a more modern house has. Anyhow, the median by itself will not tell you anything about appreciation. You need to also know how houses have changed over the years and how much those upgrades have cost. The Case-Schiller is also effected by this, but not as dramatically. Although it looks at same house sales it does not consider major upgrades to the home etc, so the rates of appreciation are going to be inflated in the Case-Schiller too (Although, at least with the Case-Schiller the house is similar in structure, size etc).

Quote:
 with 5.77% appreciation then 198k * (1.0577)^9 = 328k
Needless to say if real estate consistently appreciated much above inflation nobody will be able to afford real estate in the future. Lets project your delightful analysis into the future. Assuming an average rate of appreciation of 5.77%, average inflation at 3.5% then a house that costs \$200k today will cost the following (top number is inflation adjusted price, bottom price with projected appreciation)

30 years:
\$561,000
\$1,076,000

40 years:
\$791,000
\$1,885,000

50 years:
\$1,116,000
\$3,304,000

60 years:
\$1,575,000
\$5,791,000

70 years:
\$2,222,000
\$10,148,000

100 years:
\$6,238,000
\$54,611,000

Even in 30 years, real estate would have doubled in real terms making it highly unaffordable.

Quote:
 If lending practices return back to normal,
Hmm.....what do you mean by normal here? If you mean pre-bubble standards than that represents a tightening. How exactly is stricter lending standards going to help the market?

Quote:
 I've always wondered where the 2-3X income comes from and how they determined this ratio. Historically, LA area has had 4.5X (average from 1980 - 2000) median
Historically lenders have only been willing to lend out about 3x of your income. For normal working class areas its typically anywhere from 2~3x income. Los Angeles during a normal market is about 4x income, but the Los Angeles numbers are pushed up due to all the wealth in the city (The wealthy/rich are rather good about not realizing their income to avoid taxes).

Last edited by Humanoid; 08-14-2008 at 03:46 AM..

08-14-2008, 11:25 AM
 Location: Chino, CA 1,458 posts, read 2,959,333 times Reputation: 546
Quote:
 Originally Posted by Humanoid How did you determine this?
I took the Case-Schiller Report, for LA Metro, the Composite-10, and Composite-20, and tracked the percent change per month over the 20 year period. To get a historical average, I took a running average of the monthly percent change over the 20 year period and multiplied by 12 to get the annual appreciation rate. In the late 80s, the monthly percent change in price were a lot higher than they've ever been. Based on this calculation, LA Metro had ~5.77% annual appreciation rate.

If you have a better way, please disclose it and how you came up with it... otherwise, we can just use 4% for inflation rate appreciation.

Quote:
 The Census data shows no such thing. It merely reports on the changes in median house prices, not how much a house has appreciated. The median house in 1940 was dramatically different than today. Not only are they much smaller (at least in California), but they lack many of the features a more modern house has. Anyhow, the median by itself will not tell you anything about appreciation. You need to also know how houses have changed over the years and how much those upgrades have cost. The Case-Schiller is also effected by this, but not as dramatically. Although it looks at same house sales it does not consider major upgrades to the home etc, so the rates of appreciation are going to be inflated in the Case-Schiller too (Although, at least with the Case-Schiller the house is similar in structure, size etc).
True, the census reports shows the median value of homes increasing dramatically over time. True, that a lot of it may be caused by what you said (a change in product mix). But, isn't the median home price what everybody is "measuring" when complaining about prices being too high? So, if builders downgraded houses (made them smaller, etc.)... then we can have smaller houses with lower medium price... right? Look at the houses built in the 60s, 70s, etc (especially those in the LA basins).. they look like shacks compared to houses built today.... But, because they were cheaper to make, that also made them more affordable.

The builders got ahead of themselves during the bubble... American's didn't make a lot more... they just wanted more and became greedy. The good thing is that people who are buying builder inventory now are able to get more house for the price (since new homes are selling at or bellow builder costs). In the future, prices will be more "affordable" but the quality, size, and materials will be cheaper/smaller.

Quote:
 Needless to say if real estate consistently appreciated much above inflation nobody will be able to afford real estate in the future. Lets project your delightful analysis into the future. Assuming an average rate of appreciation of 5.77%, average inflation at 3.5% then a house that costs \$200k today will cost the following (top number is inflation adjusted price, bottom price with projected appreciation)
True, if we continue to grow in population, and continue to have an increasing disparity between the wealthy and poor... more and more of the middle/poor will be squeezed out of owning property. Unless, we have more "affordable" housing which can be done by building smaller/cheaper/multi-housing units for the medium income earners. It'll be extremely difficult to continue to build the same types of housing we had in the past.

Considering the regulations in LA, and that LA is pretty much built out... it'll still be difficult to "bull-doze" and build "affordable" housing. Affordable housing will still have to be found Inland. The rich/wealthy will be the ones that will be able to afford housing in urban LA (ie, downtown LA, Platinum Triangle in Anaheim, and other urban/life centers). Unless, we build infamous "projects" like Chicago/New York.

Americans can't expect to continue to live in McMansions for the average middle class family when density and costs are increasing. The average middle class family in the past didn't own McMansions right? American households need to downsize for "affordability". Home ownership rate dropped in the 90s, but through "creative" financing, artificially increased in the 2000s. Home ownership rates will drop dramatically in the near term, but will increase gradually to a historically "stable" level (~66%) as the product mix changes to more affordable homes.

Historical Census of Housing Tables - Homeownership

Quote:
 Hmm.....what do you mean by normal here? If you mean pre-bubble standards than that represents a tightening. How exactly is stricter lending standards going to help the market?
Yes, I mean pre-bubble standards. Sales today are significantly less than they were pre-bubble (early 90s sales levels?), and the mba index today is also significantly less than pre-bubble. Effectively, mortgages are harder to get today than they were pre-bubble. So, if sales and mortgages went back to pre-bubble levels then sales would be a lot higher than they are today... and appreciation rates will go relatively back to historic levels. Albeit a bit lower because of current economic, social, etc. factors.

"The purchase index remained at 315.2 for a second week. The refinancing measure declined to 1074.6 from 1121.8 the prior week. It reached an eight-year low of 1074.4 two weeks ago."

Bloomberg.com: Investment Tools
Bloomberg.com: U.S.

Quote:
 Historically lenders have only been willing to lend out about 3x of your income. For normal working class areas its typically anywhere from 2~3x income. Los Angeles during a normal market is about 4x income, but the Los Angeles numbers are pushed up due to all the wealth in the city (The wealthy/rich are rather good about not realizing their income to avoid taxes).
Based on the chart of Income vs. Medium price... historically LA was 4.5X and nationally it was 3X. What I was trying to say with Mission Viejo, is exactly what you are saying about LA... the wealth/rich pushes up the ratio. San Fran has a higher ratio than LA, Santa Monica probably has a high ratio too. So, by that rationality, Mission Viejo may have a higher P/I ratio than the whole of LA Metro.

And true, everybody has their guesses as to a bottom/right price... and they are essentially ALL guesses. At least I'm not just throwing numbers out there... but trying to use historical data, analysis, etc. to come up with my "guess".

-chuck22b

Last edited by chuck22b; 08-14-2008 at 12:05 PM..

08-14-2008, 12:15 PM
 315 posts, read 281,214 times Reputation: 54
'Actually the comp price of 185k for 2007 would still be considered "bubble" pricing so you can't take that price'

The housing bubble started in 98. Find the 98 value and add 30% for normal appreciation plus inflation.

08-14-2008, 12:18 PM
 315 posts, read 281,214 times Reputation: 54
Chuck

You see those home over by the Field of Dreams little league park off the 71? I almost purchased one for 230k in 2001. Some are trying to sell same homes for 580k. That's not normal appreciation. Its bubble and it will be handed back. We have a way to go still my friend.

08-14-2008, 12:47 PM
 Location: Chino, CA 1,458 posts, read 2,959,333 times Reputation: 546
Quote:
 Originally Posted by SoCal Bottom Rider Chuck You see those home over by the Field of Dreams little league park off the 71? I almost purchased one for 230k in 2001. Some are trying to sell same homes for 580k. That's not normal appreciation. Its bubble and it will be handed back. We have a way to go still my friend.
Yup, that's still bubble prices... wow, can't imagine them still trying to sell at that price.... I would imagine maybe around ~400k +/- 20k... considering Chino Hills Income levels has risen since 2001... ~95-100k.

Income Formula = 95k * 4.5 = 427k
Appreciation Formula = 230 * (1.0577)^8 = 360k

So, somewhere between 360k-427k may sound more "reasonable".

But, I'm not sure if those are still selling for 500+k. That seems waaaay too high for today's market since you can get a brand new place of comparable size for around 400k. Also, my sister and I went out there and looked at some foreclosures in that area... and they were selling for around 320k (4 months ago?). Those selling for 500+k are somewhat delusional.

-chuck22b

08-14-2008, 06:28 PM
 Location: Los Angeles Area 3,306 posts, read 3,453,044 times Reputation: 592
Quote:
 If you have a better way, please disclose it and how you came up with it... otherwise, we can just use 4% for inflation rate appreciation.
As I said before, you would need to take into consideration upgrades over time to really determine appreciation. I was mainly curious how you got your figures. But regarding inflation. Looking at the CPI is misleading, as for housing what is important is "wage inflation". In fact if the CPI goes up and wages do not that may put more downward pressure on housing rather than move it up!! Therefore, the numbers to look are so called "core inflation" which is currently around 2.5% as "wage inflation" will typically show up in this number.

Quote:
 Look at the houses built in the 60s, 70s, etc (especially those in the LA basins).. they look like shacks compared to houses built today.... But, because they were cheaper to make, that also made them more affordable.
Sure, which is why ahem....you can't look at the median price to determine historic rates of appreciation. You can't even look at the case-schiller as a homes built in the past have been upgraded at a lot.

Quote:
 Considering the regulations in LA, and that LA is pretty much built out... it'll still be difficult to "bull-doze" and build "affordable" housing.
Housing in Los Angeles was affordable just 8 years ago, it didn't require bull-dozing anything. Like any big city Los Angeles has its wealthy communities, but historically housing outside of these areas (which are by far the minority) has been affordable. Is there a particular reason its not going to return to these historic levels of affordability?

Also, I have really no idea why housing gamblers mention "built out" so much. Firstly, Los Angeles isn't built out in any meaningful sense. But even if it was...so what? There are other forces that will keep real estate reasonable, for example businesses will leave the area. The housing bubble has actually been very bad for non-housing related business in California. Its very hard to attract latent when a crappy 3-bedroom house costs more than half a million and in other areas you can get a huge house for 200~300k.

Quote:
 The average middle class family in the past didn't own McMansions right? American households need to downsize for "affordability".
Ha! No they didn't! But depending how far back you go, they also didn't have: computers,TVs, radios, cars, telephones, air conditioning, hot water, electricity and so...
McMansions hare no different then these other upgrades to our standard of living. So if American households need to downsize for "affordability" why stop at housing? Why not get rid of the computer, electricity and so on? This of course is ridiculous. To make your suggest even more absurd is that McMansions aren't really that expensive. They are built cheaply on very small lots, just 8 years ago in California many middle class families could afford one. Go outside of California and you'll find they are even cheaper, you can purchase a McMansion in nice areas of Texas for \$200~250k.

Furthermore, there is a major problem with the distribution of homes. Over the last 10 years or so the only thing they've been building in California is McMansions. So if people truly started to down grade then this would push the prices of McMansions down (simple supply and demand). In fact it will push the prices down to the point where they become affordable to enough people to eat up the supply. The supply is huge so the price drops should be similarly huge. You are going to have to deal with the fact that your McMansion is worth much less than what you paid for it.

Quote:
 Effectively, mortgages are harder to get today than they were pre-bubble.
This is simply false. Lending standards today are still looser than they were 8~10 years ago. But there is one thing that makes them appear tightener at least in California - jumbo mortgages. But jumbos were harder to get pre-bubble, they are just required more now.

Quote:
 What I was trying to say with Mission Viejo, is exactly what you are saying about LA... the wealth/rich pushes up the ratio.
Umm....except that Mission Viejo isn't an affluent community by any means. Its your standard middle-class city. Oh but it has a fake lake! Regardless, during normal markets housing in Mission Viejo is about 3.5 times income.

Quote:
 At least I'm not just throwing numbers out there... but trying to use historical data, analysis, etc. to come up with my "guess".
Not all analysis is a guess, in my view what you are doing is guessing. Why? Because not only are you looking at a very small percentage of the available data you are using it in a way that makes no sense (e.g., using median price movements to determine historic appreciation). But I agree with your original post - that you can determine where prices are going to go by looking at their pre-bubble inflation adjusted prices. The problem is you need to look at "core inflation" and not CPI or some inaccurately obtained appreciation rates. But also, the typical behavior in a downturn is for prices to decline sharply for fews years and then for nominal prices to flat line or decline very slowly for another 4-5 years. Your "analysis" assumes a V shape to price movements, but this has never happened historically.
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