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In recent decades, realtors have been endlessly touting the desirability and scarcity of Bay Area real estate. Make no mistake that there are challenges here with regards to natural features such as waterways, mountains, valleys, and animal habitats, as well as onerous governmental regulations, that make it difficult to build new units. Yet the population continues to grow. That is not in dispute. Real estate is and continues to be a continually pressured resource, and this is expressed acutely with the rising cost of rent.
It would seem, on the surface, that this supply and demand equation had an equally acute effect on real estate appreciation. And, in pure dollar figures, it did. For an all-cash investor, it has never been as expensive to buy a piece of the Bay Area. Hedge funds and holding companies are overbidding against foreign investors trying to hide dirty money in a lucrative and desirable market. For the average person who wants to buy real estate, pressured by the need to come up with increasingly unrealistic amounts of money and waive any rights to inspection, it is becoming harder and harder to buy in truly desirable markets in the San Francisco Bay Area.
However, there is an interesting mechanic going on behind the scenes here. I'll give the example of my parents. They bought a 3,300 square foot, 4 bedroom house in 1989, then at the peak of a bubble, in a quiet Bay Area suburb, with a lake view. They paid $432,000. Now, in 2015, the house is valued at approximately $975,000. Most people would look at those numbers and say they won the real estate lottery and have gotten far greater appreciation than most Americans.
What those figures don't tell you is that in 1989, the average interest rate for a mortgage was 11.24%. Over the course of 30 years, with a down payment of $32,000 on a loan for $400,000, you would have paid $1,348,800 in interest and ultimately a total cash outlay of around $1.8 million by the time it was paid off. Today, if you put down $50,000 and took out a jumbo loan for $925,000 on the same house, the average rate of 4.16% would have you only paying $1,154,400 in interest, for a total outlay of around $2.1 million.
Suddenly, instead of more than doubling the value of the home, you can see that in a full 25 years the cost for the average financed buyer has only increased about 16%. Yes, they need to come up with slightly higher down payments now, but it isn't this sea change in affordability that the media makes it out to be. It's less than 1% a year change. It's true that some isolated markets have seen more dramatic growth, but realistically, they are the exceptions. In the typical family house in the typical family suburb, for a family without deep cash reserves, the cost of financing is not that much greater than it was a generation ago, despite the influx of investors and despite the consistent population growth.
The interesting thing about this whole dynamic, though, is that after 2 decades of falling interest rates, they're about to start going up again. The Fed rate is at zero and has been for years. This has kept interest rates low, and people who were fortunate enough to buy in 2011-2012 are going to be super happy for a very long time, but the Fed has signaled that it is going to tick upwards to prevent an out-of-control runup in the economy (even though that has already happened in stock valuations).
What this new trend in interest rates will mean is that suddenly, the same home at the same price will become more expensive. And if, in 25 years, housing realistically hasn't become any more expensive to finance - what is the wisdom in thinking the market will be able to tolerate this change now? What's going to happen is, buyers will still be limited by the amount the bank will let them pay, and it will get them less house than before. So these cash investors will no longer need to overbid madly to get ahead of the financed buyers, and the market will cool dramatically and immediately. The more interest rates rise, the more you will see this happen.
The people buying at the peak, now, may enjoy some short-term appreciation as Wall Street attempts to buck the trend and push gains higher. But it won't last; even they don't have that much money. San Jose has 314,000 housing units, and if they are all valued at an average $500,000, it would cost $157 billion to purchase all of them. No company has those kinds of reserves; there is always going to be a limit to how much outsiders can invest in any real estate market. What will happen then is that those buying at the peak will continue to enjoy their affordable payments, but they will be dragged very suddenly underwater, and they will be well and truly stuck if they need to sell. Further, the institutional investors, faced with mounting losses and under pressure to stem the bleeding, will divest their holdings. Guess what that is going to do.
My advice to anyone looking at this market is to carefully consider their situation and how conditions are likely to change within the next 10-20 years. I think it looks ugly. The prospect of rising interest rates without wage growth doesn't give me a lot of confidence in the future of the market. If you really just want to set down roots in a wonderful area with beautiful weather and are willing to ride out a period of turbulence and uncertainty, I won't go any further to dissuade you. If you are coming here chasing after capital appreciation and investment, planning for retirement etc., I would be extremely skeptical and hesitant to even think about the Bay Area real estate market.
I think you are wrong. There are many aspects to look in this equation.
For example population growth. Regardless of interest rate population growth is important factor. If we have 2% new people coming in some parts of bay area every year that is at least 4% price growth. Because people who come here are most likely that they will come here for job and there is more chance that they will buy house instead of general population.
Second thing interest rate will go UP but just by 0.10 points at max. No more than that.
Jobs market. Real estate prices are related to job market here at Bay area. Many buyers got their 'cash' from vesting stocks. Since Apple and Google are growing as crazy now that would mean more people who are willing to vest stocks for real estate. More jobs = real estate prices growth.
In any other area you might be right but here at SF bay area your equation has many unknowns. My prediction is that prices will go up 7-10% year after year for next 10 years. This is pessimistic view. Don't be surprised if you look yourself in mirror in about 5 years and tell yourself omg how stupid I was I could buy 1/1 condo in San Jose for "only" 500k and now is 1 mil.
In any other area you might be right but here at SF bay area your equation has many unknowns. My prediction is that prices will go up 7-10% year after year for next 10 years. This is pessimistic view. Don't be surprised if you look yourself in mirror in about 5 years and tell yourself omg how stupid I was I could buy 1/1 condo in San Jose for "only" 500k and now is 1 mil.
7-10% p.a. over a 10 year consecutive period has never happened in Silicon Valley, at least going back to 1982 (the furthest back my data goes).
Additionally, the median home price in Santa Clara County in 1990 was $390K. Adjusted to inflation, that's $700K today. Median sales price today is around $800K +/- $50K, giving you an average ROI of approx. 3% -- barely above the rate of inflation. ROI is significantly higher if you bought several years before or after 1990, but it's also lower if you sold several years ago as well. Timing is crucial.
Like any investment, there are differing opinions all the time. This is my take. Real estate is an excellent long term investment vehicle. For primary residence: there is tax benefit, monthly payment you pay goes back to you (compared to rent), great vehicle for inflation, and leveraged purchase power (20% down enables you to buy). If investment: income, deferred tax for earnings, plus other benefits already listed.
Just some contradicting points to OP's post:
Realtors do not drive the prices. The market drive prices. That means buyers and sellers dictate the prices. So don't think that buyers are fools and they just eat up realtor's marketing pitch.
Interest rate moves up and down depending on economic conditions. If interest rate goes up now, they will come down sooner or later during next economic slowdown. And the cycle repeats. I don't know any new trend in interest rate that you expect it to go up and stay up. That would definitely be new trend if true. Maybe in the next stagflation (like in the late 70's and 80's), interest rate will stay high even when economy tanks.
The net worth of real estate in San Jose? You don't have to worry about $157 billion and who will buy that. At any time, there is a fraction of homes on the market. If 100% of house are on the market, then supply and demand will be completely skewed and it will be huge buyers market. I doubt that will happen. Even in worst market conditions (sub-prime issue just 3-5 years ago), inventory in Bay Area is still limited.
So OP suggests that buyers should beware. Completely agree. With any investment, there is risk and reward. If anyone is putting down $200k to buy $1M house, obviously they should fully understand what they are doing, the investment, potential gains and losses.
Historically there is no correlation between interest rates going up and house prices going down. In fact, it is the opposite, when interest rates go up, so do house prices. The reason is that generally when interest rates are high, the economy is hot and inflation is high also. A hot economy means more demand. And houses are one of the best investments when there is high inflation.
Like any investment, there are differing opinions all the time. This is my take. Real estate is an excellent long term investment vehicle. For primary residence: there is tax benefit, monthly payment you pay goes back to you (compared to rent), great vehicle for inflation, and leveraged purchase power (20% down enables you to buy). If investment: income, deferred tax for earnings, plus other benefits already listed.
Just some contradicting points to OP's post:
Realtors do not drive the prices. The market drive prices. That means buyers and sellers dictate the prices. So don't think that buyers are fools and they just eat up realtor's marketing pitch.
Never said anything along the lines that realtors drive prices. Buyers determine what the market will bear. If their buying capability changes, it affects pricing. In all markets, buyers will buy as much as they can afford; they will make compromises to fit their budget; and they will adapt to market conditions as they change.
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Interest rate moves up and down depending on economic conditions. If interest rate goes up now, they will come down sooner or later during next economic slowdown. And the cycle repeats. I don't know any new trend in interest rate that you expect it to go up and stay up. That would definitely be new trend if true. Maybe in the next stagflation (like in the late 70's and 80's), interest rate will stay high even when economy tanks.
Right now, interest rates have nowhere to go but higher, unless the Fed starts charging banks to take their debt with a negative interest rate (which, as I understand, has happened at times on the open market but never formally). Since wages are still stubbornly flat, and a great percentage of the population is hopelessly priced out of the market, it is going to come under serious pressure even with a 1/2% increase. This also means that unlike my parents, in this environment it is unwise to save money short-term with an ARM because you will certainly pay for the savings later.
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The net worth of real estate in San Jose? You don't have to worry about $157 billion and who will buy that. At any time, there is a fraction of homes on the market. If 100% of house are on the market, then supply and demand will be completely skewed and it will be huge buyers market. I doubt that will happen. Even in worst market conditions (sub-prime issue just 3-5 years ago), inventory in Bay Area is still limited.
Certainly, there is always going to be a limit to how much property is on the market. A sale is always an agreement between a buyer and a seller. When prices start to tick downward, though, the typical and inevitable reaction is fear of further loss. It reminds me of the old "pump and dump" scheme of falsely inflating a stock price only for the truth to come out shortly after and reveal that the stock is grossly overvalued.
At the same time, what the simple math tells me is that while there has always been a boom and bust element, the market long-term is more stable and sane than it actually seems on the surface. Low interest rates are a very, very powerful market driver because of the very high savings that compounds over time. I showed that you paid more in interest on a 30 year, $400K loan starting in 1989 and going to maturity than you would now on a 30 year, $950K loan.
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So OP suggests that buyers should beware. Completely agree. With any investment, there is risk and reward. If anyone is putting down $200k to buy $1M house, obviously they should fully understand what they are doing, the investment, potential gains and losses.
I would go further to say that unless you have large reserves and resources and have structured entities to manage your investments - in other words know exactly what you are doing - you should not view your home as an investment, whose only purpose is to deliver you mountains of cash. You should, however, certainly plan your purchase with the market factors in mind and with an understanding of the impact that federal and bank policies will have on the value of your property.
My in-law bought his 1800 sq,4BR house in 1997 for 260K in Berryessa area. After few time of refinances, now he pay less than 1000 a month for mortgage + $400/month for property tax. Today, it's worth ~900K. Once time, he was thinking to sell it in 2000, dot com era to move to apartment for $1,000/month. Gladly, he did not do it. Now the rent for 4BR in Silicon valley is $3000-4000/month.
People need a place to call HOME. Renting does not give you a freedom to do whatever you want such as building a garden or remodel the way they like. My wife, told me before."Buying a home, you will pay less in the future. Renting a home, you will pay more in the future." I am glad I did it because I need a place to stay long ( hopefully till the end of my life). Even I bought my 1st home after the dotcom... but no one see the boom in 2006, and no one see this boom again.
However, there is an interesting mechanic going on behind the scenes here. I'll give the example of my parents. They bought a 3,300 square foot, 4 bedroom house in 1989, then at the peak of a bubble, in a quiet Bay Area suburb, with a lake view. They paid $432,000. Now, in 2015, the house is valued at approximately $975,000. Most people would look at those numbers and say they won the real estate lottery and have gotten far greater appreciation than most Americans.
In addition to the other points you made, it's worth noting that the CPI has roughly doubled since 1989, so $432k in 1989 dollars is equivalent to around $864k in today's dollars. So in fact the inflation adjusted total return was only 13%, a tiny fraction of the stock market return over the same period. The real advantages are that your parents locked in their monthly housing costs and avoided the rapid rent inflation in the Bay Area over the past 25 years. Even when accounting for maintenance, property tax, and other costs, they probably came out way ahead.
I agree with your main point: I don't think people who buy today will do nearly as well, despite the very high rents. Your parents enjoyed a 25 year period during which interest rates fell from 11% to 4%, which boosted housing prices and presumably allowed them to refinance their monthly costs downward. Nobody buying today is likely to experience falling interest rates; in fact, the opposite is much more probable.
This is pessimistic view. Don't be surprised if you look yourself in mirror in about 5 years and tell yourself omg how stupid I was I could buy 1/1 condo in San Jose for "only" 500k and now is 1 mil.
No the pessimistic view is that the San Andreas fault will have an 8.0+ earthquake and real estate prices fall 50% as people just abandon the area instead of enduring years of rebuilding. The more likely scenario is that the Hayward fault will eventually have its 7.0 event. Based the on the 140 year cycle it is already 7 years overdue. This will devastate the east bay and have negative effects all over the bay area. It will probably lead to at least a 25% decline in current prices. Also sooner or later interest rates will return to more historical norms. When 30 mortgages are back to 6 or 7 percent those million dollar loans won't look so cheap anymore.
No the pessimistic view is that the San Andreas fault will have an 8.0+ earthquake and real estate prices fall 50% as people just abandon the area instead of enduring years of rebuilding. The more likely scenario is that the Hayward fault will eventually have its 7.0 event. Based the on the 140 year cycle it is already 7 years overdue. This will devastate the east bay and have negative effects all over the bay area. It will probably lead to at least a 25% decline in current prices. Also sooner or later interest rates will return to more historical norms. When 30 mortgages are back to 6 or 7 percent those million dollar loans won't look so cheap anymore.
hahah you must want to buy some property so badly that you want people to panic. LOL.
I am purchasing another house very soon!
Real estate prices are actually at bottom I guess y-o-y increase will be 10-20%.
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