Friday, December 12, 2008

California Housing Dynamics

At this point I am largely discounting the Great Depression scenario. It is not impossible, but its probability has receded to the extent that I believe it is better to focus my analysis on less grim pictures.

I even doubt the recession will last into 2010. A lot of this has to do with housing.

Right now mortgage rates (standard 30 year rates) are moving towards 4.5% interest. Unless you already own a house, it is foolish to pass by what may be a once-in-a-lifetime opportunity. In California, in some areas, houses can be bought for less than they were priced at before the bubble began in 2002. Even desirable San Francisco neighborhoods are off their peaks. Many new and nearly new homes are available at bargain prices as well.

Why are people not buying, at least not in sufficient numbers yet to prevent price declines? Fear in an auction market. Few people want to buy an asset with a declining trend line. Most people think in straight lines, not in cycles. They don't want to guess at turning points.

We know there will be a turning point, in California and elsewhere. Once housing prices start back up, pent up demand from immigrants, the houseless, and the braver sort of speculators will turn into actual buying. At first this will drive houses to what would be their equilibrium price in a non-auction system, basically somewhere between the cost of building or replacing the house and the rental equivalent.

Getting to the turning point will require stages. We have already completed, or nearly completed, the first stage: a dramatic drop in house sale prices to below their equilibrium value.

With 4.5% mortgages we will get the next tranche of buyers, those who can put rationality ahead of their fears. They are going to get serious bargains. They will worry that houses or interest rates will go lower, but that will be offset by the desire to get into the house they want, before choices get narrowed.

Meanwhile, the employment situation in the real estate industry will improve slightly. Not too many houses are being built, and less are being started, in California right now. Brokers and realtors will get some wind in their sales from the first tranche of buyers, and the most optimistic builders will start making plans just in case their inventories start to sell.

When prices clearly stop going down, a lot of fence sitters will jump in. At first this will absorb inventory rather than raise prices significantly, but again it will result in increased employment in real estate, and maybe even at building supply and furnishings retailers.

We will know we are on to the third tranche of buyers when people start seeing their favorite potential homes picked off by someone else. The word will be out: buy now while interest rates are low, prices are low, and there are a lot of choices.

Then prices will start rising. You know the rest of the cycle. Builders will have lagged with new home starts, so by the time inventory is getting to normal levels they'll be in a panic to start up again. Lots of people will get hired. For a while the porridge will be just right, and then, lessons of the past forgotten, the porridge will get too hot.

It is a great time to move to California. I heard in 2005 people wanted to move here but could believe the housing prices. In some places today, in the central valley, houses are at midwestern prices.

But I am not thinking of getting into speculating in housing. While the leverage advantages are good there, I think stocks are even more undervalued than homes right now. I already own a home, but I don't own anywhere near enough stocks or bonds (but it is a bad time to buy bonds) yet.

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