Should People Buy or Rent in Overheated Bubble Markets?

Question

The housing market has been crazy in Southern California and Los Angeles for a while now.  Black Enterprise just came out today with an article stating that LA housing is still not that affordable.

What should people living in overheated markets like LA do now?  Is it time to buy, or should they hold off and wait until prices fall (if they do)?  If someone has seen price increases, should they sell and rent for a while?

What are your thoughts everyone?

N/A N/A · Answer

Hello!

hmmm.  If a person likes renting they can rent, or either wait until times get better and  then purchase a home. Myself, if my home was not through owner financing I would wait until things got better. Just my personal opinion of course.  I am in the cash flow business so I deal with people with owner financing.

There is a solution for those who has owner financing.(land contract is an example)  A person interested in purchasing, can buy a owner financed  note from an individual who wants to sell it for a lump sum, or it could be set up where you can make  monthly payments. This enables the seller  to receive a nice income each month and the buyer enjoys the home.  Win win situation.

Deals can be made even in bad times especially if  owner financed. This works in good times and bad times.

Ryan B. · Answer

GreenHorizons, you are mistaken. It is clear from recent history that prices certainly can fall quite a lot in places like Southern California and NYC. From 1991 to 1996, median inflation-adjusted prices in LA County fell by 31%. Many individual areas in So-Cal fell much more; looking at the sales histories on zillow.com I can find countless examples of houses that sold for around 40% off the 1991 peak. I don't have the exact stats, but my understanding (correct me if I'm wrong) is that NYC and several other high-cost cities experienced significant declines in the early 1990's as well. And don't try to claim it was because of the recession or the cutbacks in defense spending - leading indicators of a housing bust such as declining home starts and rising inventory started in 1989 well before the larger economy started to head south. And even in the early 1990's, was not the US the richest country in the world, with the strongest banking system in the world?

The housing market tanked in the early 90's for the simple reason that prices had become disconnected from fundamentals and a correction was due. The same thing is happening now. Yes, places like So-Cal and NYC have a lot of great things going for them. That explains why a home in NYC or LA is much more expensive than a home in Nowheresville, South Dakota. However it does not explain why an a home in LA in 2006 costs three times more than a home in LA in 1999. I mean think about it: what has changed in So-Cal over the last seven years to justify prices tripling? Is the weather better than it was in 1999? Are the schools better? Is crime lower? Has the population grown at a faster rate then usual for So-Cal? And even if there is some special reason that you believe in, explain to me why it hasn't pushed up rents the same way - over the last seven years rents have increased only a little bit over inflation. And explain to me why it has, by some AMAZING coincidence, simultaneously come true all over the country in places like South Florida, Boston, DC, SF, Seattle, and even places where there is tons of buildable land like Phoenix and Las Vegas.

The speculative bubble that swept over the nation is now ending. Prices are poised to fall big time in So-Cal and all the other bubble places. Don't take my word for it; go online and the stats are all there for the world to see. Inventory of unsold homes is at record levels all over the place. Foreclosures are starting to skyrocket. Homebuilders are canceling land options because they know they won't be able to sell high enough to make a profit. It doesn't take a PHD in statistics from MIT to figure this out, it just takes some basic econ knowlege and a couple hours research online.

Ryan B. · Answer

People should buy whenever it makes sense to do so based on comparable rents. Right now in Southern California and the other bubble markets, you are going to pay about twice as much to buy as opposed to rent something similar (assuming a fully-amortized loan). This is absurd and history has shown that home prices always correct to be more in line with rents. Unfortunately home prices are "sticky" on the way down and this process takes years, probably 2-3 years at least if we look at the last Southern California downturns in the early 80's and early 90's. I hope it happens ASAP, since I am one of those renters who is waiting! But hey, if prices correct a lot in the next year and finds a great deal that makes sense compared to rent, they should go for it.

Jeff Takle · Answer

I think one more year is just about right. On a less objective level, I think seller psychology has transitioned from "We can get any price we want" to "We can get 5-10% more than what our neighbor's house just sold for" to "Holy crap, I can't believe no buyers see the value in my house and will pay that amount!!!" this past summer. I saw sellers holding out for absurd prices and their properties just sat. They, however, held onto this hope that the market would somehow surge back upwards. About a year from now, seller's will have...in the nicest possible way..."Given Up Hope".  When that spirit is broken, good deals will abound and the people who have to get rid of their properties will do so under more realistic (aka desperate) terms.

When those ARMs come due and refinancing rates are significantly higher than when they bought in 2001-2002, when they have kids, get divorced, quit their jobs or get laid off...you name it. Cash flows dry up and they'll no longer see themselves as able to ride out the storm because they've given up hope of a quick turnaround in the market. That lovely fear will help everyone buying next spring and summer.

If you have properties in that kind of market, now is the time to rent them out if you can handle the cash flows. Rents rose 4-5% last year and are forecasted to do the same this year. That's good times at last for rentals.

-Jeff

Wes Tuinstra · Answer

This came in this morning's email briefing from 
barchart.com:

We have not bottomed out yet.

Wes Tuinstra · Answer

My impression is that people should wait one more year.

Here's why.

Next year the majority of adjustable rate loans will come due
for their rate increase. Many of those who bought at low
rates because they could not qualify otherwise will be put
in a bind -- to put it mildly.

There will be substantial distressed selling. This is when a
person looking to buy for residence should buy.

Once that inventory is cleared out, prices will stop falling
and start rising again -gulp-.