A Guest Post from Paul Gabrail -

I have family/friends in many “hot spots” for real estate in this country: California, Florida, Arizona, Massachusetts, etc…They think that prices will go back to a stable growth rate.  When I inquire about what they think a normal stable growth rate would be, I have heard 6-7% and I am floored.  Granted, not everyone says that.  Most of them say “I don’t know” and they just leave it at that, which is probably a better answer than 6-7%.

I know that many in this country are used to the 2000s where rates of growth were in the double digits in many markets across the country. Most would think that 6-7% would be very reasonable compared to double digit growth rates, which is something I can understand.  But just like the stock market and other investments, just comparing to boom times and bubbles is going to cost someone in the long run.

Do you want to know how much real estate in your area will go up?  Well, there are two major factors: Supply and Demand. Just like everything in life, supply and demand is key. I have a previous post titled Real Estate – Supply vs Demand…which is more important? in which I discuss the supply side in great detail, but from the demand side, there is one major factor that matters: Income growth.  For the long run (20+ years), and keeping supply issues (population growth and land availability) constant, real estate values cannot grow at a pace that exceeds the income growth in that particular area.  Does it sound complicated?  I hope not. But if it does, here is the logic behind it…

Let’s say that someone who makes $50,000 per year can afford to buy a $100,000 house.  Nothing crazy.  So let’s say in 20 years, their income has gone up 5% per year and they are now making $132,000 per year.  It is logical for someone to say that since their purchasing power has increased by 165%, they should be willing to pay 165% more for that $100,000 house.  That is not an unreasonable hope/expectation.  So their $100,000 house has gone up to $265,000 in value and that makes sense.  Now, just extrapolate that out as 1,000,000 people in an area who have an average income of $50,000. They should all be willing to buy 1,000,000 houses worth $100,000 each.  The percentages are the exact same, but the amount of dollars is much higher, but it’s all the same math.

So now let’s look at what my friends/family are saying and let’s look at some historical data from certain areas.  They believe that in these major markets they should be able to see 6-7% appreciate per year over the long run.  Let’s pick one spot: California.  Very nice climate.  People are moving there.  Business is moving there, so it’s a happening state. The supply side of the equation is definitely HELPING real estate values.  Back in 1970, the population of California was 19,950,000 and now it’s over 37,000,000! That is a large increase for such a large state as it is.  So clearly there was increasing demand in real estate as their population went up almost 90% in 40 years! Compare that to my home state of Ohio which has only gone from 10,600,000 people to 11,500,000 people in 40 years.  A mere gain of 8.5%!

Since 1970, the average home in California has gone from $25,000 per house to $160,000 per house which is an annualized increase of 4.4%.  Still VERY respectable and a nice appreciation rate. Yes, they have seen the brunt of the drop in the last few years, but they also saw the large increase in the late 1990s as techs were booming and in the early to late 2000s as interest rates were low and real estate values were skyrocketing.  Meanwhile, the average per capita GDP in California was $4810 per person to $53,000 per person, which is an annualized increase of 5.75%!

So, as I said above, real estate values will most likely  NOT grow at a pace faster than the increase in income, so even with a state like California who has doubled its population in 40 years and has seen growth each year and has experienced the highs and lows of real estate…they still haven’t seen massive price appreciation above regular income.

Now compare it to Ohio. Like I said…barely any increase in the population.  Let’s compare income to real estate values.  In 1970, the average house in Ohio was selling for $17,600 and today, the average home is selling for $151,320, which is an annualized increase of 5.57%! So in a time where Ohio only gained 8.5% appreciation while California almost doubled, we outpaced them in appreciation as a state.  Let’s look at income: In 1970, the average Ohioan made $4086 per year and now they make $42,083, which is an annualized increase of 5.57%!  Again, in a very consistent population growth state, we didn’t even see real estate values beat the growth of income.

If all this data was a lot to grasp, look at the chart below to see the recap:

As you can see above, income grew at a rate 30% higher than real estate values per year in California over the 42 year period and 9.2% higher in Ohio per year over the same period.

So going back to our example above of the person making $50,000 per year and buying a $100,000 house, if their income increases by 5% per year, in 20 years, they will have the $132,000 in income, but if the real estate values go up by 7% per year, a mere 2 % difference, instead of having a house at $265,000 to purchase, their house is now $386,000! Quite the difference and on income of $132,000, that may be a bit harder.  Go 20 more years, and the 5% increase in income goes to $350,000, but now their house at 7% is now having to be purchased for $1.497Million! Clearly, the same house with the same wage earners cannot grow that much higher than income levels over the long haul.  It has to be like the situation above where income outpaces real estate values and, at worst, they grow at the same rate.

As you can see from this chart, the same house went from 2X the income of the individual to almost 5 times the income! Any mortgage banker will tell you that a house cannot be bought for $1.5MM on income of $350,000 per year! Granted, it took 40 years, but even after year 20, it was almost triple the income.  It’s just a matter of time before things have to settle back to normal.

Unfortunately, as our economy matures more and more, I don’t think the rate of income over the last 40 years will be the same for the following 40 years.  Our economy is too mature and strong to have the large growth rates that we had experienced in the past. if the last 40 years didn’t beat 6-7%, why would we expect the next 40 years to do the same?

About the Author: Paul Gabrail is a partner at Select Investment Group, a real estate investment firm, and a blogger at thecapitalistmanifesto.com. For more articles and thoughts like this, follow Paul on Twitter @capmanifesto, subscribe to his RSS feed or visit his blog thecapitalistmanifesto.com.

written by Joe \\ tags: Real Estate

A Guest Post -

There has been little good news for homeowners in the past few years. Where home prices once climbed steadily, they have since plunged; throwing millions of American homeowners into foreclosure and leaving millions more owing more than their houses are worth. So far, there have been few signs of recovery. A housing market rebound will depend on a number of factors.

Dropping Unemployment Rate

A drop in the unemployment rate is essential to a housing recovery. Consumers understandably hesitate to purchase a home when there is a good chance they will lose the income needed to pay the mortgage. Unemployment has hit young people particularly hard. When the unemployment rate drops substantially among Americans aged 25 to 34, these young people will buy homes. Until now, they have been staying in school, moving in with parents or living with friends, which has contributed to a lower demand for housing. These young people represent a pent-up demand that will emerge as the job market improves.

Falling unemployment rates also improve consumer confidence, which fell significantly after the 2008 housing market crash. As jobs are added and the broader economy grows, people will feel better about spending. Confident consumers are more likely to buy a house, spend money on renovations and pay for home services. Increased demand will also spur an increase in home prices.

Reduction in Inventory

The massive inventory of homes on the market is bad news for homeowners. A number of lenders, under pressure from lawsuits claiming improper foreclosure processes, have put the brakes on foreclosures, adding to the huge backlog. Until this inventory of stalled foreclosures has been cleared, the housing market cannot recover.

Speeding up the foreclosure process is vital to clearing the shadow inventory that exerts a negative pressure on housing prices. Selling foreclosed homes will help stabilize prices and improve the health of neighborhoods. If current low rates of new construction continue, buyers will choose their new homes from among the pool of existing homes, helping to clear the market.

Higher Rents

With the large number of foreclosures in recent years and millions of potential buyers shying away from a home purchase because of financial uncertainty, demand for rental units has skyrocketed. With increased demand, rents have begun to rise. When renters realize their monthly rent costs as much as a mortgage payment, many will turn to home ownership, depleting inventory and increasing demand for houses.

Increasing Home Mortgage Rates and Prices

As potential buyers sense that the housing market has bottomed out and prices begin to increase, more will jump into the market to take advantage of record low prices. While the significant yearly price increases of the housing bubble are unlikely to occur again, a return to the steady appreciation of the ’80s and ’90s is a distinct possibility.

Potential homeowners currently do not feel pressure to buy a house, and many are afraid to invest in a deteriorating market. Mortgage rates remain low. As soon as home prices begin to appreciate and home mortgage rates nudge upward, potential buyers will move quickly to take advantage of bargains. The increased demand for mortgages and houses will boost the cost of both. As prices rise, lenders will become more confident and ease their lending standards, making it easier for consumers to buy homes.

This article was contributed by Jonah Trenton, an Editor at RefinanceMortgageRates.org

written by Joe \\ tags: Mortgage, Real Estate

With home prices down from the big bubble and rates down as well, I was curious about the current state of housing affordability.

The latest stats I find show median household income at about $52,000 (2008). With rates at 4.5% or lower on a 30 year fixed mortgage, and a conservative underwriting, 28% of income for the mortgage and property tax, we’ll assume 24% is for the mortgage only. This is $1040/mo. At 4.5% this will fund a $205,000 mortgage, so with 20% down, a total house price of just over $250,000.

This graphic shows lower median home prices in all regions except the Northeast where income tend higher as well. Take that median income and you can afford a pretty nice home in the south or midwest.  Makes me wonder if we hit bottom, and if this is the time to buy. Of course, bottoms are really only seen in hindsight. For an interesting spin on the rent/buy decision, check out Monevator’s Reasons to buy a house instead of renting.
Joe

written by Joe \\ tags: Finance, home sales, Real Estate

This is a Money Mavens Network post, the first of many to come. This time, a number of the Mavens will be writing on the topic of using a Real Estate broker to sell your house. (We’ve not seen each others’ posts before publishing, so any similarities are purely from the category of “great minds thinking alike.”)

A few years ago, pre-crash, a neighbor put his house on the market. When it sold within two days of being listed, I found it odd that he seemed so happy with himself. I told him,”sorry, but I think you got Freaked.” I told him that I had read the book Freakonomics, and was recalling a chapter that discussed the conflicting motivation that a real estate broker had. The author cites a study that showed, all things being equal, an agent will sell his or her own home for an average 3% more than the same home sold for a client.  It turns out that when selling your home, an additional $20,000 may be quite a bit of money to you (as it is to me) but on a 6% commission, that’s $1200. Once it’s split between the listing agent and yours, and your agent splits half with her office, it’s a $300 difference. I went on to explain to my not-happy-as-before neighbor that the very fact that it sold so quick should make it obvious the price was set too low. In his case, the Zillow estimate was nearly $30,000 higher than his sale price and I thought he’d have at least split that difference had he set the listing price higher. Of course the agent’s economic interest was best served by a fast sale. I won’t even try to calculate the hourly return the commission brought her. In the end, the impact to my neighbor was far greater than the 6% listing fee. On a lighter note, this was a neighbor I wasn’t sorry to see move, a bit of schadenfreude, I suppose.

Recently when a friend told me she was putting her house up for sale, I walked her through the story above, explaining the math, the 1.5% of the increase/decrease in price being all the agent gets and leaving her with the warning that the agent is not her friend. To be fair, real estate agents are in a better position to move a house than most of us might be. Buyers are coming to them, and through MLS and their own networks have access to more information than you or I might. On the other hand, the internet along with market pressure is fast eroding that advantage.

Check out my fellow Mavens posts as well:
Len Penzo -  Real Estate Agents: Why You Rarely Get What You Pay For
The Financial Blogger at Green Panda Treehouse – Would You Take A Realtor To Sell Your House?
Tom at Canadian Fiance Blog – Should You Use A Real Estate Agent To Sell Your House?
Paul at Fiscal Geek – Should I Use a Realtor to Sell My House?

Joe

written by Joe \\ tags: freakonomics, money mavens network, Real Estate, realtor

Recently, Jim at Bargaineering authored an article titled Your Home is Not an Investment. Looking at data gathered by Michael Bluejay, we find that the price of new homes increased by 5.4% annually from 1963 to 2008, on average. During that same period, inflation averaged 4.4%, so housing rose faster, no? Well, not so fast, the size of new houses also grew during that time, from 983 sq ft to 2349 sq ft, or 1.6%/yr on average. On a same size comparison, this means housing has lagged inflation by about .6%/yr.
When was the last time you heard of someone buying a house and leaving it unoccupied, hoping for a positive return? Me neither. What’s missing from Jim’s post is the rent saved by an owner occupied house, or the rent received by the landlord of a rental unit.
Where does that leave us? I’ll suggest that you not count on rising real estate values as part of your long term plans. On the other hand, as retirement approaches, a plan to either downsize or move to a less expensive area (or both, of course) can free up some needed money.

Joe

written by Joe \\ tags: inflation, Mortgage, Real Estate