What's the forecast?

Good first post Stacey... none of the usual Realtor-spin we are getting accustomed to here on the blog.

The article doesn't cite the methodology, so it's hard to judge. It also mistakenly reports that Case-Shiller tracks only 20 cities, which is not a big boost to its credibility.

That said, the recent track record of predictions shows a lot of surprises to the downside. Even NAR just reported pending home sales dropped more month-to-month than expected in May, off -4.7% rather than the predicted -2.8%, with a YOY plunge of -14.6%.

Plus, I wonder whether any of the published predictions take into account that we are now well on our way down a nasty recession hole. Prices took their first leap down when the economy was relatively good; now, we're facing job cuts, a credit crunch and serious inflation. So areas that never bubbled, like Upstate New York, might normally be expected to fare well, but in a shrinking economy, who knows?

The only Big Important Person to make a rational statement about future housing prices recently is San Francisco Fed President Janet Yellen, who essentially said that more declines are likely until the price-to-rent ratio falls to its historical levels. Which is still pretty far from here.

Sorry, are we talking about a drop of 10.5 percent from current prices, or from peak?

yawn . .

I note that the NAR today, while announcing the dreadful sales rate for May (by its numbers, down 14% year over year), predicted a further 6% fall in prices this year.

That's even worse than it looks if you look at the NARs perfect record of underestimating price declines.

Even Lawrence Yun had negative things to say about the market, which is a shocking first.

I'm astounded at the folks who say there's going to be a quick turnaround, or realtors who swear, "Prices are low. Buy now!" What they leave out is that prices will go even lower. We're in this for the long haul.

I have a quick layman's question (for anyone) about the price to rent ratio. There's a lot of talk about high P/R ratios being an indicator that prices have far to fall. From David Leonhardt in the NYT: "Throughout the 1970s, ’80s and ’90s, the average rent ratio nationwide hovered between 10 and 14. In the last few years, though, it broke through that historical range and hit almost 19 by the time the housing market peaked, in 2006."

Ok, between 10 and 14. Now, I own a rental property, and I have an idea what I would put it on the market for tomorrow. Given that price and the rent I charge the price to rent ratio is 13.5.

I realize there are other factors at play in determining house prices, but if a place starts at an historically reasonable P/R ratio, wouldn't the price dropping another 10% make it undervalued?

accidental, your question isn't that easy to answer. We don't know your house, or your market.

But first, I want to point out that we should expect real estate to overshoot on the downside. Look at the charts, and you'll see that every up and down cycle in real estate to date shows that prices have gone below historical norms before leveling off and rising again. This bubble was the biggest ever, so the overshoot should be pretty impressive, too, especially if accompanied by a nasty recession.

Second, P/R ratio is of course just one metric. Other rules of thumb include price to median income (not that easy to figure out for one particular house), as well as fair rates of appreciation since 1997 (should come out to just over inflation). But once your listing price starts hovering around 100-120 times monthly rent, you are now "in the zone" where an investor who demands positive cashflow might take a serious look at your property.

Gross generalizations, of course, but there it is.

Thanks for the response Marcus. My place is a two-bedroom condo in Somerville, in the $275-$325 range, basically first-time home buyer territory. Increasing mortage rates and the credit environment are certainly working against me. On the other hand, gas prices are working for me. Much to watch and sweat over.

I'm curious about the median income metric. I've looked for this online without success. Anyone know the median income for Boston area?

As for my listing price getting to 100-120 times monthly rent, forget it. That's a rather long way down and I'm not so desperate as to need an investor to save me (yet!). I'd be better off waiting two or three years and selling to some young first-time buyers.

A 13% price increase over the past 5 years? Roughly 2.6% a year? An additional projected 10.5% drop in prices? Hmmm, maybe real estate is not the great investment that people say :) Duh!!!!!!!

Accidental Landlord -

Your situation would actually be interesting to analyze. Care to give us a few more details? Nothing that would make clear who you are, of course. But where in somerville are you, in terms of minutes to Union Square, or Davis Square, or some such? And honestly, what is the apartment's level of finish - Bad, Poor, Average, Good, Great?

You do have to pay attention to rental prices, as that's part of your competition, and to investors, as they are part of your market. In a normal market, you really shouldn't be able to sell your apartment for much over an investor price - basically that plus an appreciation premium, and that sometimes. I'm not familiar with the 100-120 rule, but I bet its reasonable. Assuming 300k price, 20% down, at 240k mortgage rule of thumb is 1920 rent at least - if your place isn't renting for close to that, it's overpriced...

If you don't want to be a long term landlord, give serious thought about the wisdom of chasing the market. The odds are quite high that the prices are year from now will be down noticeably, and that we won't see todays prices in real terms for 5 years or more. I'd be hesitant to bet on prices going up any time soon...

That article is a mess!

10.5% decline in Boston home prices compared to what? Decline from what number from what date?
10.5% decline from the highs?
10.5% decline from the February number?
10.5% decline from May 08?
Are there any editors at Money Magazine?

"Anyone who is currently trying to scrape together enough cash for a decent down payment -- and worried he or she won't be able to do so before prices suddenly start shooting up"

This notion of sudden price jumps is preposterous. Didn't occur during prior housing busts why would it happen now...

charles: Five minutes walk to Union Square. I'd say the level of finish is Very Good. The previous owner did the condo conversion for all units, de-leaded and replaced all of the windows with energy-efficient stuff, and put in completely new bathroom and kitchen (lovely). Seven rooms total (office), porch, one parking space, roof replaced last year, gas heat, dishwasher, washer/dryer in basement, recently landscaped. On the downside the boiler is fairly old, there's some flaking paint, and the killer is that the bedrooms are small.

I'll just throw the rest out there, as there are many similar places: the rent is 1850 (which I think is a bit high) and for various reasons I think it's worth roughly 300K right now.

As for landlording, I'm deeply conflicted. Part of me wants to dump it next spring and get on with my life. This would make my wife happy. But with another 10% nominal drop I'd be close to having to write a (small) check at the closing. Painful. On the other other shoulder sits a small fellow telling me that I'm not bad at it: I'm proactive about potential problems and diligent about fixing current ones. There's a risk of losing some money on the cashflow in the next couple of years, but nothing backbreaking. And good things are happening in Union Square. In five years it should be much improved. Over 7-10 years there's money to be made here. On the downside I could get monstrous tenants, spend eight months evicting them, and nearly go broke in the process. That wouldn't be fun. So: do I tough it out and feverishly watch real estate blogs for a few more years, or dump it and move on with my life? Tough one....

"A 13% price increase over the past 5 years? Roughly 2.6% a year? An additional projected 10.5% drop in prices? Hmmm, maybe real estate is not the great investment that people say :) Duh!!!!!!!"

This is in response to Bobby: I agree that the real estate market is bad now (as an investment or otherwise). But figure this - you have to live somewhere, right? You're going to be paying rent unless you're living with mom and dad. So what you have have to include in your calculation is the cost of renting vs. buying plus any appreciation or depreciation you might experience.

This is not applicable to today's market, but in 1997, I put $20K down on a 2 bedroom condo for $169K with a mortgage maybe $400/month more than what it would have cost to rent a similar unit. I also had a roommate to help defray a lot of the cost. 6 years later I sold that same unit for $310K. So basically, I turned $20K into about $170K in 6 years (the amount I took out after paying off the outstanding mortgage). That cost me $400/mo more than renting - and at that point I had a ton of cash to pay off all my school loans, invest, and put into a new place.

The real estate market will probably never repeat that performance - but for a long time, it was almost a no lose situation. Most people grew to expect those kind of "idiot proof" returns. Now it's harder, but I've made a lot of money since buying and selling properties as well as doing the landlord thing. The problem is that it's not for everyone. It takes rigorous analysis, a completely unemotional attitude towards buying, a great eye for a deal and above all, patience. Most people don't have the ability to do it well and overpay or buy into bad situations. That doesn't mean that real estate is necessarily a bad investment for everyone - it just means that people tend to vastly overestimate their ability to buy smart. In my experience, most people are definitely wrong.

I've never paid market price for a property because as my father always said, you make your money when you buy, not when you sell. Most people don't have a good enough eye for a deal or can't afford what they are trying to buy so they get over their heads. It's not the real estate market that's the problem, it's that people buy on emotion even though this is the largest purchase of their lives. Plus, most people are absolutely useless at doing fairly easy maintenance/repair - like installing toilets and sinks, repairing walls, refinishing floors - the sweat equity crap. People feel the need to buy a house in perfect condition and ignore the fact that they are costing themselves thousands and thousands of dollars in the process.

Anyway, sorry, rant over. Just wanted to point out that real estate CAN be a good investment. It's just that for some reason everyone thinks they are an expert when it comes to buying or even that they are on the same playing field, when in fact, that's absolutely not the case.

J.P.

You are making the most basic of financial errors: you are looking only at the purchase price and the sale price. That works great for stocks, but not so well for real estate. You have to look at your entire carrying costs (down payment, closing costs, taxes, insurance, commission, etc.) over the course of the 6 years vs. the returns you would have gotten by renting and investing your down payment and monthly savings. Now it could very well be that if you ran the analysis, you still made out better buying than renting, but the point is, you can't just make a blanket statement that you turned $20K into $170k and therefore renting would have been a poor financial decision.

Of course, your purchase and sale occurred at the beginning and peak, respectively of the biggest real estate bubble in history, so you basically achieved the perfect timing for this "investment". Of course, I could argue that you could have achieved double digit returns in the stock market in the late 90's by throwing darts at a list of stocks (of course you had to realized it was a bubble and got out before it popped) and turned your $20 k down payment and $4800 yearly savings into a six figure investment account after six years.

The bottom line is that, over the last 100 odd years, real estate has appreciated at a rate that is at or slightly above the rate of inflation. If you look at the bubble years, real estate looked like a no brainer investment, if you look at longer time periods, real estate (that you live in) is at best an inflation hedge and not the great investment that many believe. Rental properties that generate positive cash flow are another story, and yes can be great investments.

I also wanted to address the whole leverage argument that people use when discussing real estate as an investment. People love to point out, that for example, one can put down $20k on a $300,000 home that appreciates at say a generous 6% a year. At the end of 5 years, the home is valued at roughly $400,000. Wow! You just turned $20k into $100k in 5 years. That equates to an annualized return of roughly 38%. Very impressive. Again, see my previous post on looking at the entire carrying costs and not just purchase price and sale price.

But, one can attain much more impressive returns by using leverage in the form of options, in the stock market. It is entirely possible (although not necessarily easily accomplished) that one could turn $20k into $100k in a matter of months, weeks or even days. That my friends is the true power of leverage.

So, leverage is one argument for real estate as an investment class, but not necessarily a great argument.

bobby - you're telling me that in 6 years you could turn $20k + $4800/year into $170k? You'd have to be getting some pretty insane returns on your investments to make that kind money (and undoubtedly, with those kinds of returns, you're talking at least some exposure to the internet high-flyers). As you mentioned, if you're in the 2% that predicted the tech bubble, I salute you. Most likely, you were one of the vast majority who lost their shirt getting their hand caught in the cookie jar.

Re: carrying costs - I factored my carrying costs into the $400/month figure. Though interest rates were slightly higher at the time (maybe 1/2 a percent or so) - my mortgage was small - the $400 figure comprises mainly insurance plus condo fees. The mortgage payment itself was about equal to what rent would have been for the same unit.

You can talk all day long about whether or not real estate is a good investment vs. the stock market. All I know is that the Dow and S&P 500 have made anyone much money since 2005 while they've treaded water - and if you took a 15 year mortgage on your property, you've already knocked a giant chunk off your outstanding principal. Carrying costs are certainly a factor to be considered, but when you minimize your costs at the outset, that's how you make your money.

Believe me, I work in the financial services industry and I know there is money to be made in the stock market as well. I am simply responding to people who think that real estate is a lousy investment - success or failure is usually about the investor himself than about the market. If you make stupid choices, they will come back to bite you in the end.

One other point - let's say you're in the stock market and you strongly believe that a company like Cisco is going to dominate the market in a few years because they not only make the infrastructure the internet is built on, but they also make everything from routers to network hardware. They are a solid company in a great position with solid financials and they are widely respected in the industry. You you go long on them right before the tech bubble bursts. Not an unreasonable position and the company seems solid and well positioned to dominate. Guess what - you just lost your shirt - just as you would have if you were bullish recently on such esteemed and respected companies as Bear Stearns, Lehman Brothers, Goldman Sachs or any other US banking related stock.

After the smoke clears - what do you have left over? A giant smoking hole in your portfolio and not much else.

Contrast that with buying a home: as long as you didn't get sucked into an exotic ARM that you couldn't afford, after this housing crisis is over, people will still have their homes to live in. Sure, if you bought at the top of the market, you can't get what you paid for it a few years ago, but who looks at a house as a short term investment anyway? A piece of property is almost by definition one of the most illiquid investments you can have. I can almost guarantee that based on inflation alone, most properties will eventually sell for more than you paid for them as long as you hold them for the long term. Plus, you get to live in it. What investment in the stock market can you say either of those things about? Pretty sure the people who were long in Bear Stearns a few months back aren't thinking that if only they hold it long enough it will bounce back. Too late - it's been sold and their losses are already locked in.

So I'd say the downside risk on real estate is much more limited than it is in the stock market as long as you educate yourself and don't do anything stupid like take an ARM you know you won't be able to afford. Worst case scenario you're going to have to sit on the sidelines for several years and wait for property values to inch up. I'd say that's considerably less bad that the worst case scenario in the stock market.

Couldn't agree more Bobby. If a home is such a great investment, than why are we not a nation of retired millionaires? Why is it many people cannot afford to retire and need to work well into their 60's? Why is that 30 years ago, a family of of 8 could live quite well on a single income, but today a family of 4 with dual incomes is struggling to make their mortgage payments? Why has homeowner equity been declining over the past 60 odd years from peak of 81% in 1950 to a record low of 46% last quarter?

"Couldn't agree more Bobby. If a home is such a great investment, than why are we not a nation of retired millionaires? Why is it many people cannot afford to retire and need to work well into their 60's? Why is that 30 years ago, a family of of 8 could live quite well on a single income, but today a family of 4 with dual incomes is struggling to make their mortgage payments? Why has homeowner equity been declining over the past 60 odd years from peak of 81% in 1950 to a record low of 46% last quarter?"

We're not a nation of retired millionaires because we're a nation of rampant consumers. Even during the real estate boom, people weren't satisfied with an annual 10% appreciation and instead of sitting on their nest eggs, they used their houses as ATMs to keep up with the Joneses. Everyone has to have the latest and greatest in terms of tech gadgets and cars. 60 years ago most families had one car in the garage and no XBox360 or equivalent in the living room. There was no such thing as a camcorder, ipod, blackberry, iphone, etc eating away at their bottom lines.

Just for a small example, let's look at spending on baby junk. My wife and I have a 13 month old at home. We've got THREE strollers for the kid. I don't even know what they all do! She's never had a cloth diaper - it's all disposables. My parents made a decent living when I was a baby, but my mom used to use cloth diapers because they were much, much cheaper even though they were obviously a lot more work. Parents these days wouldn't even consider that. Baby wipes were probably a wet paper towel. Now? People buy fancy ones by the thousands. 30 years ago babies ate mashed up macaroni and cheese or some equivalent. Now it's jars of organic green beans specially grown and picked and lovingly packed at a 75% markup. It's just a different era. It's not the fault of the real estate market. If the stock market is such a slam dunk - why isn't that letting people retire at a ripe young age?

Another result of rampant consumerism is house-envy - which has caused a spike in home prices and even more rampant borrowing. People have been taking out these crazy ARMs to finance purchases they can't afford with no plan to pay for it when their rates adjust. That's just the kind of fiscally irresponsible behavior that got us into this current mess. I mean, when you take a low teaser rate that you initially can afford but which will later skyrocket to completely unsustainable levels... honestly, what do you think is going to happen?

Still, it's like anything else including the stock market - if you plan well, you'll be fine. If you don't, you won't. People are coming out of the woodwork now to whine about how the real estate market stinks and houses are a lousy investment. Hello - the stock market has tanked twice since the late 90s - that's not a perfect answer either. People who are over-reliant on a runup in house values are going to get burned, bottom line - just like people who have blind faith that the stock market will return 8% consistently every single year are in for a rude awakening as well.

JP,
The principal risk when buying a call on Cisco is the price you paid for the option. The principal risk on buying a house is the amount of money down (assuming you are willing to be foreclosed upon).

However, comprehensive, total return analysis of two investment options must include opportunity costs, carrying costs, inflation, etc. Money can certainly be made in real estate, but it is not easy - as you pointed out. Compounding the difficulty is that the market is opaque and illiquid; the tools professional brokers are taught are inadequate to value real estate as an investment; all real estate is local; and there are governmental restrictions and bureaucratic processes attached to every transaction. These situational complexities create opportunities for those that can unravel and simplify them. You may be able to or you may have been lucky.

I bought Bear Stearns. The position was nuked. My portfolio is fine because I understood the risks and I invested (gambled) an appropriate amount of my total portfolio Bear Stearns.

However, when someone buys real estate they are usually committing a significant amount of their total net worth to the purchase in the form of a down payment. As we have seen recently, that down payment is at risk. Granted, it may be a loss on paper until they decide to sell, but since the money is locked up, they forgo the opportunity to invest in another asset. Meanwhile they must continue feeding cash to the real estate investment by paying taxes, insurance, buying mowers, painting the house, roofing, etc.

Take a $250,000 condo with a $150 condo fee and $225 taxes. If the Boston market falls 10% in the next 12 months as the article suggests, you will break even in 7 full years ***if and only if the housing market immediately rebounds to grow at 4% every year after.*** (The tax benefits for married couple are approximately $850 per year in the 25% tax bracket.) A gradual recovery that moderates to the long term trend in Boston will take around 10 years to break even.

My position in Bear was nuked. I lost over 65% of that position, but it was less than 3% of my investment portfolio and even less of my investment portfolio + cash. Contrast that with home buyers who put up the vast majority of savings for a down payment. They essentially put 75% of their assets into a single investment that currently appears to be very unstable in the short run. If I had put 75% of my money behind Bear Stearns, what would you say? Remember, I now own JP Morgan and the market always goes up in the long run, right?s up in the long run, right?

Marcus:

"It also mistakenly reports that Case-Shiller tracks only 20 cities, which is not a big boost to its credibility."

Money Magazine:
"The S&P Case/Shiller Home Price Index, which tracks 20 of the largest housing markets, . . "

Standard & Poor's:
"The S&P/Case-Shiller Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States"
"

WSJevons, the media consistently reports the 20-city index without mentioning that it is only one of the Case-Shiller indices available from S&P. C-S also tracks "a broader composite of single-family home price indices for the nine U.S. Census divisions [...] calculated quarterly." I have seen many attempts to argue that the C-S figures overstate the declines because they "only" track a few big cities--especially right here on this blog.

It's fine that this article was using the HPI for its chart but this vague media ignorance of the quarterly national index is persistent and tiresome.

I have seen some of the criticisms too. They seemed to come from real estate agents and permabulls.

They may overstate the declines, but they still capture what? 80% of the total housing stock by value?

Regardless, the chart doesn't delineate between what is C/S and what is not. Although, I believe Fiserv calculates the C/ S indices. (SOURCES: Fiserv Lending Solutions; First American CoreLogic, LoanPerformance data; city and county assessors in McAllen, Texas, Poughkeepsie, N.Y. and Lake County, Ill.; MetroTex Association of Realtors; Scranton Board of Realtors; and Greater Tulsa Association of Realtors.) Are they sale pair methodologies? (Which, I think was part of your point.)

A report from MGIC forecast a 10% drop from 2005 highs for Boston.

WSJevons - I hear you on the opportunity cost argument and also on the fact that a house or condo will almost certainly represent a disproportionately outsized percentage of your portfolio if viewed strictly as an investment. That said, my comfort level with stocks isn't what it is with real estate, so I'm a little biased. Clearly, if you have the financial means to diversify your portfolio in individual holdings (or I guess buy a bunch of index funds), then you're probably in a much better position to handle long term risk than you are in a single, illiquid asset like a house.

That said, my philosophy has always been look - you're going to pay to live somewhere anyway. Are you going to pay for your own mortgage or are you going to pay someone else's? I admit, I got lucky in that I started buying and selling real estate on my own behalf a little over a decade ago during the big run up. There's no question I was a massive beneficiary of a great market. But at the same time, I've been able to use patience, negotiation and strategy to make money even in the last couple of years when the market has derailed. Will I be happy if the market plummets another 25% or more? No. But if the real estate market tanks like that on top of gas prices and everything else, there are very few stocks you could hold that would be doing much better.

For me, personally, real estate has been a great complement to my overall portfolio (obviously including stock holdings). But for some reason, I've always had a lot more confidence in my ability to make money with real estate than with stocks - probably because it's what I know a lot better - even though I have my series 7. That's just a personal opinion - and I know a lot of people disagree with that because the housing market has been so soundly thrashed the last couple of years - but for some reason, I found it incredibly easy to predict the fall of the housing market and prepare accordingly. I got demolished in the tech bubble implosion of the late 90s - not that I couldn't see some of it coming - but the depth and breadth of the wipeout really took me by surprise. So I guess that has something to do with my opinion on the matter - for me, it's just a lot easier to read the in and outs of the real estate market than it is with stocks. But I still don't get some of the people on here day after day ripping real estate as a waste of time, yet being fine with the fact that the stock market has taken two tremendous beatings in less than a decade (and arguably, the worst is yet to come).

This blog has attracted some pretty good posters. I think JP reflects what he has experienced and is good to hear from because he has ran a couple of green lights and hasn't really been stung badly with real estate. To assume that things will repeat might be a gamble, however.

Although the dialoge seems off topic, if you step back and look at the cluster diagram of discussion you'll see that it is benchmarking the growth and potential of a real estate investment with others like stocks.

To add to this type of dicussion, I'd say compare two things: First, what is the base minimum housing situation that would be liveable and acceptable to you, and then how much money would be available to put to work in other investments. Second, pick the best reasonable living situation in a desireable location that will attract future upwardly mobile buyers. Then, I'd model out a variety of scenarios within these two and just try to find the optimum situation.

I think before being critical on yourself and others, look at right now and think about how well you can predict the future. Although the "experts" seem to parott the same stuff about the conditions we are in, many do not agree about what the future holds. Whether we get green or red lights ahead of us is a mystery to some extent. When people are more cautious, they tend to slow down and take on less risk, which is why there are better buying opportunities for those that are willing and able to take risk in a down market. Which is what I think JP means when he and his Dad say "You make money when you buy". I think now, understanding your risk taking ability with the topography of the risk taking disposition of the market, you can target opportunities. I think now it is about risk and risk affecting behavior. This behavior creates a migration of activity and if you can get a sense of that activity you can see opportunity.

JP, we'll have to agree to disagree. You are fixated on short term time periods and I'm talking long term returns. The fact is if you are happy with only matching inflation over the long term, real estate is a fine investment. If you want to best inflation, you need to look at other asset classes such as stocks or commodities, and educate yourself such that you know when to be in or out of a given asset class.

Accidental Landlord - sorry, been busy. But I think you are looking to head to 225-250k on that apartment. If you can hold it comfortably as a long term rental you may make money in 12 years or so at a guess. But it will require work.

JP - I actually somewhat agree with you, as I made a lot of money buying and selling real estate over the last 12 years. That doesn't mean, as you allude to, that the average person can or should do it. I've also made a lot of money in various shorts and options over the last several years, but I think all would agree the average person would be crazy to do that.

I think there will always be money to be made in real estate. But I don't think anyone will be making it for merely owning a house, or buying it and re-painting the living room. Those of us who do it professionally, and actually add value, and understand the market, will continue to find it profitable.

I made a lot of money buying real estate from 1995-2005, and I've made a lot of money effectively by selling out in 2005. And I look forward to making money in real estate again, when I buy in 2009 or 10 or 11, whenever it is clearly time to go back in

However, The average person will probably find once again that their returns on real estate basically track inflation. Its a classic case of economic rent trending to zero.

charles, you're obviously a knowledgeable guy, but...what you're suggesting is that the price from peak to trough will be roughly 25-30%. Let's say it's lost 10% so far. You're predicting another 20% price drop?

I'm sorry, I don't agree. I've read price predictions far and wide, optimistic and pessimistic, and none have predicted a total 30% price decline for Boston. That would be the single most pessimistic outlook I've read in two years.

And as for the 2020 prediction, most also predict a price bottom in 2009-2010, meaning you must be further prediction price appreciate of what....2-3% a year for ten years?

Now, it depends on whether we're talking real or nominal prices. If you're talking real, maybe. But frankly I don't care about that.