Credit Suisse Historic Housing P/E Ratios

There’s no doubt Bay Area average rents are up. And while we wouldn’t be surprised to see another 10-15% increase in 2008 (at least for San Francisco proper), keep in mind that the current housing Price-to-Earnings ratio is still well above its long-term average for the San Francisco MSA.

An analysis by Credit Suisse pegged the historical housing P/E ratio for the San Francisco MSA at 24x Earnings (or annual rent) versus a top 52 market average of 16.6x. So yes, we have long paid a premium (compared to most other areas) to buy versus rent in the Bay Area (or as many often comment, “it has always been expensive to buy here”).

That being said, the same Credit Suisse analysis pegged the housing P/E ratio for the San Francisco MSA at 42x in 2006. Assuming no change in property values and a 9.4% increase in rents during 2007, the current P/E ratio would be 38.4x. And a return to the historical 24x would either require rents to rise another 60%, property values to fall 37.5%, or a combination of the two.

92 thoughts on “Bay Area Rents Surge, But Housing P/E Ratio Remains Out Of Line”
  1. hey it’s 2008 and rents are surpassing 2000’s “dot com” levels!!!
    Quick, everyone buy some property in SF and rent it out. Do your part to drive down rents again as you compete with all the empty condos, foreclosures, shortsales, etc looking to generate income to stay afloat.

  2. Bear, I’m unsure at what you’re trying to say. Are you saying that rents will begin to fall or stabilize because of “all the empty condos, foreclosures, shortsales”? Any evidence of this?

  3. Excellent, I am pointing out two things.
    One, it took 8 years for nominal rents to return to “dot com” levels. Considering you have had 8 years of inflation and wage growth this means that real rents are still well below these levels. So the idea that rents have returned to dot com levels isn’t some significant positive sign it is a false indicator.
    Two, it is very common at the beginning of a housing downturn for rents to spike briefly as owners in trouble try and cover their mortgage by asking for very high rents. Unfortunately, if there is not a rise in incomes this spike can’t be sustained and renters, who have a much higher level of mobility, choose to rent in less expensive areas. This leaves landlords with empty units and facing growing vacancy rates especially as, typically, the economy slows and prospective renters worry about job stability and cutting back on living expenses (which results on them searching for the cheapest rent possible). Soon rents return to levels support by wages if not below.
    so basically I am saying the recent spike in asking rents is likely a unsustainable as the economy slows and fear sets in and market rate rents choose much cheaper places in east bay (or where ever) instead of ‘prime’ SF.

  4. badlydrawnbear,
    Your analysis of rents and the implications of the housing overhang (plus the recession, which by now everyone seems to be acknowledging as inevitable) is excellent IMO.
    Just a data point for me (now I really am becoming a broken record). I rent a large SFH in a very nice area of San Francisco west of Twin Peaks. The rent has not increased 1 cent since I moved in almost 6 years ago AND it remains 25% below what it rented for in 1997-2001. I am always looking around, and the rent I am paying is only *slightly* (maybe 10-15%?) below market around here, even now. Rent is roughly 1/4-1/3 the cost of owning for this neighborhood (depending upon effective tax rates/financing options, etc.). Oh, and despite what many of the realtors are saying on the blog, prices ARE falling out here in the nice parts of District 4, and are probably back to around very late 2003 levels, on average, on an apples-to-apples basis. This is about 15-20% lower than what I estimate were the bubble peak prices here in mid-2006 (I think we peaked a bit earlier out here than more “prime” areas of SF.) I expect prices to keep falling, and would expect to see 2001/2002 pricing within 12-24 months. When prices reach about 200-250 times equilibrium monthly rents, I will buy. Right now, I estimate that prices out here are approximately 400 times actual monthly rents for nice 4/3-type SFHs.

  5. The dotcom spike in rents was transient in nature and more of a “blip”. We should be looking at what rents are at compared to all years EXCEPT for the few outrageous years of dotcom when rents went haywire – income went haywire during those times too. Satchel is referencing the same time period – can we all not agree that 1997-2001 are not good years to compare against? Most metro areas in the world have not ever seen the size boom/bust that we had here from the dotcom era to right after.
    I’ll buy that rents should ease as the coming national recession sets in, but only if the national recession pulls in the Bay Area – of which it really hasn’t yet. Housing has obviously been nailed, but we haven’t seen Silicon Valley layoffs yet, which will be the harbinger of lower rents, IMO.

  6. Satchel, I plainly showed you prices did not fall, but rather increased for one part of 4 Miraloma Park. You qualified my evidence. You asked for apples to apples and discounted all remodels as proof positive. Your theory was that the remodel trend only started about a year ago because of all the porta-pottys you noticed while bicycling around. Just to be clear about things.

  7. Fluj,
    I really like you, and I do think you have been getting a little too much flak lately. So I didn’t want to fight you tooth and nail on every minor point.
    OT – (The porta-potty thread was fun! The point is, that the numbers of porta potties had been increasing exponentially in the 6 years I’ve been here. Many of those flips sold, but MANY washed out and flopped. I could go on, but the main point is that the housing stock has been significantly improved during the peak bubble frenzy of 2003-2005, with many of the flips and increased value in existing stock flowing through to comps in the late 2004 to early 2007 period, thereby distorting the data.)
    About prices not going down, I’m not sure of the ethics of posting individual situations, but I’ve got a file of them. Typically, these are pulled off the market, as they would result in loss.
    For example, take a look at 280 Hazelwood, offered recently at 5% UNDER its early 2007 sales price (I think that was a divorce situation). It was pulled off, after reductions, and after failing to sell. That sounds down to me.
    Take a look at 1260 Monterey. That was purchased in 2005 for $1.6mm, and a DOWN TO THE STUDS remodel was undertaken. The house was “see-through” for a while! It failed to sell, and was taken off. A few weeks ago, a roughly similar house apparently sold around the corner (house a little smaller, but in MUCH better condition), 201 West Gate. The last listing price was $1.224MM (reduced from an original ask of $1.7MM – ouch!).
    The 201 West Gate comp is not going to sit well with 215 West Gate, DIRECTLY next door. That house was listed at 1.98MM, and has been reduced to $1.7MM. They’re different houses, of course, but most of this neighborhood is roughly comparable, and, as you know, most of the value of any SFH in SF is its lot value.
    SS today is running the story about 414 Foerster (District 4, as you know), and that one is being offered at 11% LESS than its 2006 purchase price. Oh, and it was renovated (mostly) in between.
    1495 Monterey was featured in SS a few months ago. That one sold for $1.5MM all the way back in 2002. Plans were drawn and permits apparently obtained, and it was offered a few months ago for $1.85MM, which would have represented appreciation of basically inflation (0% real return). Only, of course, it failed to sell after 4 months or so of showings.
    There are two flips directly across the street from 1495 Monterey, both of which failed to sell, and were delisted (in one case, it is being used as an “informal” boarding house).
    Proceeding down the street from 1495, on the very next block actually, you will come across 110 San Aleso, another flip that failed to sell. Right next door, is an empty house (empty for YEARS!) that now house a for rent sign on it. The sign has been up for at least 5 months.
    Moving along, and proceeding down West Gate again, you will come across 39 West Gate. Renovated, failed to sell, so taken off the market. Maybe in the spring, I’m sure their realtor told them, but they had better hurry because directly to the right, and two houses to the left, are two more flip/remodels bought last year and now being prepared – both down to the studs. Oh, and there is another apparent remodel (not too sure if it is a flip) directly across the street from those two.
    Moving now to one of the nicest areas of St. Francis, you will come across 135 San Benito. That one sold in 2004 for $1.75MM, and just sold again for $1.80MM. After commision, that’s a loss of course, but what we don’t know is how much of a selling concession was made. My friend who just sold his house (yesterday, actually, was the closing) told me that buyers are demanding closing cost concessions, and that the lenders are generally OK with up to 3% being hidden in the price. As a realtor, I’m sure you will tell us whether this is true 🙂
    I have a VERY large file. This tour could go on and on…. But I don’t want to go crazy here – I post WAY too much!! Rest assured, ther are many others. I am watching right now about 4 large properties in the process of being flipped, where the flippers are about to be roasted.
    Now, if this is an UP market, I shudder to think what is going to happen when the crunch really hits!! And, BTW, what was with all those realtors taking on all those houses that failed to sell? Did they misjudge the market and give the sellers faulty advice, or did they just waste their many Sunday afternoons at open houses (not to mention advertsising costs, stc.) for fun?

  8. Satchel, I don’t discount your files. OK? But here’s Miraloma Terrace, only:
    2007 74 sales, avg price 945,956 sq ft 646
    2006 76 sales, avg price 937,947 sq ft 592
    To counter your loss anecdotes, I have an anecdote of relatively large gain. 629 Los Palmos. Bought for $1.025M in ’04 and sold under asking in ’07 for $1.735M. That’s just one I happen to know about.
    But I also said before that 4, for flipping, is dicey. Too costly to get in. Big square footage = big expense. And relatively few $2M+ sales on the back end.
    A home that sells for more, yet yields a loss due to realtor commission, still went up in price. Also, doing nothing to a property and selling in a year or two is asking for a loss.
    Realtors try their best. Often sellers can’t be convinced to sell lower Often realtors are wrong. What can I say?
    Last, District 4, as lovely as parts of it are, is not central. Look at Potrero Hill. Much less safe yet 2007 over 2006 showed increases in price whether condo, SFR, or multi-unit.

  9. fluj,
    Let’s still stay buddies! You’re trying to draw inferences from statistics that can’t really be drawn, largely because of the heterogeneity of the samples (also, because of all the remodeling, the samples demonstrate heteroskedasticity – I’ll leave it to others to go into this otherwise I will be accused of being an even more pompous windbag than I am!). Apples-to-apples is the only thing that works in real estate, although you could try some down-n-dirty data manipulation (“clipped” medians, various test for heteroskedascticity, etc.) if you insist on using medians and averages.
    I don’t know the specific property, but if it was renovated, is it really fair to think about it as indicating a trend (other than perhaps a trend towards remodelling and upgrading of the housing stock?). Think about it this way: if I buy a house for $1MM, and I put in a solid gold faucet (with melt value $750K), and I sell it for $1.5MM, are prices up??
    That’s what’s going on (well, not the solid gold part, but you get the idea :)).
    And, if the market is up, then selling within a year or two should yield a HIGHER price. Up is up (ignoring commissions), except in SF real estate, I guess, where even in an “up” market where “prices are rising”, any particular purchase can be expected to go down I guess. Or, are you just saying that you won’t cover your commission if you sell with 2 years, so that you shouldn’t expect 6% appreciation? Anyway, I love your postings. They’re often like zen poetry.

  10. Stachel – Thank you for giving specifics, I have been waiting to see the exact locations you have been talking about. You will see me driving around there this afternoon. I am looking for a SFH rental, and have found the numbers that people are now asking for rents spiking as of late. I fully believe that those numbers are purely a reflection of owners trying to push their carrying costs on their mortgages through to the renters, but I am not sure if renters are biting.
    I have read in your earlier posts that you think Craigslist and the rental prices we see out there do not represent the real market. How can that be? We go to rentals every weekend and there are lots of people there and these places by and large go pretty quickly, we have even put in our name and been rejected more than once. So, it seems to me, someone who is out in the rental market, that people are getting their price, or near to it. Of course, I don’t know for sure, but that is what it appears to be, and the recent rent spike the Chron just reported on seems to indicate that. Do you still think the market on a nice SFH in St. Francis Wood is 3k per month, or more like 4.5K and up that people seem to be asking? Curious as to your thoughts. I just can’t tell if you are in a unique situation or if you feel you are renting at market value.

  11. Bunk:
    You may be the victim of selection bias. You look and apply at rentals that are appealing to you. You skip rentals that look awful, either online or from the street. Other people make the same choices. As a result, you and I and everyone else wind up visiting properties that are good prospects, and these get snapped up quickly. I did an intense search for two bedroom apartments in the Western part of the city last month. A lot of the places that were in my price range but too obviously ugly to bother with at the asking price are still on the market.

  12. The Bunk,
    Please do drive around, and confirm to some on this board that I am not just a blowhard, and the info I relate is accurate! (If you are lucky, when you drive by 1495 Monterey, you might get a gander at the failed flip across the street – rather not give the exact address – after failing to sell, it looks like three generations of a family moved in, and if the garage door is open, you will see the dining room table, with all the place settings, set up on the garage cement floor!)
    I know of 3 families that are renting nice SFHs on the borders of St. Francis for less than $3K. I do feel that rents have spiked a little in the last year, so that my rent is now about 10-15% under market. So, I would look to spend around $3.5K, and that should get you a nice 2300-2600 sq.ft 3/2.5 or 4/3 around here. My advice is to bargain hard. Solvent renters for SFH who are willing to pay upwards of $3K are very few and far between. So, look at listings in the $4K+ range. My SFH was advertised for $4k, and we got it for $3K. Offer to place 6 months’ rent in escrow (I’ve always offered that but have never been taken up on the offer).
    1 Rosewood Way sat vacant at a wishing rent of $4K for about 12-18 months, but it did just rent (finally). That will give you another data point.
    Offer to pay some or all in cash. Lots of strategies. Bargain hard (did I say that already?). Always look up how much money the house you are interested in is paying in Prop 13 taxes. If it is an absurdly low number (most rentals are), you’ll know (1) the owner is a longterm owner and is probably more interested in preserving the asset than generating income; and (2) you are unlikely to be thrown out, so don’t bother trying to negotiate a long lease to lock in your rent. Rents won’t go up anyway.
    There is a nice house right at the bottom of San Anselmo (west side) where it meets Portola tht is now vacant and popped up on cl a few weeks back. They were asking $4.2K. My wife and I know the famiy that used to rent that a few years back, and they were paying significantly less than $4.2K. Drive by that one.
    About rents in apartments versus SFH, I think it’s market segmentation. Most people looking at 1/1s have little or no assets. For them, it was often easier to buy, because banks would lend them 100%. It was actually easier to buy, because no security deposit had to be accumulated, and credit rating really didn’t matter.
    In the SFH market, prop 13 keeps carrying costs absurdly low, and ther are few people it seems willing to shell out $3K+ for properties that are not in the “glamour” spots, is all I can figure. It’s all over the Bay Area, as I’ve said many times. Marin SFHs can aften be had sub-$4K for $2MM peoperties. Ditto Los Gatos (just to name two places where friends of mine have just rented places).

  13. Satchel – Thanks. We will spin around the neighborhood. We have friends who listed their Mill Vally home for $4750 and got it with multiple offers just last week. All were on corporate relocation accounts, however. We have been looking in the nearby East Bay too, and still seeing the 4k price tag for SFR’s often enough. Almost all of the places we see are empty and part of flips that have been pulled off the market, many of these people think that this Spring will get them what the want, we think they are sorely mistaken. There is going to be a very interesting time in spring when homes go back on the market and don’t sell at the price that these folks wanted, as they are all eating some portion of their mortgage right now as the rents are making them whole.

  14. When I read about the rent increases in SF yesterday, this is exactly the first question I had as to where we are. I am wondering what is going to happen to rents as prices do what they will in this climate. At some point, some of the unsold condo inventory is going to convert to rentals. As a renter, I am hoping to realize the concept that somebody else posted earlier this week about renting a place I love until I can buy a place I love.

  15. I really wish rents went up by 15%….then I could rent out my non-rent controlled condo and be cash-flow positive. Sweet – Bring it on!

  16. Bring on the rent increases! When housing/rent P/E valuation reach their historical 24x, then my rent vs. buy decision will be made very easy.

  17. David – We do tend to go and look at places that are either in the right neighborhood for us or seem to be nice, and skip the rest. Satchel has said before that he lives in a nice house in a nice neighborhood, and that the “market value” for renting the homes there are much below what we see on Craigslist. I am wondering if that is possible, isn’t market value what people will pay? I sense that people will pay a premium for these nicer homes in good areas, however it is hard to tell exactly what is happening out there. There are no hard stats to go on, you see properties for rent at a price on Craigsist, then it is gone, and you don’t know what the final price was, that is all you know.
    Anyway, Satchel may be on to a way of getting around the market where there is competition by going straight to owners who may be sitting on unrented properties for long stretches and not advertising. My sense is that there are distressed owners out there who need to rent their places at high prices, and they are finding just enough people to do so right now. That could change soon.
    I have enough money saved for a down payment for a $1.4 million and up home, but not going to jump in now, especially with the rent to buy spreads where they are. There may be quite a few of us out in the same situaiton, I really don’t know.

  18. Says Fluj, the Realtor: “To counter your loss anecdotes, I have an anecdote of relatively large gain. 629 Los Palmos. Bought for $1.025M in ’04 and sold under asking in ’07 for $1.735M. That’s just one I happen to know about.”
    Gosh, now let’s go look up the permit history, to see if this “gain” was an applies to apples comparison, or if it was remodeled. Whenever a Realtor points out a large gain, my experience is the Realtor “forgot” the large amount of money, time, inconvenience and design expertise that was invested to obtain the gain. The gain is usually real, just much smaller than what is implied.
    A review of the permit history is in order. Uh oh. It’s extensive. Looks like my suspicion was correct. Gosh. What a surprise!
    They STARTED, two days after closing, with:
    and have 4 other electrical permits and half a dozen or so plumbing permits.
    Now lets turn to the building permits:
    They did some foundation work, replaced some windows, then added two bedrooms, remodeled the kitchens and baths added french doors and redid the electrical again. Wow. What an apples to apples comparison!
    Who knows how dilapidated the house was when they got to it and how spiffed up it looked.
    I’m sure they spent nowhere near $700K, but they could have spent $200K. Just the electrical work was probably at least $75K They probably spent at least 3K per month more than they would have paid in rent (in what probably was a dump for awhile) for another $100K. And they paid commissions (mortgage broker, realtor, etc) of $130K. So they made $270K for their effort.
    Good Job, Fluj. Someone took a run down house and over the course of 3 years fixed it up and added bedrooms and sold it for more than they bought it for. (Danger: sarcasm alert–>) Well if that doesn’t prove prices are rising, I don’t know what does!

  19. Bunk,
    Interesting info. A corp relocation is exactly what I think happened with 135 fernwood (failed flip) and the 1 Rosewood Way property I mentioned. If you come out today, it is a beautiful view of the ocean right now!
    I think your intuition about what is coming regarding failed flips/excess inventory, etc. is spot on. We’ll see. The basic intuition for me is that a bubble sends false price signals leading to an oversupply of the good subject to the bubble. Thus, on an equilibrium basis, as the bubble deflates, both the price of the good falls, and the utility value of the good (which is of course what is captalized – mostly – by the price; there is an imperfect inflation hedge in there somewhere, a “call option” on increased future productivity of the region reflected in rising equilibrium waages, and an embedded “put option” given to you for free by the law which allows you to walk away from an underwater property w/o substantial loss, and there is a whole lot else in the asset we call the SFH!) also falls – hence, lower rents.
    BTW, I track some of the big flipper properties getting stucco’d now. I’ve noticed an interesting phenomenon of transfers of title to a wife (in one case), or to an LLC (another I’ve noticed), subsequent to the failed listing. I’m getting the sense that some people are starting to “Chinese Wall” off some losing investments – perhaps putting in some structures in place in advance of the personal BK and walking away from the obligation? Time will tell.
    I am also hearing anecdotal stories from friends in Marin of impending distress problems in Tiburon properties, where current owners are scraping to make $14K mortgage payments on houses they now think are underwater. Stay tuned. I just can’t see how the Bay Area is going to duck what’s coming. Although the financial markets may have already completed 50% of the adjustment, I suspect the real economy has not reflected the impending credit deflation even 5%.
    As someone wrote above, “dot-com” rents were not sustainable. Exactly my point. So, why do you think these housing prices (which are of course even higher than in 1999!) are at equilibrium? My best intuition is that the SF Bay Area underwent a real demand shock at the tail end of the 1990s (from tech and the internet), which was turbocharged by generally falling interest rates throughout the 1980s and 1990s, and the exogenous shock of the capital gains treatment for owner-occupied homes, which was instituted in 1996 and took some time to be capitalized in prices.
    Some of this gain would have proven to be durable IMO, but some of it would have been washed out by the dramatic change in tech post-2001, just as rents did. But then the global housing bubble interevened, and away we went…… I strongly suspect that the washout is now beginning.

  20. Satchel –
    I love reading your posts. I drive through your neighborhood every day. Yes, on a clear day, the ocean views are gorgeous.
    As I drive by, I wonder about the houses I see. It’s great to get some inside info.
    If you have a very large file, post it! I’ll read it. If not here then elsewhere.

  21. As someone wrote above, “dot-com” rents were not sustainable. Exactly my point. So, why do you think these housing prices (which are of course even higher than in 1999!) are at equilibrium?
    These housing prices are NOT at equilibrium – I never even suggested that. However, it was Bear who said:
    One, it took 8 years for nominal rents to return to “dot com” levels. Considering you have had 8 years of inflation and wage growth this means that real rents are still well below these levels. So the idea that rents have returned to dot com levels isn’t some significant positive sign it is a false indicator.
    This is suggesting that dotcom levels were something sustainable. But Satchel, if you’re saying that dotcom rents were not sustainable – either rents have again risen to unsustainable levels, or we have had enough job/income growth to now justify those levels.

  22. excellentlydrawnbear,
    Sorry – I meant no offense to you (just sloppy writing on my part – the “you” really refers to the collective “you”, meaning all of “us” :)).
    You’re probably right (in your implication) that incomes have now advanced to levels supporting 1999-2001 rents, and hence 1997-1999 house prices (nominally). I’ll buy that. And BTW, in 1997, the SFH I rent now would have sold for right around $800K, near as I can tell. IOW, 200X rent, or perhaps 250X “equilibrium” rent (factoring in that the dotcom craze was foolish, as was obvious to most sensible investors). Had I been here at the time, I probably would have bought it, rather than rented it…..
    In 2002, when I decided to rent it, the price was $1.3MM, or roughly 400+ times rent. To buy it then would have been foolish. It’s taken a while, but my intuition has been validated, as the house would sell for no more than $1.4MM today, and going the wrong way. The person who bought the house right next door to me (basically the SAME house) in 2004 has been paying upwards of $8-10K in after tax cash (that $18K prop 13 tax must be a killer – good thing my landlord – a VERY smart guy – only pays around $2K per year in tax or he might not be able to rent it to me at a price I wanted to pay). That’s a $5-7K spread, every month. It adds up. If prices fall 20-25% (that’s really all I am forecasting for this neighborhood), it could be a financial killer. Time will tell…

  23. Tipster, man, I never said otherwise. Look at what Satchel said. Oh wait, you can’t. It was deleted.
    Of course it was an extensive remodel. Some of Satchel’s examples were remodels that took big losses, he says. Geez Louise. That was just a D-4 anecdote that popped into my head.
    Get a grip. I hope you thoroughly enjoyed yourself whilst looking up all the permits pulled for this project.

  24. By these numbers a correction from 2006 to historical norms would mean a 43% change in real value. With prices where they are and inflation running hot there is already good progress on that. Another 3-5 years and inflation might do even more of the heavy squeezing than deflation.

  25. Is this P/E for the Bay Area or SF proper? Seems likely that it is the Bay Area as I doubt San Diego (26x) would be higher than SF proper (?x) historically, though I could be wrong.
    [Editor’s Note: As noted above, “San Francisco MSA” which includes San Francisco, San Mateo and Redwood City (“San Diego” includes San Diego, Carlsbad and San Marcos).]

  26. Fluj, my buddy, you missed my point, but that was MY fault (sloppy writing again). The point of some of the specific flip information is that the unrenovated disaster (1260 Monterey), which needed foundation work, new roof, down to the studs remodel, etc. sold in 2005 for MORE than a relatively nice comparable property (with no major structural or remodel problems) sold for now (201 West Gate). Like 25% more. That’s a wipeout. All anecdotal, though, of course. But let’s face it – there are only a small number of houses for sale or selling in SF. The data set is small, and we do struggle to try to figure out what’s going on.
    I’ll also note that 1260 Monterey (as a disaster fixer) in 2005 fetched almost as much as 135 San Benito (MUCH nicer house, in a MUCH more desirable area) just garnered a few months ago.
    That’s basically the whole point of the flipper stuff. At the time EACH one was bought, the buyer, in consultation with his realtor, judged that there was good profit potential, based on the comps. They are now eating their flops. Some have moved in, others are trying to rent, some have succesfully rented at negative cash flow in the hopes that the market comes back.
    In each case, they are slowly bleeding all over their financial lives. At some point, the blood will come in spurts, and it will be real, arterial blood.
    Dude, in the thread on the foreclosures today, pointed out that there is a foreclosure in St. Francis now (“formerly $2M, now reduced to $1.36MM”).
    A few months back – August 20, or thereabouts – my wife and I had dinner with a foolish guy who had just bought in Noe Valley (friend of a friend). We got to talking about real estate. He insisted that you would “never, never, NEVER!” see foreclosures in SF proper. Never. I took a look at the chart of the company he works for. The stock has dropped like a rock (for a few years now), and looks set to go right into the BK dumper). The CFO of the company only makes $250K, so this guy is not a big dollar guy, that’s for sure.
    Attitudes are changing. No one today would say something that silly. With foreclosures in St. Francis and in places like Tiburon, fear will build.
    A lot of people here are leveraged to the eyeballs. SF is a very wealthy place, but NOT wealthy enough to sustain these prices. Show me any city in the US (prior to the 2003-2007 bubble) that sustained median housing prices in excess of 8 or even 10 times median income, at ANY time in history, and I will consider adjusting my macro opinion about SF real estate.
    Show me a true apples-to-apples from say, 2004 to 2007, in my neighborhood, and I will adjust my micro opinion about where prices have gone around here since 2005/2006.

  27. Fluj, Satchel refutes your assertion with facts, and then you resort to a personal attack about him getting a grip and you hope he enjoyed himself digging up those permits?
    C’mon. You can have your opinions, but when someone shows you facts, applaud them for their research and disagree on their conclusions. In an ideal world, we’re all supposed to be helping each other learn more.
    Good work, Satchel. I find the data you’ve compiled pretty impressive.

  28. Timkell,
    Tipster, not Satchel, challenged me while I was specifically addressing Satchel. Tipster not only didn’t refute me but he actually proved the party in question profited. He used rather conservative numbers too. I happen to know the owners walked with 400K.
    Somehow 270 or 400K isn’t a profit? I was responding to Satchel’s “flips gone bad” anecdotes. I showed a flip (if you can call three years a flip) which went fairly well.
    In return, I was dissed. Dissed by someone who actually proved me correct. But in the end neither you, nor Tipster, really read everything that was written by either Satchel or myself with any degree of closeness. ANd that is our fault for postimg too much!

  29. Fluj, your response proves my point. You’re right. It was tipster. And somehow, that was the gist of my post?
    No, it wasn’t. And was the gist of tipster’s post that the guy only made $270k? No, it was that your anecdote was not evidence of a price increase because, due to the extensive renovations, it was not apples to apples.
    You said: “To counter your loss anecdotes, I have an anecdote of relatively large gain. 629 Los Palmos. Bought for $1.025M in ’04 and sold under asking in ’07 for $1.735M. That’s just one I happen to know about.”
    You statement implies two things
    -that you know of many other examples that you don’t have the time to mention.
    -that you feel this is a legitimate example of a price increase.

  30. No. Some of Satchel’s ancdotes were also flips gone wrong. I merely showed one, off the top of my head, that went OK.

  31. I think I’m in love with Satchel. I’m a gal that knows a good handbag when I see one… incredibly stylish and practical all in one!

  32. Satchel,
    Your posts truly mystify me. You’re a seemingly rational, competent individual who can write in complete sentences (many, many, many complete sentences), and yet your pronouncements and statistics are totally outlandish.
    D4 isn’t down 25%. You know that. It’s not going down 25% from today. 1997 isn’t coming back.
    It would make more sense to me if you were just having fun as a contrarian and playing to your audience, but the time and effort you put into SF real estate would seem to be borderline obsessive compulsive.
    I will say this: if you are truly interested in owning in the city (as you certainly seem to be), you’re going to have to back off your extreme parameters. Good luck.
    And FWIW, there’s not another Great Depression looming around the corner. Just a recession. A cuddly little recession. No worries, mate.

  33. OK, Fluj. Well, let’s just keep it cool around here.
    You’re one of the few non doomsday peeps around here, and it pains me when I think you stop debating with real facts. I expect more from you is all. Is that so wrong? 😉

  34. The funny thing is, the more I read about Satchel’s post, the more I think the future is bullish if he is right.
    Satchel is saying the market has been going down since 2004/2005/2006. Quote: “Show me a true apples-to-apples from say, 2004 to 2007, in my neighborhood, and I will adjust my micro opinion about where prices have gone around here since 2005/2006.”
    Given a normal downturn takes 4 years to shake out, we are just a little over one year from the bottom if 2005 is the top. -2% YOY after two years into the downturn isn’t that bad.
    However, if we believe fluj, we are still at the top. It is a scary thought that we will have a ride down into 2012.

  35. Prices have been a mixed bag for some time now. I bought a 2br/2bth, 1160 sf, new construction, downtown view, in a high rise,top floor, for $729K in 9/2004. Refinanced in Nov. 2005 for a much better rate and it was appraised at $800K. I took the excess of the 20% ratio out. I tried to sell it to a friend in February 2007 and the SAME appraiser with Wells Fargo that had appraised it at $800K in 2005 said the most it was worth was $695K. Zillow had it at a high of $875K last Spring and now at $745K. The only way to find out what it is really worth is to get it listed and see what happens. However, I have a very good tenant and the rent covers the expenses so I’m not doing that until I have to. It is amazing how there can be so many different ways to evaluate the market, and that is not a good thing as there is no real basis to value the product anymore, maybe there never was. Pretty funny if it did not involve so much money.

  36. Regarding renting in SF. Someone in a previous thread discussing the difference between renting in SF versus renting in New York made a good suggestion–walking around the neighborhood you want to rent in. I’ve noticed a lot of landlords in San Francisco that simply hang signs in windows rather than post on CL.
    Satchel’s neighborhood also is a good location to rent because not as many people moving to SF think of renting there. Most new people to the City I know consider the Mission, Noe Valley, Cole Valley, Pac Heights, lower or upper Haight, the Marina, etc.–the more logical areas.
    The rest of Satchel’s advice on renting seems right on.

  37. On a related tangent, is there going to be a statewide proposition to eliminate rent control in California on the June ballot? I’ve seen this mentioned here and there, but nothing official.

  38. Actually, to follow up on John’s comment — In Russian Hill (and probably other areas), you often see properties listed which had 6-7%/yr appreciation over a period of, say, 5 years. Good appreciation, but not exactly bubble-like (not like Las Vegas — +50% in one year!). Prime areas have ALWAYS been expensive, and always will be, by definition.
    Just how expensive is of course a matter worthy of much debate, apparently …

  39. I have to add a few data points to badlydrawn’s analysis at the top. We were at ~2% unemployment when rents soared in 1999. Comparing rent now to then is incomplete if you only factor in wage gains and inflation. BDB fails to take into account that unemployment is 2.5X greater now than then when he poo-poos the meager, inflation-adjusted gains in rent.
    Secondly, in the analysis of how rental markets behave during housing downturns, bear doesn’t factor in the impact of the greater number of renters. Quite simply, many new renters today are joining the renter pool because they don’t qualify for mortgages (or just got foreclosed, etc.) Fewer buyers = more renters = greater competition for rentals = higher rents…
    From the original post:
    Assuming no change in property values and a 9.4% increase in rents during 2007, the current P/E ratio would be 38.4x. And a return to the historical 24x would either require rents to rise another 60% or property values to fall 37.5%, or some combination of the two.
    This is the imbalance of the housing bubble, working backward toward equilibrium. Note that the Fed is heavily influencing this equation. By continuing to lower rates in the face of economic weakness, some small cushion is placed under house prices and the unemployment rate. Propping up asset prices and employment will continue to push the price of rent (and copper and milk and baseball tickets) increasingly higher.

  40. Jamie, I believe they are still collecting signatures to place in effect laws to remove rent control from all of California. Although I myself would like to see rent controls eliminated, I wonder if it would pass in a statewide election?

  41. John,
    “Given a normal downturn takes 4 years to shake out, we are just a little over one year from the bottom if 2005 is the top.”
    But this is not going to be anything like a normal downturn. Just a little good natured ribbing – aren’t you the same John who told me back in December that the banks had written down all their losses – something about “everyone knows that new CEOs immediately take all their lumps” or something like that – back about when Pandit was elevated to CEO at Citi? I think I said, “watch” the financials and you will be surprised. Are you surprised yet? 🙂 If not, keep watching, as I said above, the financial markets have only priced in around 50% of the adjustment. It may take some time, but the next few years are going to be real eye-openers for people who think the Fed knows what they are doing. (Actually, the Fed does know exactly what it is doing – it’s just that the American public doesn’t, or refuses to accept the implications.)
    Give me some credit here – I have traded wipeouts in a number of markets, most notably Japan 1992-1995, ERM blowup 1992, peso crisis 1994, Russia bubble and spectacular blowup 1995-98, ASEAN blowup 1996-97, in a world class hedge fund, and out of NYC, London and Greenwich, CT.
    I’ve got some experience, but of course every market is different, and nothing ever happens exactly like you expect it to. I’ll give you a prediction about the housing finance market that everyone here will be able to check back about: by the end of Q2 2008 (more or less, could be earlier), there will be a growing chorus of wails from places like SF and Manhattan for prospective relief on Option ARM, and prime ARM bailouts. That’s a hint that the regions are neither so wealthy nor so crazy to sustain the prices that were set at the margin largely by inexperienced people bidding with other people’s money. Any fool can predict all that of course. But here’s the prediction: the bailout will ONLY be available to borrowers who put no (or very little money) down, almost certainly less than 5%. Anyone who was prudent will not get the goodies. The Fed is engineering a deflation. It knows housing is going to undergo a drastic repricing. People who put real $$ down will be very reluctant to walk (need to protect their “equity” after all). The goal is to slow down the adjustment, trapping as many homeowners as possible. The playbook is Japan, although the adjustment here is not likely to be nearly so severe.
    @jojo – reread my post. I said my *forecast* for D4 is an average 20-25%. Not sure how long it takes – much will depend on how succesful government programs are in slowing the adjustment process. My guess – just a guess – is within 12-24 months, although it may take longer. We’ll see.
    Of course, we can probably safely say that with foreclosures going for 60% or less of peak bubble prices in the Bayview, an up to 20-30% fall has ALREADY happened there.
    Getting back to my view of my immediate neighborhood, I stand by my view that “true” prices have already declined 15-20% from peak bubble pricing (late 2006, it seems, but the data is sketchy, so just an estimation).
    I often hear that inflation will bail everyone out. The $9T US bond market seems to disagree with those inflationistas (10Y yields now BELOW current CPI price inflation, although strangely, the government reported Deflator inflation for Q3 at 0.8% annualized – quite a spread, don’t you think?). About $4-5T of treasuries are traded externally by some EXTREMELY smart people, and they don’t seem too worried about inflation. Perhaps homebuyers (the same ones that bid up prices 100% in a few years with no real appreciable change in trend growth or other real economy indicators) know something these bond guys don’t? 🙂

  42. I need to read through the comments on this when I get home tonight in more detail, as this might have already come up, but my quick review didn’t see anything. If you do the math on this though, my current condo would be priced well below 42X annual rent. In fact, those calculations would mean that the rent on a $1M condo at the Infinity would actually rent for less than $2k per month, which is ludicrous. Rent in a basic two bedroom apartment is $2,500 these days, which implies a selling price of $1.25M using these calculations. The math here doesn’t seem right. Thoughts?

  43. “Dave” don’t worry about those calculations.
    The prime south beach area you are talking about for the infin is def going to be able to be rented out @ the rate Lance mentioned.
    People keep forgetting that good properties @ good locations will always fare a lot better in any market.
    Let those who live in the SFburbs say what they want to say, but no matter what they say, they live in san francisco but they don’t live in the city.

  44. [Editor’s Note: As noted above, “San Francisco MSA” which includes San Francisco, San Mateo and Redwood City (“San Diego” includes San Diego, Carlsbad and San Marcos).]
    Good point. this means that prices are even more out of whack.

  45. “900K 2 Br 2 Ba will rent for $3600-3800/month unfurnished $5000/month furnished.”
    i don’t know anyone who would rent a 2bdroom in south beach for 3600 a month.
    my friend lives on the top floor of the rincon building overlooking the bay for $2700 and it is not rent controlled.
    i have several friends who pay under $2500 for a 2bdroom in south beach.
    I pay 2150 for a 1300Sq ft 2bdroom in Pac Hts
    I ahve recently been offered a 1200 sq ft 2bdrm 2 foor apt in telegraph hill with private garage for 2400/month
    70% of my friends are renters/ Most of them live in new buildings in pac Hts, The Marina, South Beach or Russian hill and none of them pay over 2800/ month.
    The rental prices that people are talking about on socketsite are out of whack.
    The only people paying over 3K for a 2bdroom apt are living in a fully furnished or corporate housing.
    The cost to own in SF is 3x the cost to rent. It is out of whack. The rental prices may continue to go up, but the housing prices will come down furhter.

  46. Agree with Spencer about what people end up paying for rent is not what is asked for on signs or Craigslist. There was a two bedroom on Scott St. near Marina Blvd. with 1 car parking listed for 2950 a month. I just met the couple who rented it walking my dog the other night and they told me they got it for 2,400. It is rather small without any real view, but rents have seemed rather stable around here for the last four years.

  47. I am pretty keen on this idea that a historical P/E ratio could be used to valuate property. It is extremely simplistic since it doesn’t account for interest rates or other drivers of overall cost that are included in rent/buy calculations such as missionite’s spreadsheet.
    However, it reminds me of the arguments during the tech bubble about high stock prices for companies with no earnings. At that time we were dealing with “new business” and the old P/E ratios “no longer applied.” Of course that turned out to be false.
    So my question for Satchel and other finance guys is, can we use this kind of rent multiplier to approximate the value of property. If so, what would it be. A previous SS post pegged the norm at around 18. At 18, everything looks incredibly overpriced right now. At 24, prices start looking more reasonable.
    Any thoughts?
    [Editor’s Note: The Fortune analysis we previously posted actually pegged the 15-year average for the San Francisco MSA Price-to-Rent ratio at 27.4x (compared to a national average of 17.3x), and calculated a P/R ratio of 38.2x as of June 2007 (suggesting a required correction of 28.3%).]

  48. “Good point. this means that prices are even more out of whack.”
    Spencer, you lost me. It doesn’t matter if these numbers are for SF or outlying areas, 43 times rent is 43 times rent. As long as the rent and mortgage are for the same part of the bay area, this is an apples to apples comparison. How does this mean that things are “more out of whack”.

    My hypothesis is that owning has become more of a luxury than it was in the past. In other words, the difference (price and quality) between rentals and purchases is greater now than it historically has been. It used to be that purchasing a home was something that most working class families could afford, and now it’s become more of a luxury…. at least in the Bay area. The mix of houses that are purchases is more high end than it used to be.
    Regardless, you can still buy a place for 24x annual rent in San Francisco. It might cost you $1M, but it would cost you $3500 to rent the identical unit. That equates to approximately 24 times annual rent. I’m not sure that things are that different than historic ratios if you look at it that way.

  49. i don’t agree with your analysis. I think you can rent an apt for 2500 that you could buy for $1M or even more. There are very few 2bdrm apts renting for above $3000 in any area.
    regarding the MSA and out of whack, i meant that the prices to buy in SF are much more for a 2bdroom apt in SF than san in redwood city, but the rents are not that different in the 2 places.
    Therefore, the outlying areas are bringing down the averageP/R for SF

  50. Spencer, thanks for the clarification. I get your points, but I disagree on one point in particular. There are lots of 2br apartments in SF renting for $3K or up. I have friends who are paying $3500 in SoMa ,and it’s not uncommon. For them to purchase the same place, it would cost in the neighborhood of $1M (roughly 24 times rent).

    I’m not bullish on the RE market at all, but I don’t think there is an impending crash either. It’s expensive to live here whether you rent or buy. I’m not sure that’s so different than 10 years ago when I first moved here.

  51. No worries folks… rents are soon to be tumbling with the massive layoffs we’ll see due to the recession we’ve just entered.
    It’ll be a race to the bottom between rents and homeprices. I think homeprices will win!

  52. Evan,
    Because of the impact of tax deduction, properties in the 1.3 to 1.4M range can justify the highest P/R (assuming 20% down, 1.1M tax deduction under AMT). I would say the P/R is OK at 250x (monthly rent), or 21X.
    Properties above or under that should demand much lower P/R, so I wouldn’t be surprised with 18X or even lower.
    However, keep in mind the P/R ratio only makes sense if you use the same property. I am not sure how the study is conducted…if it uses the median price/average rent, obviously the number is not right. Ignore the numbers quoted by the article. Go to some open houses and check it yourself.
    The market is a mess right now. Some sellers ask for 50x (and it stays on the market forever). Some properties are sold at 40x, but occasionally you will see a good deal at 20x, but very rare. I think most properties are sold at 25X to 30X at this moment.

  53. Obviously you guys aren’t looking for an apartment. The rents are not what you’re saying, they are very expensive for nasty apartments.

  54. Gross Rent Multiplier (GRM) or simply “Multiplier”
    for real life South Beach 2 br 2 ba condos in newer buildings:
    $900K gets $3600-$3800 / month unfurnished $5000 / month furnished.
    In the penninsula a $1 mil house will get around $2800 /month more or less depending on micromarket.
    Let’s use GRM from now on, “P/E” sounds like it is coming out of the mouth of a desperate housewife speculator.

  55. So, what are folks here saying is the right GRM or P/E ratio to justify a buy? Satchel?
    To illustrate, here’s my story: In early 2002 I bought a small 3-bedroom house in a good SF neighborhood for $800k. At the time, I guess it probably would have rented for about $2500 per mo or $30 k per year. Today, it probably would rent for about $3500 per mo (i.e., $45 k per year).
    Was this a good buy from a GRM point of view?

  56. Rents are very expensive. These guys don’t know what they’re talking about. Just a little while ago they all said that rents haven’t increased since dot com.

  57. I don’t think this analysis can capture all the folks who’ve sublet their spaces for a lot more than they rent them for.

  58. Here are kind of historical multipliers (off of the top of my head) for different type of proeprties:
    House 30 GRM
    Condo 25 GRM
    Duplex 20 GRM
    Fourplex 17 GRM
    8-10 unit 15 GRM
    20-50 Unit 13 GRM
    50+ Unit 11 GRM
    Of coarse this depends on micromarket, deferred maintenance, age, how close to pro forma the rent rolls are, and of coarse the almighty interest rate.)
    GRM is a quick and dirty way to compare properties. If you really want to do a good analysis you of coarse would look at the CAP rate (Net Operating Income before debt service divided by Value). Of coarse this requires a lot more information than the GRM.
    Moreover, historical values for CAP rates (end therefore GRMs also) follow the bond market for obvious reasons (i.e. simple interest is at 5% and you have an investment at 5%. Which one are you going to pick? Risk free interest of coarse. If the interest rates go up, then the CAP rates must follow in standard markets (i.e. interest rates go to 10%, who is going to pick a 5% ROI investment with more risk?)
    Buying Real Estate to live in is not all about making money. If it is then, yes there are better investments (in real estate) than a house or condo (i.e. commercial space with 6.5% CAP in the path of growth.)
    To me $1 mil investment should be producing $6500-$7000 / month net operating income before debt service. However, it’s not all about making money, it’s about finding a place to live that you can experience the life that you really want.

  59. Thanks, Paul. I’ve never had much of a head for finance, but I think I follow you. Not sure that 30 GRM squares with $6500-7k net operating income on a $1million home, though.
    Good investment or not, I love living in my house.

  60. That wasn’t me. But it was my friend who is looking for a place to live using computer. I’m done with this site. Have fun storming the castle.

  61. Paul, I found your comment helpfull. For multi unit buildings in San Fran, say 2 units with unwarrented inlaw, GRM = 6000. If valued as TICs that have sold recently for 800k per unit + say 300k for the inlaw you would get 1,900,000 or GRM of 26.3. I think the average of GRM being 42 is incorrect by the way.
    If looked at as rental property (which it is) I would want a 5% cap rate, right? Otherwise buy a MUNI bond. So a 1 million dollar price tag would be more appropriate, delivery roughly 5% cap. So can I offer my landlord 1 million (…no.. waste of breath).
    What is the real price for such a place? I suspect 1.5 million would be expected at least, GRM of 20.8 and a horrible cap rate. True?

  62. I agree with Paul: “To me $1 mil investment should be producing $6500-$7000 / month net operating income before debt service.”
    I also agree with Paul: “for real life South Beach 2 br 2 ba condos in newer buildings: $900K gets $3600-$3800 / month unfurnished $5000 / month furnished.”
    That’s the problem, the real life example is producing about half the income it should! What’s the CAP rate on your example, under 3% unfurnished and under 5% furnished?

  63. i really dont agree that the average 2bdr in south beach in renting fro 3500-3800/month.
    I gave several examples of friends who are paying well under 3K in 2bdroom in south beach and other top neighborhoods
    i even went to the avalon by the bay website, one of the nicer buildings, and the 2brooms are listed at 3100. These are negotiable. I know, because i have lived there.
    there may be lots of places on craigslist listing for 3500, but the majority of 2bdroom in south beach are renting for &lt2800.
    the GRM is well above 25, although i’m sure the owners in this area are trying to push it down to 25 and recoup their investments by raising rents. They are lucky in this area because a good portion of south beach rentals are corporate rental

  64. @sanfrantim,
    “Today, it probably would rent for about $3500 per mo (i.e., $45 k per year). Was this a good buy from a GRM point of view?”
    Are you ACTUALLY renting this place for $3500 right now? Or are you living in it? What do you realistically think it is worth right now? Could you have found something that you would have been happy to live in in 2002 for the $2500 figure you mention? How much in updating/remodel $$ have you actually spent? What is your effective tax rate?
    If you give me these answers, I will tell you approximately the change in wealth that you have undergone by buying, rather than renting (very rough). You may well be ahead – if you are straight with me, let’s find out!
    As I am sure you are aware, diversified US equities (S&P) have returned approximately 60-70% over this period, gold approximately 300%, diversified foreign equities (EAFE) in excess of 100%, totally safe, deferred tax Treasury I-bonds in excess of 60%, foreign high quality bonds (primarily Europe and Japan, with a smattering of some other high yielders) in excess of 100%, diversified emerging markets equities in excess of 300% (!), and even just plain laddered treasuries in excess of 50% (state tax free), all of which of course a well diversified person of some means would have been holding.
    Think about those returns for a minute. In a credit hyperinflation, almost EVERY asset class goes to the moon. What has gone on is MUCH bigger than SF only, and up until now, the general wealth of the area has allowed it to weather the storm – so far. Stay tuned. Please look at the chart of debt, and use some common sense about what has gone on with asset values (stocks, bonds and real estate) since the credit inflation started (mid-1980s, really). Look carefully at the insane ramp in debt following 2000 or so – that’s mortgage debt, which increased more than 100% in 7 short years (more than in ALL the 65 years since the modern mortgage system started in the 1930s COMBINED):
    This debt CANNOT be paid back – the productive capacity of the economy is not up to the task; don’t let any fool tell you otherwise.
    Assets inflated based on the back of rampant debt. Unless the Fed can find another bubble to inflate – and soon – this is not going to end well. Credit deflation has only occured once in the US – following the early 1930s. It happened in Japan following 1989.
    Ok, now I’m officially a broken record again! If you give me your numbers, I’ll let you know the change in your wealth position that flowed from your decision to buy! As I said, it may well have been the right decision! I decided to rent at that very time. It turned out to be a good call for my circumstance….

  65. Satchel – we checked out the properties you mentioned and all were as you said. i called the place for rent on san aleso and they are asking $4800 a month. that place is huge, and vacant. if it has been for 5 months as you say, then someone is taking a bath on it. we loved the area, it reminds me of palo alto, but in the city.
    anyway, thanks for the tips, if you see anything new out there throw it up on SS, we saw all kinds of places that were clearly completely under renovation and empty, so there could be some distressed owners out there when they all come on the market if they can’t move them for what they want. i was hoping 280 hazelwood would be empty, but it seems that someone is living there.

  66. Satchel, What about outside of San Francisco? I currently do a lot of work in Chicago and spend almost 4.5 months a year there and am renting a condo in a “luxury” building for about 2,500 a month ( I own in San Francisco btw). In Chicago banks are now pricing foreclosures at almost 50% the cost of what similar units were selling for only two years ago!!! There are now units in similar buildings to mine where if I were to put about 20% down, my payments would be about what I am paying in rent plus taxes. Are you saying it could get worse than this? I am seriously thinking of purchasing a second-home condo for my use while I am working back there. The difference between S.F. and a city like Chicago is Chicago has a huge oversupply of housing, and I just do not see the same situation here and cannot imagine the decline here could be as bad as what is happening in Chicago (at least I hope not). Check out Chicago blogs like Cribchatter to see what I am talking about.

  67. That’s a great chart Satchel.
    I would also like to see the government debt as a percentage of gdp over that time. I’m guessing it will show an equally depressing picture.
    Do you think all assets will deflate in the near future? Housing and discretionary items I understand. But what about food or oil or commodities?

  68. Thanks double dub. But color me not convinced by that analysis.
    The argument that U.S. debt levels are sustainable because they are backed by real estate—is uh, funny. Except that our best and brightest apparently made the same incorrect assumption–which isn’t so funny for our economy. Those assumptions may have flown back in 2004 but anyone holding a mortgage-backed security right now could tell these authors that assumption was naive.
    Likewise the cocky assurance the authors give that financial instruments are more efficient nowadays, and ergo, hokus pokus, more debt is sustainable.
    I also don’t understand the argument that more women entering the workforce allows for more debt. If more women enter the workforce then the GDP goes up and more debt can be taken on. But why should the percentages change? I don’t follow the argument. Say a family had one breadwinner and he was making 100K and the family had debt of 200K. Then say the wife entered the workforce and made another 100K. These authors then argue that, hokus pokus, all of a sudden the household can take on a higher percentage of debt,–in this example, more than 400K of debt. I just don’t follow that logic.
    I’m sure crestmont research is very embarrassed by that paper right now.

  69. @dub dub & SFHawkguy,
    Thanks SFHawkguy. That Crestmont Research piece is simply a piece of garbage. It would take a while – so I won’t bore everyone here with a line by line refutation – but I will give you the basics of why it is silly. And dangerous.
    First, a simple intuition, regarding housing. We have read postings on this blog about people who have worked for 10 years and have only been able to save a 5% down payment for a starter or midlevel condo. Think about that. Ownership costs here are higher than rental costs (in general). A typical career lasts – what – 30 years? After 10, you’re well on your way. Now, if you cannot generate enough economic surplus from your productive capacity to purchase even 5% of a home, how on earth are you going to be able to generate the 95% (+maybe 100% extra in interest costs over the life of the loan) to pay for the rest over the next 20 years of your career? Especially when you now have higher ownership costs than before. Think about that, and consider that before the madness of the US mortgage system started in the 1930s, houses in Rockridge in 1910 or so – nice, substantial Craftsman houses, cost in total 2x the median wage (more or less – about $5K, while a warehouseman, or railroad operator, etc. might have earned $2-3K annually). And that was before there was an income tax!
    Another simple intuition regarding the state of the housing market madness today. I’m sure that many on this blog have read the story about the illegal Mexican strawberry picker (literally – that’s what he did for a living) who bought a house in Gilroy for $720K? Now, tell me how he can ever generate enough economic surplus to pay for that?
    About the debt/GDP chart. It is certainly worse than the 330% debt/GDP level shown (end 2006, higher now). This is because GDP has been systematically overstated (on a trend basis) going forward since about the mid-1980s or so. This is due to: (1) the secular shift from a manufacturing to a service economy introduces distortions because of the way GDP is measured (nominal prices paid, deflated by the general Deflator, more or less) means that the salaries paid (just how much more productive is the lawyer today than the lawyer who, say, negotiated the Standard Oil mergers of the early 20th century in a miniscule fraction of the man-hours required to do merger deals today? ) are not as reliable proxies as prices in a manufacturing-based economy; (2) changes to “chain-weighted” measures of price inflation and myriad “hedonic adjustment” monkey business, which has the effect of lower the Deflator (and hence artifially raising real GDP as nominal GDP is deflated by the phony deflator series – did anyone notice for example that Q3 2007 real GDP “printed” at +4.9%, using an inflation deflator measurement of only 0.8% annualized! when CPI inflation is running 4+%!); and (3) lots of other technical reasons that I won’t bore everyone with! 🙂
    About “sustainable” levels of debt/gdp. Here is the simple intuition recognized by real economists like von Mises and Minsky (and Friedman, to a lesser extent). In real terms, the economy can only grow as fast as productivity plus population growth. There are lots of back and forth arguments about measurement details, but in essence, this number (in real terms) is on the order of 3-4%. Contrary to what Crestmont implies, trend productivity has been in a secular DECLINE in the post-war period in the US, although there is a little controversy regarding very recent productivity trends. My gut feeling is that much of the argument would be resolved in favor of continued decline if GDP were properly calculated.
    So, using this approach, each year the economy generates no more than, say, 3% real gain. But debt has a real service cost. It’s probably on the order of 3-5% on average (I’ve got treasury I-bonds AAA that yield CPI+3.4%, and there is a lot of junk debt at high levels, some old government debt, etc). Let’s say 3% (te exact numbers are not very critical for the exercise). Think about that. At 350%+ debt levels, that means that at least 3.5*3% = >10% must be “diverted” from income available to the population to service the debt. That’s not good. And, it’s even worse when you don’t save, and the money needs to be directed overseas to the tune of $2B per day (that’s our current account measure). Last, it’s especially bad when the debt is incurred not to increase productive capacity (which would increase trend productivity allowing one to “grow” out of the problem; think about a kid borrowing for college versus a kid borrowing to spend on soda pop!), but rather to indulge consumption like granite countertops, or simply to inflate a basic asset class like shelter (what did cause those house prices to rise??).
    The only way to plug the whole left by the diversion of resources into bankers and lender countries’ pockets is to increase debt. The von Mises school argues that the debt increase must continously accelerate (new debt incurred to service old debt, resulting in even more aggregate debt to be serviced by the incurrence of more debt!). At some point, it either collapses in a currency crisis (effective default as the currency is hyperinflated to repay the debt with worthless dollars) or in a deflation – which NEED NOT be catastrophic, so long as the government retains its ability to borow at low rates. That is what Japan did. It is also what the US did during the Great Depression, although the outcomes there were worse than they probably needed to be. But a hyperinflation (massive printing to bail out reckless housegamblers and an overleveraged houseold sector generally) would lead to an inflationary collapse, as interest rates skyrocket and the price of food and essentials soar. I can’t see this happening in the US – we’re not Indonesia circa 1997 – and I don’t think the Fed wants this.
    Anyway, you guys get the idea. Don’t listen to the economists – they’re slaves to the data, and they never get the intuitions. I worked with a lot of Ph.D economists in the past. I never saw a single one be able to formulate a view, balance the risk and reward, and put on a trade. But they were all nice guys, snart, and fun to talk with 🙂
    @SFHawkguy – about your questions, gov debt as a percentage of GDP is fairly low – on the order of 70-80%. On a trend basis, gov debt increased rapidly in the 1980s, leveling off in the 90s, with some wiggles here and there. The secular decline in interest rates post early 1980s has helped a lot. The latest GAO data I’ve seen shows that gov debt service spending declined from around 19% of fed spending in the late 1970s to around 10% today. I’m not worried about the gov sector. The last time I looked Japan had gov debt ratios (properly calculated) well in excess of 150% of GDP, and even lost their AAA rating. They still fund in the sovereign markets at

  70. Satchel – great stuff as always. To better understand your last point, you’re saying that markets really aren’t more efficient, right? I’ve kinda always wondered what all these so-called innovations have really brought us. How can the hedgies make so much money? Their investors are really sophisticated, aren’t they (like pension fund and endowment fund managers)? So are you saying these guys really do earn their compensation?

  71. arlo,
    I think that if you define financial market efficiency as the ability to allocate capital to its most productive use, then the markets are much LESS efficient than in the past. But if you define it as the ability to siphon capital into the pockets of financiers – well, we have made some great strides there! You might find Bookstaber’s “A Demon of Our Own Design” interesting – I’m reading it now, and he was right in the thick of it.
    Now, I better shut up about all this econ. 🙂
    It’s interesting that with rents “spiking” in SF (which I actually partially believe – I just do not think it will prove to be durable), SF apparently has a relatively high “vacancy” rate:;_ylt=ArvPwCmUyURhpnVVddp936ZO7sMF
    Price controls (rent control) do it every time. They always raise prices (rents) by restricting actual and potential supply.

  72. @Satchel
    You paint a very dire picture of the economy and what’s to come. While clearly off topic, would be curious on your thought on investment strategies outside of real estate, particularly given your former hedge fund days.

  73. to Dub Dub who posted this to help people sleep at night.
    I have *no idea* if this analysis is any better than satchel’s, but a little perspective might allow some to sleep a little better :)”
    Oh my god. Guy did you actually read that analysis? I especially loved the chart that showed the last time debt levels were this high was the great depression in 1929. I mean wow. And that was just 2003 –I am sure the stats are much worse now. Aside from the very bad argument that the increase in debt is okay because its backed by real estate ..the argument that we have more workers thefore we can support a higher percentage of debt to GDP is just as much of a fallacy. GDP is 100% reflective of total income earned which reflects wages as any economist worth half his salt knows. That paper by crestview should scare the bejeebus out of anyone and gives credence to the idea we may be in for a deflationary spiral where no asset classes survive. Glad it helped you to sleep tho. WHEW.

  74. To satchel:
    I liked your piece and I am worried about the same thing. However, there are a couple places in your argument where I think it’s not quite as bleak.
    1) The transition to services I believe UNDER estimates not over estimates. Inherently its a lot more difficult to quantify so production there is hard to capture at times. 2) The CPI is not really the best way to measure impact on GDP…the topline CPI is up at 4.1% because of oil imports but oil as a % of output is a much lower share of the economy. Also, I believe the reason our savings rate is negative is people are spending out of net weatlth (domestic and foreign stocks/bonds/assets). this income also is often hard to capture but it’s income and not really net borrowing. That said, I agree with your overall sentiment–I am a bit more concerned over a deflationary spiral however. That if you remember is one of the reasons greenspan lowered rates so aggressively. The 320% to GDP ratio is asounding and I did a little extra digging-it seems to be coming from two places—debt held by banks and consumer debt. Federal and state debt is actually lower then other historical periods. Like the 50s 70s and 80s. I am really looking for some kind of rational justificaiton for this…maybe we are able to underwrite more of the assets in our economy because of more sophisticated markets (try not laugh). Essentially we’ve gone from normal averages at 150% of GDP to 350% of GDP. Either that debt has to be written down or we need some rationale to explain why assets now can support more debt.

  75. That Crain’s article is strange. Oakland/East Bay rents are currently 1/4 of home payments? I don’t think so. I think in some ‘hoods it’s 50%, and that’s the floor.
    I’m looking at several foreclosures in the Oakland area where the housing payment (PITI) would only be 20% more than the rent. If you subtract out the principle (a forced savings account), the rent is actually more than the interest, taxes and insurance. Historically in Oakland, the P/E ratio has been around 20-22. Most areas are about 20% overvalued, but that’s way less than the 50-100% overvalued it was 2 years ago. And occasionally now you’re finding these gems where before they didn’t exist
    Yes, I’m going to be making offers on at least 1 or 2 of them.

  76. Satchel,
    I think you’re a bit off on your estimate of wages and when the mortgage market started, but your price/income ratio is about right, it used to be 2-3X here and places like NYC, less elsewhere. My grandfather was making about $3500/year after WWII, and bought his house in San Diego for $5,200. But SoCal was cheaper than NoCal then.
    As for the mortgage market, there are posters from 1871 in Chicago listing houses in my old ‘hood for $1000, $15/month, 6% interest.

  77. David,
    I heard that $2.5K in 1910 or so was a good average wage in the Oakland area from some history walking tour guy, but I can believe it, and it would not be inconsistent with what your granddad was making. Remember, there was very little inflation prior to the Fed’s founding in 1913, and the Great Depression compressed wages during the 30s. Add a little FDR-mandated wage controls during WWII, and a 3.5K immediately afterwards doesn’t sound too far off. Also, of course, there was very little house price inflation – my understanding is that a house in 1780 would have cost approxinately the same as in 1920. Seems right to me, under a fixed gold standard. So, $5.2K for a house in SD also seems consistent with an estimate of $5K in Oakland. (There was also an article in the Chron a few months (?) back about a nice old Oakland Victorian that sold new in the 1880s for $4,5K, or thereabouts.)
    About mortgages, I was referring to the MODERN mortgage system, which most assuredly started in the 1930s. Of course, there were mortgages before, but they tended to be short term balloon mortgages. If you run the numbers on the 1871 example, you’ll see it’s basically consistent with a 5-year baloon. In the 1930s, during the Depression, we got the beginnings of government-sponsored (guaranteed) long-term amortizing mortgages, largely becaus eno one had any cash to buy! Tanta over at Calculated Risk has done a number of interesting articles on the origins of the modern system. Also, of course, the modern mortgage differs significantly than in the good old days, because of tax implications (no income tax prior to WWI, basically). The special status of HOME debt (as opposed to all debt service payments) stemming from the 1986 tax revisions also contributed to the artificial inflation of home values, as did the special capital gains tax treatment follwing the 1996 provisions.
    Best of luck finding a nice place in Oakland! There are a lot of besutiful Craftsman houses from the 1910s that are wonderful. the workmanship is astounding, especially when you compare it to the junk that is typical of today. I would be careful about your estimate of rents, though. My opinion is that rents will go down, and also the rents actually being paid in my experience seem to be lower than the asking (wishing) rents. Again, good luck!

  78. True, you didn’t have any 30 year terms–when the life expectancy was about 50-60 (for those who lived past infancy/childhood), who would make a 30 year loan? Half of your borrowers would die before paying it off, and without securitization, whoops, you’re bankrupt! Never mind that it was fantasy then, as now, that your typical worker would be in one job for such a long period of time (the period of 1950-1972 is an anomaly in many many ways).
    But you did have mortgages, of course as you say. I just don’t think it was entirely due to lack of cash, rather a lack of life.
    Oh, and I’m looking at haciendas;) and a ’30’s deco-y house. I love Craftsmen too, but haven’t seen bargains on them.
    And I plan on loooooowballing. starting out 20+% below ask, it’s a bank, their feelings won’t be hurt. If they don’t hit my bid, it’s their loss. I know my upper limit.
    That way even if rents go down a bit, I still won’t be too far underwater. Of course if they stay flat, I have a place for less than my rent for once out here. And I have plenty of $$ left over from selling my Chicago house for way more than I’ll be paying for any Oakland pad.
    Speaking of rents, I don’t recall them dropping that much in the East Bay during the last downturn. But maybe I left too soon.

  79. David, my eye is on Oakland as well and plan to make the lowball offers, but not in the near future. Why are you not waiting for at least 6, 12, 18 months? You think now is the time? I say it’s too early, even with the 20% below asking offers…

  80. @David & dg,
    Sounds like you guys have smart plans. Buy a nice house to live in, not expecting to make a killing from the “investment” aspect of it – who would have thought of that?!
    Still, this unwind is going to be brutal. I’d be eyeing 1999 pricing when you formulate your lowball offers. At some point in the next 24 months, I’ll bet almost anything you’ll get it!

  81. Funny you should say 1999 prices. Basically I’m planning on offering them prices that would make it just under a 3% annualized gain since 1990ish sales. So right around double what they were then.
    Why won’t I wait? I will, if they don’t hit my bid. My bid, being 20% below ask, accounts for a pretty steep drop in the near future.
    Basically I feel it’s fair value and won’t lose me much (if any money if I’m willing to rent it out in a few years if forced to move) if they hit my bid at 20% under ask. Why?
    1) Rental possibility
    2) Fair long-term annualized gain (essentially 0% inflation-adjusted over 20 years)
    3) Bid price is cheaper than rent. Not much, but it is, after taxes and adjusting for principle paydown.
    All these things lead me to believe my bid is “fair value.” Yeah, things can overshoot to the downside, but that’s a bet too. We’ll see.

  82. Bunk,
    Not sure if you are still monitoring this thread. But if you are, glad to hear that you liked looking around in St. Francis, and here are some leads I noticed.
    About that big house on San Aleso for $4800. That’s a laugh, and it’s definitely been for lease and empty for 6+ months. It’s advertised on craigs all the time for $5500. It’s a long-time owner who is preserving the house for his grandkids (prop 13 tax is like $900 or so). I very much suspect that the *real* price will be much lower. Might as well go see it, and offer $3K. The house is really nice, but the kitchen is a little dated.
    There is a smallish house up for rent in St. Francis in an EXCELLENT location (as far as convenience goes) at $3900. Maybe that’s worth $3K if you like it?
    15 San Anselmo is still empty so far as I can tell. They were asking $4200 – maybe leave a letter under the door. People before were definitely paying a lot less.
    If you liked Westwood Highlands – that’s a nice neighborhood, with some pretty views. This smallish house is always advertising on cl at $3900; might be worth seeing it and offering $2.5K.
    I can’t really figure out exactly what is going on with rents out here (who really can), but this flat in West Portal started out at $3250, and now they are down to $2860, over the past two months or so, and it’s still empty:
    I hope those are a little helpful, and best of luck!

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