Bubblehead trilogy:  the manifesto.

Bubble-think for Dummies.

In the other chapters of the bubblehead trilogy, The Messenger and The Movement, I look at America's Number One Bubble Blogger and leading movement thinker, whom I call Sage, and at the bubblehead movement itself.  Here I'll respond to the heart of Sage's bubble blog, the core beliefs I call the Bubblehead Manifesto. 

"Manifesto" is, of course, my unoriginal allusion to the Communist Manifesto, Marx's clarion call to revolution; and for power, eruditeness and all-around gravitas, the Bubblehead Manifesto ain't no Communist Manifesto.  But it is the best summary I've found of the core beliefs, the Head Bubblehead's revealed vision as to why Bay Area home prices and, by extension, all home prices, must fall. 

The Bubblehead Manifesto is also a summation of what’s being said up and down the cubicles and around the back yard barbeques.  Since 2005 this stuff has even shown up in national magazines.  Someone needs to roll up his sleeves, pull on his hip boots and respond, point by point.  To give you some context, I'll leave this section mostly as I wrote it late in 2005 when I stumbled across Sage's blog.  As you've no doubt heard, the market has changed since those halcyon days, and Sage continues to refine his dogma as well, so I've included any necessary updating in brackets. 

Here's the highlight reel:

“Home prices are disconnected from their fundamental relationship to rents and salaries.”  Rents can go down when sales boom because the most affluent renters are leaving the rental market for the sales market.  The rising gap between salaries and home prices is indeed worrisome, and may well cause a correction—but not necessarily a crash—in home prices.  On the other hand, it’s possible that what we’re seeing is a long-term shift in typical homebuyer income/debt ratios, particularly in high-demand areas, although this prospect also carries its own considerable baggage.  [Things have changed since late 2005.  First, many renters have postponed buying.  Second, in 2006 Silicon Valley rents and wage gains rose faster than home prices.  A quick glance might even suggest that rents and sales prices are at long last moving toward equilibrium.  Wage and income increases actually outpaced Silicon Valley home prices in 2006 for the first time in years.  According to the Joint Venture:  Silicon Valley Network Index of Silicon Valley 2007 annual report, local median household income went up 6 percent, average pay 5 percent, while MLS data shows that average home price went up less than 3 percent in most Silicon Valley markets and was flat in others.  On the other hand, rents have shot up about 20 percent since Q1 2005, according both to MLS data and to a chart of Craigslist asking rents displayed on Sage's home page.  So it seems that the sales market is returning to the ordinary buyer it lately spurned.  But I doubt it.  In key local industries, wage gains far exceeded the average.  The Joint Venture Silicon Valley report shows 2006 median household income up 15 percent locally in the computer hardware industry, 14 percent in the semiconductor industry and 10 percent in the financial services.  This wide disparity between a few employment sectors, on the one hand, and everyone else on the other, is reminiscent of the late 1990s, when it created an upper tier of super-affluent residents who pushed home affordability below 20 percent.  Looks like that's happening again in Silicon Valley's more desirable neighborhoods, if indeed it ever stopped.]

“The dramatic drop in rents and increase in vacancies proves that demand for housing is down.”  No, it just proves that the demand for rentals is down.  Different markets, different dynamics.  The rental market doesn’t benefit from low interest rates.  [Demand for rental housing has been on the upswing since early 2005.  MLS rental inventory in this area has declined by over half, from 1009 units Q4 2004 to 453 units Q4 2006.  MLS data shows that Q3 2006 actual rents received were 99.2 percent of asking rents, the highest percentage since Q3 2000 my God, it's a rental bubble!  and one of the highest percentages since the rental boom of 1995.  According to a year-end 2006 multi-family market report published by a local commercial real estate brokerage, NAI BT, Bay Area vacancy rates declined to a low 4 percent.]  

“High rental vacancies prove that there’s an oversupply of housing.”  No, high vacancies just prove that there’s a normal, cyclical oversupply of rental housing.  This happens periodically.  I went through it in the early ‘90s.  This too shall pass.  [Hey, I was right!]   

“If interest rates go up 40%, from 5% to 7%, then prices must fall commensurately”.  Sage assumes a direct correlation between interest rates and prices that probably wouldn’t exist even if the loan product whose rates he quotes—the 30-year fixed—was the only one available.  And as he admits, buyers have responded to rising rates by going to adjustable loans of both the fully-amortized and interest-only varieties.  This has sustained the momentum, at least for the time being [until late 2005].   Sage apparently dismisses ARMs and interest-only loans as gimmicks, but he might be interested to learn that the thirty-year fixed is a relatively modern invention with downside—greater expense—as well as upside—less risk.  That’s a fair trade-off, but it’s still a trade-off.  The thirty-year fixed isn't the “best” loan, it’s just the most conservative.  A more fundamental reason the market in his area, Silicon Valley, may cool is that the affordability rate is down to 14 percent, very low by historical standards.  Will home prices deflate catastrophically?  The people who think so don’t have history behind them.  And if they think that “this time it’s different”, well, maybe it is, but their overall understanding of real estate suggests that this feeling comes more from habitual pessimism than from sophisticated insight.   

“Risky loans.”   Sage was crying “bubble” even while most buyers were using that most conservative of loans, the fully-amortized thirty-year fixed.  However, there’s no question that the interest-only adjustable-rate loans now popular in some markets are riskier.  Inflationary pressure on interest rates could make things very uncomfortable for those borrowers in the future, but we’ll see how this plays out.  [The inverted yield curve on Treasury bills has so narrowed the difference between fixed-rate and adjustable loans that there's currently a boom in refinancing out of ARMS into fixeds, although not everyone has the cash or equity to do this.] 

“Massive job loss”.  Sage cites the wholesale loss of jobs from Santa Clara County, due not only to the dot-com crash but also to outsourcing.  He says that “Santa Clara County posted its third straight year of job losses in 2004, so it’s not over yet.”  What's interesting about Sage's claim is that a) it isn't true, and b) it's the sort of scare tactics that bubbleheads accuse the real estate industry of using.  How is "don't buy now because job losses aren't over yet" any different from "buy now because prices will just keep going up"?  Both use short-term economic trends to pressure buyers.  Since I’m sure Sage wants to be fair and honest, he undoubtedly meant to say [back in 2005] that “the monthly average number of employees in Santa Clara County dropped less than 1 percent in 2004, after much steeper declines the previous three years.”  Fair and Honest Sage would also add that average annual income went up 6.9 percent in Santa Clara County in 2004, and that the number of business establishments went up 2 percent, a sign the economy was recovering.  [State data shows that Santa Clara County had a 2.6 percent increase in total jobs from Q4 2004 to Q2 2006, the latest quarter available as of this writing.] 

“Population loss.”  Sage says San Francisco is losing population more quickly than any other city in the U.S.  However, California Department of Finance data show San Francisco's population gaining 3 percent from 2000 to 2006.  Admittedly, San Francisco did officially lose 451 residents in 2005, but that's the only year during this period when any of the nine Bay Area counties lost population.  San Mateo County, where Sage lives, gained 2.5 percent in population between 2000 and 2006, while adjoining Santa Clara County, where Sage once lived, gained 5.6 percent.  Obviously such increases by themselves don't justify double-digit price jumps, but they do confirm that the Bay Area hasn't turned into a ghost town.

“The 2000 stock market crash stripped buyers of wealth, especially in the San Francisco Bay Area.”  The tech crash hit the top end of the Bay Area market hardest, but even there the damage was selective.  Atherton, the jewel of Silicon Valley, took a big hit, but Hillsborough, another exclusive community only a few cities to the north, shrugged it off.  But by far the bulk of our market is entry-level and mid-range housing, as it probably is throughout the country, because there are far more players in those markets.  These price ranges weren’t hit nearly as hard by the tech bust and they bounced back almost immediately, because buyers are progressively more driven by wages and interest rates, rather than by stock-market wealth, as you move down the price ladder. 

“The extreme use of leverage puts homebuyers at risk.”  Leverage—the ability to purchase an asset with cash that’s only a fraction of the asset's value—is considered one of real estate’s greatest advantages because it amplifies your return on equity.  Admittedly, it’s a two-edged sword.  But Sage goes hyperbolic when he claims that a homeowner who loses his 10 percent down payment to a 10 percent decrease in home prices is “bankrupt”.  That’s neither a common nor an accurate definition of “bankrupt”. 

“The drop in affordability is causing a shortage of first-time buyers.”  He's partly right, but when the affordability index drops to 14 percent, it doesn’t just affect first-time buyers.  Even current homeowners think twice about moving up.  That's why inventory has been declining in Sage's neighborhood for years, and that inventory shortage helps keep home prices high.

“There’s a surplus of speculators.”  Sage cites national statistics that fail to distinguish between properties bought a) to rent out (old-fashioned investment), b) to flip (speculation) and c) as second homes, a market that's boomed over the past few years.  Sage, the statistics I’ve run using county databases indicate that speculation is negligible in our area if it’s defined as “homes bought and sold within the last six months”.  For example, ultra-high demand Palo Alto would seem to be a natural venue for "flipping", but less than 1 percent (eight of 831) Palo Alto residential buildings of all types sold in 2005, at the height of the boom market, were purchased within the previous six months.  Maybe that average sales price of almost $2M is keeping speculators out.  In fact, I've read reports and heard anecdotally that Bay Area residents, priced out of speculating in their own back yard, helped fuel the booms in the Central Valley, Las Vegas, Arizona and San Diego. 

"The Bay Area is a lot more expensive than it was ten years ago, but it isn't any more desirable."  Yes and no.  The Bay Area may not be getting more desirable to you or, for that matter, to me, and I've lived here since before you were born.  But an article by Richard Florida in the October 2006 Atlantic Monthly confirms something I've suspected for years:  the Bay Area is attracting an exponentially wealthier elite.  According to Florida, two academic studies suggest a "mass relocation of highly skilled, highly educated, and highly paid Americans to a relatively small number of metropolitan regions", including San Francisco and Silicon Valley, "and a corresponding exodus of the traditional lower and middle classes from these same places."  This means that people like you (and me) find themselves getting priced out of the Bay Area.  Florida goes on to say that these areas "already have a high concentration of highly talented people.  And as more such people are added, their multiplier effect on growth seems to keep increasing...Because the return on colocation [congregating in these 'super cities'] among the ablest is so high, and because high-end incomes are rising so fast, it makes sense for these workers to continue to bid up real estate and accept other costs that traditional middle-class workers and families cannot afford".  He describes the Bay Area in general, and Silicon Valley in particular, when he says, "America's most successful cities may increasingly be inhabited by a core of wealthy workers leading highly privileged lives, catered to by an underclass of service workers living in far-off suburbs."  Hey Sage, ever gotten caught in the rush-hour traffic of plumbers and cops commuting to and from their homes in the Central Valley?  I always take whatever academics say with a grain of salt, but not only does Florida's theory match Joint Venture Silicon Valley's sobering annual reports showing the top 20 percent of income earners pulling away from the rest of us.  It also matches what my wife and I have seen in microcosm since the 1950s, as Palo Alto has transitioned from a university town with a healthy blue-collar contingent, to a city of middle-class engineers, to an enclave of super-affluent entrepreneurial Ph.D.s.  No, this doesn't mean that Palo Alto home prices can go up 15 percent every year, but it does suggest that real estate in this area has more upside than most.        

“You get more house for the money in other parts of the country.”  Yeah, but you get a lot less of everything else and Sage, I notice you haven’t moved to Indianapolis.

“Credit is being tightened.”  That’s true at the fringes of the credit market.  A phase-out of the more aggressive forms of lending, [particularly sub-prime lending], will undoubtedly take some buyers out of the market.  [The stock market's reaction to the subprime lending crisis which, at least at this point, involves about one-half of one percent of outstanding mortgage debt, has resulted in a tightening of credit in many but not all loan markets, according to August 2007 articles by "The Mortgage Professor", Jack Guttentag.  But since that time, there's no doubt that credit is harder to come by, although it's my experience that the generally affluent and well-qualified buyers who can afford this area still have choices.]  Whether that’ll cause a catastrophic drop in home prices is open to question, especially in Sage's neighborhood, where 100 percent financing and bleeding-edge debt ratios were never common and where prices still creep up [prices there have declined since late 2008].

“It’s more expensive in the short run to buy instead of rent.”  No one denies this, although the difference between renting and owning at the lowest end of the sales market is surprisingly small when interest rates are at or near historical lows.  Besides, some people think beyond the short term.

“A rental house costs more out of pocket than it brings in.”  Nobody’s denying this either, at least in the Bay Area, where prices have shot up as rents have slumped [until 2005].  Maybe that's why no one is buying rental homes around here.  It is possible to get positive cashflow out of apartment buildings in the less desirable parts of the Bay Area.  But you don’t buy prime Bay Area property for short-term cash flow.  You need an investment outlook longer than your nose, something that seems to have fallen out of favor since the day-trading days of the 1990s.  Eventually, cash does begin to flow from income property to investor.  I managed a variety of rental properties for nine years and saw guys who as young men didn’t have much on the ball except the discipline and foresight to scrape together a down payment reap big rewards in middle age.  And Sage doesn’t mention depreciation and other tax deductions available to the real estate investor, or real estate’s ace in the hole, the tax-deferred 1031 exchange, which allows a small investor to get bigger by deferring the capital gains tax.  Try doing that on Wall Street.

“Appreciation won’t compensate for negative cash flow.”  Tell that to the everyday men and women who’ve cashed out of real estate and retired after holding ten or twenty years.  Yeah, it usually takes a while.  The quick gains of the recent market are unusual.  But real estate encourages the buy-and-hold strategy that makes an investor the most money in the long run.  That’s why I say that real estate’s supposed drawback, illiquidity, is really its greatest asset.  Illiquidity makes it a lot harder to chase hot tips, move into and out of markets at precisely the wrong time and consistently shoot yourself in the foot, as so many hot-shot stock market investors do.

“Disciplined renters end up with more in thirty years than homeowners.”  “Disciplined”.  Interesting choice of words, Sage, because it implies that you understand that homeownership is like a forced savings plan—it forces the homeowner to save and invest for the future.  In fact, it usually takes discipline just to buy.  Watch renters pull up to their seedy 1950s apartments in $40k cars, while homeowners drive ten-year-old Hondas, and you’ll see what I mean.  Who the suckers are in this case depends on your point of view, but when the difference between the two groups is discipline and a willingness to defer gratification, to me it's no contest. 

“Owners frequently end up with nothing because they lose the house to foreclosure.”  "Frequently"?  You’re going hyperbolic again, Sage.  Or maybe I missed that massive wave of foreclosures.  [Okay, this is one line I'd like to have back, but you have to remember that lots of supposedly smart people in the lending and investment banking industries and in the field of economics didn't see it coming either.  Foreclosures have certainly made the news lately, but so far they've been confined mostly to ultra-low end neighborhoods where 100 percent or subprime financing was common.  That doesn't make it okay, but it does make it relatively contained, something you wouldn't know from watching the 6:00 News.]   But this wild-eyed claim raises an interesting question:  how much of Sage's attitude toward homeownership goes back to the Great Depression or, more precisely, goes back to the stories he may have heard around the dining room table?  Sage wasn't around in the 1930s, and his parents probably weren't either, but I'll bet his grandparents gave everyone an earful about how bad things were back in the day.  Mine did, but despite that they were homeowners for over forty years.  Up until now I thought Sage's thinking was nineteenth-century.  I was selling him short.  It's 1930s thinking.     

“Home prices aren’t driven by supply and demand, just by interest rates.”  Did we really hear Sage just deny one of the fundamentals of the marketplace?  Maybe what he meant to say is that he thinks interest rates have artificially increased the demand for homes.  I’ve never understood why low rates are an artificial stimulus.  Interest rates have long been recognized as one of the three drivers of real estate, along with employment and consumer confidence.  Each real estate market is the legitimate product of the interplay between these three market drivers.  Now, all of a sudden, we’re supposed to take interest rates out of the equation?  What kind of revisionist thinking is this?  Are people foolish to borrow money when it’s a bargain?  Were the 18 percent interest rates of the early 1980s an artificial brake on real estate sales?  Are real estate booms legitimate only if the economy is revving out of its motor mounts, unemployment is nil, everyone is manically optimistic and interest rates are in double digits?

“The supply of housing in Santa Clara County has actually increased 3% per person since 2000, so prices should go down 3%.”  Anyone who sells real estate in Santa Clara County can tell you that there wasn’t enough housing to meet demand in 2000, and there still isn’t today.  But don’t take our word for it—ask buyers.  Or better yet, go out and look for yourself.  This reasoning also ignores what really drives demand for housing, the number of households in an area, which differs from the number of persons.

“They may not be making land anymore, but they’re making houses at a record rate.”  Not in the most desirable parts of the Bay Area, where prices have gone up the most, because those areas have been built-out for forty years.  Seen any big housing tracts go up in Menlo Park lately, Sage?  In high-demand areas, new housing is built only where old housing used to be or, sometimes, where surplus office space was.  Sure, there’s still plenty of land out in the boondocks, but it’s two or three hours from work.  [And it's these outlying areas—not the core Bay Area—that have been hit hardest by the slowdown.]

“The rental owner subsidizes the renter, because rent doesn’t cover the owner’s expenses.”  That’s a debatable use of the word “subsidize”—you could just as easily say that renters subsidize their landlords—but it’s true that early in ownership most Bay Area landlords put more money into their rentals than they get out.  How long they "run a negative" depends on how much they put down and how quickly rents go up, but I’ve managed property for long-time landlords who lived off their rents.  Compare the landlord who owns a rental for twenty years to the tenant who rents that house those twenty years and does what most people do with discretionary income:  buy high and sell low, if they even bother to invest, and party like it’s 1999.  Meanwhile, the landlord gets positive cash flow for maybe half those years, plus he gets astronomical appreciation.  Yes, there’s a downside to landlording—mainly the midnight phone calls—but I’ve seen real estate equity bail out people who otherwise had little in the way of assets.  This was particularly true after the dot-com meltdown, especially here in the Bay Area, where people who invested heavily in what they thought they knew—tech—saw 80 to 90 percent of their stock market wealth disappear in days or months.  Homes also took a hit, but only briefly and not nearly as much.

“Renters don’t always live in dumps in bad neighborhoods.”  That’s true, but here Sage tacitly acknowledges one of the most powerful arguments for homeownership:  owner-occupied homes are better maintained than rentals, which improves neighborhood quality and therefore the quality of life of its residents.  Sage doesn't think so, but as someone who’s done both rental management and home sales, I know it’s often true and, more important, so do others.  The Federal government’s record of social engineering, from the FHA-insured loans of 1934 to the Tax Reform Act of 1997, strongly suggests that the Feds see homeownership as a social good.  Not every renter lives in a dump, but most rentals don’t get the maintenance of an owner-occupied house.  I know this.  I used to manage them.  Landlords don’t like to cut into their bottom line, especially if, as Sage gleefully points out, they’re already putting more money into the house than they’re pulling out.  So it’s not unusual for a rental to have peeling paint and sport a dead lawn.  The landlord doesn’t care what the neighbors think because he never sees them.  The renter’s attitude is, “If the landlord doesn’t care, why should I?”  Best bets for renters with high standards are the homes of people who’ve been transferred and expect to come back within a few years.  But trust me, that’s a very small part of the rental housing stock.

“The law says that the landlord has to offer you a minimum one-year lease.”  There’s no Federal or California law that makes your landlord offer you a one-year lease.  There are a handful of rent-controlled cities in California that do—a handful—including Palo Alto, where Sage used to live.  And once you’re beyond the lease period, all it takes to get you out of a non-rent controlled house in California is a sixty-day notice.

“Renting is temporary, but then, so is life.”  Hey Sage, that's heavy.  But tell me, does it mean there’s no tomorrow?  I'm thinking of the woman on fixed income who’s just had her rent raised 40 percent by the new owners.  Or the elderly renters who get sick, burn through their savings and don’t have home equity to bail them out.  Better hope they have rich and dutiful kids.  That’s real life, Sage.  Say hello to it.

“People are buying houses for the very short term.  The difference between long-term owner and short-term flipper has gone away.”  It’s just more Sage hyperbole to say that every homebuyer is a speculator.  It is true that many homebuyers expect to gain equity almost immediately.  I’m not sure this is anything new—appreciation has always been one of the more alluring aspects of homeownership—although the short time frame may be.  But whether this is unhealthy or just unrealistic is debatable. 

Speaking of which, Sage might be interested in hearing about the only clients I've ever worked with who were obsessed with what their home would be worth next week.  They:

But aside from that, they did everything right.  And, no, I'm not bitter.

“High overbids don’t prove the market is still hot.”  One high overbid doesn’t prove anything.  A pattern of high overbids suggests that demand is outstripping supply and that prices are going up.  Not every house is under-priced to get 27 offers. 

“Agents are ripping off buyers by encouraging high overbids.”  Sage would disappoint me if he didn't dust off this old chestnut, because it's a classic example of shooting the messenger.  Your agent’s job is to get you the house you want, in whatever market you’re in.  To get the right house in a hot market, the house you and nine out of ten other buyers want, sometimes you have to pay more than list price, and sometimes much more.  "Market value" is not the same as "list price"; sometimes "market value" is lower, and sometimes it's higher.  If it's higher, that’s not your agent’s fault.  It just means the current market has too much demand for too little supply. 

With me so far?  Great.  It's really not that complicated.  Now, about those high overbids agents are "encouraging".  Your agent would be remiss if she didn’t tell you what she thinks you'll have to offer to get the house you want.  If she's been consistently underestimating what you need to offer, you would or should drop her like a hot potato, because she's not doing her job.  You'd figure that she should know what a house in her market is likely to sell for.  That insight is why you hired her. 

But it all comes down to you the buyer.  You can play the game to win, or you can turn homebuying into a head-butting contest, you against the market and finding out it's bigger than you are.  You can get real, or you can take a page from Sage's playbook and go around boasting that "no scum-sucking agent tells me what to do".  You're free to leave the market "until prices settle down".  Of course, waiting out the market has risk too, because now you’re trying to time the market like a day-trader.  When will it start cooling?  When will it stop cooling?  How will you know?  Are you willing to buy when prices may still go down?  Or are you waiting like everyone else for the magic moment when real estate is once again a "sure bet"?  No one knows whether you should buy now or wait.  Not you, not your agent, not even the guys who peddle homespun wisdom on blogs.  No one knows what the future will bring.  That’s the risk inherent in both action and inaction.

Let me illustrate these points with a story.  In early 2004 I did an open house for a home that wasn’t my listing.  A day or two later I got a call from a woman I'd met at the open house.  Suspecting that the home would get multiple offers, she pumped me for the price I thought it would sell for, probably so she could pass it on to her clueless out-of-area agent.  I explained that the list price of $989,000 had come from an out-dated trustee-ordered appraisal that didn’t take into account the sharply rising prices of the past few months.  The level of interest in the house suggested it would sell for $1.4 to 1.5M.  Instead of thanking me for this invaluable insider advice, the woman scolded me for suggesting that she pay “far too much”.  The next day I heard from another buyer I'd met, an experienced buyer who knew enough to listen to good advice and unhesitatingly wrote an offer at $1.5M.  On the offer date the seller got ten offers and countered the top few, including ours, at an even higher price.  We improved our offer to $1.575M, but it sold to another buyer (not an investor) for $1.625M.  Our improved offer was only the third-highest.  My point:  if you listen to your agent, you don't get any guarantees but you do get a fighting chance.  If you don’t feel like listening, you're another daydreamer clogging the fast lane.     

“The MLS is full of misleading information.  If a house doesn’t sell, the listing agent can remove any trace of it from the MLS.”   Maybe that’s true of Internet listing sites, but that’s not true of any Multiple Listing Service I’m aware of.  Sage, those listing sites aren’t the MLS, they’re just selected information from the MLS.  If you subscribed to the MLS you’d find plenty of unsold houses in either the “canceled”, “withdrawn” or “expired” categories.  That's right, three of the eight property status codes in my MLS are devoted to properties that didn’t sell.  This points up the difference between “free” (Web site) and “$439 a year” (MLS subscription).  It also points up one of the many differences between bubble-think and real life.  

“MLS prices are often just wrong.”  “Often?”  Make a statement that sweeping and at least a few of us would like to see proof.  How do you know?  You're not involved in transactions.  You don’t even subscribe to the MLS.  It’s true that MLS prices don’t show credits from sellers to buyers, although they’re sometimes included in the remarks.  But not to worry, Sage.  In the hot market we've had, credits aren't often given and they're small when they are, so it's unlikely that they inflated sales prices during the run-up, especially where you and I live.  I’ve always found historical MLS sales prices to be reliable predictors of current prices, but then, I know how to use them.  You do have to take the data with a grain of salt, but if Sage has taken a statistics class he knows that’s true of any data.

“Even a broken clock is right twice a day.”  Yes indeed, Sage, and that's your salvation, because if you keep saying “bust” long enough, the cyclical nature of real estate will eventually prove you a prophet.  More than a few Ph.D. economists are counting on this too.  Even the National Association of Realtors® warned, in early 2005 at the height of the boom, that it wouldn't, couldn't and shouldn't go on forever.  I wonder if any potential home buyer took Sage seriously and missed out on the 40 percent appreciation, but then again, I don’t think real buyers hang on Sage’s every word.  He works a different crowd.

“A fair housing price is between 100 and 200 times the monthly rent.  A house renting for $2000 per month should be worth $200,000 to $400,000.”   Now there’s a useful analytic tool, Sage.  Setting the market value of a house at between $200,000 to $400,000?  That's a price range you could drive a Hummer through.  “Mr. and Mrs. Seller, I think your home is worth anywhere from $200,000 to $400,000.  Hello?  Hello?”  And by the way, Sage has produced yet another yardstick—his third—for establishing market value.  Elsewhere on his blog he says current prices should be 50 percent of what they are now.  Elsewhere he says 33 percent.  Now he's saying in effect that the house he rents for $2350 a month should be worth $235,000 to $470,000.  Since it's probably worth at least $1M today (I know his neighborhood) he's now claiming that homes should sell for about 25 to 50 percent of their current prices.  This inconsistency helps us to more fully appreciate how creative bubble blogging is.  Once Sage starts riffing, there's no telling what'll come out his horn.       

“Past performance is no indication of future results.”  Hey, I keep seeing that disclaimer in the ads for the stock brokerage you used to work for.  Yeah, there aren’t any sure things in life, although some people keep waiting for them.  But if the historical trend is up, and if you don’t want a landlord on your neck, then homeownership looks pretty good.  Just don’t expect to be printing money the day you move in. 

“Some buyers voluntarily pay more in transfer tax to make the price higher to fool the next buyer.”   I’ve never seen that, Sage, in all the closings I’ve been to and in all the closing statements I’ve read.  There's bubble think, and there's real life.  I doubt that any escrow officer or title company would assume that liability.  I also doubt that the county would accept an overpayment.  There's bubble think, and there's real life.  Besides, I’ve never seen a buyer who thought he should pay more for a house just because the seller paid too much.  There's bubble think, and there's real life.  On the other hand, I have heard of buyers and sellers understating the gross purchase price by paying the agents' commissions outside escrow, so that the sales price would be lower for property tax assessment purposes.  I've also heard they were sued by the county assessor.

“Vote against County Recorder Warren Slocum in San Mateo County unless he fixes his public computers to allow you to save data.”  Warren, the nerd vote has spoken!  By all means, buy more server space with my tax dollars so that obsessives with too much time on their hands can save the data they crave and live for.  A Starbucks in the lobby with Wi-Fi would be nice too. 

“Appraisals don’t prove what your home is worth.”  Very true, and I wish more sellers would realize this.  A house is worth what the highest bidder is willing to pay.  That’s market value, and buyers are the market—real buyers, that is, not bubbleheads. 

“Calling a house a home is a manipulation of your emotions for profit.”  No, it simply recognizes that an owner-occupied house is a more personal asset than a hundred shares of stock.  You don’t need to tell a real buyer that.  That’s a big reason he’s in the market.  On the other hand, a bubblehead will never understand this.  That's a big reason he's not in the market.

"'My wife will divorce me if I don't buy a house.  FALSE.'"  Here the multi-faceted Sage branches out into marriage counseling.  Is there nothing this man can't do, no insight this man can't have?  "She won't divorce you if you rent a much better place than you can buy, and take her to Paris for a month each spring, which you can do just by avoiding that mortgage."  What a romantic!  Let's see those plane tickets, Sage.   

"'Rents could shoot up, making it a better deal to buy.  FALSE.'"  Sage disproves this worrisome idea by assuring us that "rents are limited by the money people earn."  Boy, that's a relief!  Sage just assured us that renters will never be priced out of the rental market by inflation, increased demand or more affluent renters!  Sage just assured us that Bay Area renters weren't feeling financial pain in the late' 90s as rents went up 10 percent a year, because their income had to be going up 10 percent a year as well!  It makes me wonder why any city would bother with rent control. 

“Don’t worry about getting priced out of the market.”   I call this the "Alfred E. Newman 'What Me Worry?'" school of market timing.  Maybe Sage doesn't worry, but I think by now there's some doubt as to how much he wants to own his own home.  Me, I'd worry.  I’ve seen people get priced out.  Sure, extreme price spikes tend to correct over time, mostly, but the historical trend has been up, and anyone just barely able to afford something now should be, if not worried, at least real alert.  Maybe a price correction will get you back in the market, and maybe it won’t.  And what will interest rates be by then?  [Will you even be able to get financing?]  How lucky do you feel?  How’s your crystal ball working? 

“Japan proves that limited land availability doesn’t prop up prices.”  Japan is whole 'nother kettle of fish, with fundamental economic problems and a stock market that’s been depressed for years.  This comparison simply proves that it's not smart to draw lessons from real estate markets that operate in radically different financial, economic and cultural environments.

“A 50% price decline is well justified by the fundamentals.”  Cripes, Sage, even 9/11 didn’t knock 50 percent off home prices except for a handful of ultra-ultra-top end trophy properties.  And that was on top of a recession that, as you know, hit our area like a ton o' bricks.  The rest of the top-end market took maybe a 35 to 40 percent hit, but those were the homes that had had the biggest run-up during the dot-com boom.  Most homes lost 10 to 15 percent and that was only for a few months from late 2001 to early 2002. 

“A house doesn’t produce anything, so it doesn’t increase in intrinsic value.  Its price just goes up.”   Welcome to real estate’s version of "how many angels can dance on the head of a pin?"  It’s a great example of the blind spot the size of Rhode Island economists have when they turn their lofty gaze on real estate.  Who, besides a landlord, cares what the productive value of a house is?  The value of an owner-occupied home is the shelter it provides its owner, a value that's historically exceeded the rate of inflation, plus all the un-measurable but real emotional benefits it provides.  And as the more desirable areas get built out, the price of existing homes, or the land they sit on, goes up.  That's all that matters to anyone besides the economists and the economists wannabes called bubbleheads, and they're not the market.  

“The housing market is just pets.com all over again.”   Pets.com was driven entirely by speculation.  You couldn’t live in a share of pets.com.  Speculation has started to creep into the residential housing market in some areas, and that’s worrisome.  But a check of one of hottest local markets, Palo Alto, right in Sage's back yard, shows that in 2006 less than 1 percent of its houses met the usual definition of speculation by selling twice within a six-month period.

"There aren't any buyers left."  In March 2007 I had a Palo Alto listing that attracted over 200 people to two open houses.  That's more than came to open houses at any of the four other listings I've had in that same development over the past three years.  The home sold with eight offers, also a personal record in that development, and it set a new price record.  That's not happening in every market, of course, but it is happening in many parts of the Bay Area, and it suggests that Sage should get up from his computer and get out more often.  Besides, "there aren't any buyers left" is like saying "there aren't any bears left" during winter hibernation season.  Anyone who goes to a Silicon Valley open house in the $1M to $3M price range these days can see how much pent-up demand there is.

"Prices will go down when retiring boomers with zero savings have to sell."  Plausible, if you think that all those boomers will be renting after they sell or maybe living in their cars, instead of downsizing or buying somewhere cheaper as their parents are doing now.  Plausible, if you think that reverse mortgages will disappear, instead of increasing in popularity as they are now.  Plausible, if you think that immigration, household formation and the birth rate will all drop to zero or go negative.  Plausible, if you don't know that boomers are increasingly opting to "age in place" in their own homes.

“The last guy to buy into the bubble will get hurt the most.”   Bumper-sticker economics.

“Just wait to buy until housing costs half as much.”   When will that be, O Great Oracle?  And do you offer a money-back guarantee?

Okay, time to see how Sage grades out on originality and omniscience.  In other words, how does Sage score as a prophet?

Of the forty-nine points in the Bubblehead Manifesto, I think it's safe to say that twenty are patently wrong.  That is, they can easily be shot down by anyone whose knowledge of the subject exceeds random gleanings off the Internet.

A further twenty-two points can be distributed fairly evenly between "irrelevant", "wishful thinking" and "the bloody obvious".  So why don't I give Sage get credit for being right, even when his point is obvious?  Because prophets don't get kudos for saying that the sun will rise in the morning. 

Three points are impossible to respond to, or undeserving of a response.  Buy off your wife with annual trips to Paris?  Oy.

This leaves four points Sage gets right. 

One of those points is that even a broken clock is right twice a day, which is apparently Sage's way of saying that if he predicts "bust" long enough, a cyclical market like real estate will eventually prove him "right".  The fallacy to this, of course, is that Sage was "right" long before he was right, which meant shouting crash from the rooftops while home prices jumped 40 percent.  Not many people can afford being "right" like that.

The second point Sage gets right in his manifesto is the disconnect between home prices and rents.  But this isn't an earthshaking revelation if you recognize this disconnect as a normal part of the market cycle.  Yes, home prices do reach unsustainable levels.  Yes, home prices then go down.  We know this.  Here Sage gets low marks for originality. 

The third and fourth points concern home loans.  But before we credit Sage with predicting the subprime and liquidity crises—mighty generous, given his track record on every other point—we might bear in mind that "risky loans" and "tightening credit" were non-issues in 2003 when Sage first predicted bust. 

So what danger sign did he see back then?  I don't know, but I suspect his Bubblehead Manifesto still bears traces of it:  the Bay Area real estate market had to be a bubble waiting to bust because the tech bubble that fueled the Bay Area, particularly Silicon Valley where Sage and I live, had bust.  Like Sage says, it's simple math anyone can do:  "bubble" equals "bubble".  Except that markets are never simple.  The inconvenient flaw in Sage's postulate is that it's based on the idea that Silicon Valley would never recover—that it was down and out for good—a feeling common among techies who thought the Valley didn't exist before they got there, as Sage did, in the late 1990s.  But Silicon Valley did recover, as it has so many times over the past forty years, which is one reason its real estate market doesn't look like Modesto's or Detroit's. 

So if this was Sage's original thinking back at the dawn of his blog in 2003, then he was flat-out wrong.  And the one issue that makes Sage look omniscient today was a non-issue back then.  Sage was crying "wolf" before the wolf showed up. 

I guess you could call this foresight.  I think most objective observers would call it more proof that "even a broken clock is right twice a day". 

Maybe it's the air in here, but I feel like making a few bold predictions of my own.  Nostradamus, move over.                        

I predict that, ten years from now, home prices will have recovered their loses except in areas where economies are chronically depressed.  Not only that a hush falls over the crowd  I predict that, ten years from now, home prices in many areas will either be falling again or poised to fall. 

Not only that, I predict that many a former head-banging fire-breathing flame-throwing bubblehead will have 2.3 children and be feeling mighty smug about the appreciation his condo has turned in and will continue to turn in, forever and ever, amen, because he timed the market just right.

And that a new generation of head-banging fire-breathing flame-throwing bubbleheads will be telling him he blew it.

How can I be so sure? 

Life cycles.  Market cycles.  The immutable cycles of real life, which have an embarrassing habit of proving just how irrelevant common wisdom and wishful thinking are.

copyright © John Fyten 2007        Site Map         Home