Housing bubble

I mentioned the bay area housing bubble in the last post, and was asked to elaborate. Coincidentally, the Economist just posted this survey on property worldwide.

I can't claim to be an expert on this topic, but here goes...

I think there is clear evidence for a bubble in places like the bay area, Boston, NYC, LA and some other cities. The metric I find most compelling is price to rent (P/R) ratio, which is analogous to price to earnings (P/E) for equities. This is at an all time high in many cities, although not nationwide. The other metric which is very inflated in certain markets is price to average (family) income. Some of this data is available at the Case-Shiller-Weiss (CSW) Web site. (That's Robert Shiller, of "irrational exuberance" fame.) The bay area is particularly hard to understand, since something like 250K jobs were lost since the peak of the tech bubble in 2000, and there has actually been net migration out of the area. Rents have actually dropped slightly, but property values continue to increase.

On the behavioral front, I think a lot of people jumped into real estate thinking it was one of the few "safe" investments after the stock bubble burst a few years ago. One sure sign of a bubble is that people buy with the expectation of near-term price increases. I keep reading that units in developments in places like Florida and LA are often unoccupied - the owners have purchased them as investments with the intention of flipping. These speculators are going to get burned when interest rates rise, but until then they get to brag to their friends about their big gains. (Sound familiar?)

I mentioned in a previous post that bubbles can persist for surprisingly long periods of time, even after a fairly wide consensus has emerged that things are overpriced. I claim this has a lot to do with the timescales and effectiveness of arbitrage in a particular market. See here for related discussion in the Economist, and here for derivatives related to real estate prices.

Finally, let me note that I must not be very smart, since I thought the bay area was already overpriced 10 years ago, and should have bought something back then...