Bubble Bubble Bubble

Dan Gillmor on Grassroots Journalism, Etc.: Bubble Bubble Bubble I’m increasingly convinced that there is a huge bubble being built in California real estate — and yes, even the Bay Area. I read a similar article to this one last week in the Chronicle but thought I’d post on this topic when I saw Gillmor pick it up as well.

The decline in residential real estate values in Southern California when the last real decline took place was a slow, tortuous painful one which ended in about a 30% decline over the course of about five years. People easily forget. The housing start numbers reported yesterday were the strongest that they have been since the 1970s. Recently someone told me that the average expected permanent return on a home in California is 15%. Wow! Way too high. And then you have all these folks that have jumped on board the ARM train and have stretched to buy even more expensive homes. When rates start going up, and they will – Greenspan seems hell-bent on making sure long term rates eventually will go up – these folks will get squeezed.

I remember back when Nasdaq was above 5000 and people, myself included, were saying things like, “well, yeah it could correct but even if it went to 4,500 or god forbid 4,000 it would come back in a few years. Yeah, right. Now I hear people saying things like yeah but people in the Bay Area always need a place to live, if you live in a desirable neighborhood with a good school district you’ll be fine. Things might flatten off for a while… or, but yeah home prices have never corrected as long as I’ve been alive, prices just keep going up (huh?)… or, well everyone needs the tax break you know (like they didn’t three years ago?).

But why is that same home in the desirable school district worth so much more money than it was 3 years ago?

Have more jobs been created in the Bay Area in the last three years? Are people making 50% more money than they were three years ago?

I believe that the answer is more likely speculation and when you combine speculation with an average expected investment return of 15% and huge recent price jumps, look out folks.

Dan is a good man to fire a few warning shots across the bow. If you plan on living in your home for a long, long time, fine maybe go ahead and buy it. But if you are looking for a quick buck or to flip the house and upgrade in 3 or 5 years, watch out. And remember, a 30% decline in home values can easily be translated into a 100% decline in your investment in a down market given the leverage of real estate. Leverage can build great wealth but in a declining market leverage can also destroy completely.