New-home sales plunged… blah blah blah… largest amount since 1990… blah blah blah

I am sure everyone in the industry (or who follows the industry) has heard the same thing.  I actualy meant to publish this blog in late January when the PI posted the article… but better late than never.  I know lots of my clients, investors and friends have been asking me this same question for a while now.  So what do I say to them? OR… What do I say to all of those real estate bubble watchers!

The reality is that two thirds of the households in the U.S. lived in their own home in 2000. In 2000 the median value of these homes was $119,600. This is 18% more than the median value in 1990, and more than double the median value in 1950 of $44,600 (in 2000 dollars).  With a quick look back at 2006 and you see the national average was $224,900.  That is an 88% return in those 6 years or a 15% annual average.

So houses dropping by more than 8% last year is not that bad in the slightly bigger picture.  It still is not an easy pill to swallow considering prices are down 17.3% from 2005.  Which seems crazy, but considering the stats in 2005 was averaging a 24% increase a year and an average price in 2005 of $264,932.

This is a conversation for a different day, but if you want to take in to account that most of these homes on average were purchased with a down payment of 20% or less.  Let’s assume your mortgage was equal to your payment (just to keep it simple).  That means on average in 2000 a home owner’s (roughly) $40,000 down payment would have returned that original down payment + another $64,932 in 2005 a 162% return!  Not as good, but still a steller return using 2006 numbers, still a 50% return.

That is what I say

78 thoughts on “New-home sales plunged… blah blah blah… largest amount since 1990… blah blah blah

  1. Let’s hope that the hypothetical person in the hypothetical situation didn’t use their home as a hypothetical ATM with cash out refinancing.

  2. From the article:
    In King County, closed sales of single-family homes and condominiums fell 18 percent from the previous December while prices jumped 12.6 percent.

    Wow, that’s terrible. As someone who is going to put their home up for sale in the next month, I’m absolutely terrified that prices only increased by 12.6% last year.</sarcasm>

  3. Ben-

    I know, could you imagine only gaining 10%+ on your home in a year… I too would be terrified… or again, 100k down on a 500k house that would be worth 550k in a year… or a 50% return… of course that doesn’t include sales costs, but hey, this is a perfect world we are talking about here.


  4. Don’t worry, when prices decline for 5-10 straight years ala Tokyo Japan, we’ll see what kind of a tune you are singing! This is just the beginning… The same kind of asinine logic that ran this market out of control straight up, is going to run it straight into the ground.

    Nothing like fear to drive a market, fear of losing money, and fear of losing out on making money.

    What goes up, must come down!

  5. Matthew-

    I understand what you are saying and of course I am playing the devil’s advocate, but 5-10 years of decline may be a bit far fetched. Could you imagine buying a home for 1997 numbers today… in other words, buying a home with a view in some of the best neighborhoods in Seattle for under 300,000?


  6. I agree with everything in this article.

    I believe that the incredible returns that the combination of increasing equity and leverage brought to the table enticed many people to jump into situations that they can not afford in a dropping market. The increased demand drove prices higher and provided more incentive to take a risky grab at the brass ring. This is the definition of a bubble.

    Depending on how much real-estate is over-leveraged, the bubble principle can work in reverse on the way down too.

  7. Jon,

    Unlike with Ben Stein, you and I agree that in the long run an owner-occupied home is a great way to spend one’s money. I’d even argue they can be a great place to invest. Where you and I disagree is in your analysis. The U.S. Census figures reflect the median value of homes ($119,600 in 2000) whereas the NAR numbers from 2006 reflect sale price ($224,900 in Q3 2006).

    Furthermore, prices aren’t down 17.3% from 2005; rather the number of units sold was down by this amount.

  8. Jon,

    Of course it might seem far fetched at first glance. However, in Tokyo Japan people were buying at what they believed was the bottom of the bubble (at what priced were before the crazy run to the top) only to watch housing fall twice as far as many expected.

    Look at the Nasdaq bubble we experienced recently. Once the bubble was popped, the psychological factors that drive every market usually push the run down farther than expected. Eventually, it will correct itself.

    I’m not saying that 5-10 years of declines and or flat-lined appreciation will happen on its own. Right now we have a very robust economy. However, if trouble is housing should spill over into the economy (which eventually I think it will take its toll on both our national and local economy) than I can easily see 5-10 years of pain in our future.

    Remember, housing prices usually tend to be sticky. People don’t want to admit that there house is worth less than what they thought it was 6 months ago. This will only exacerbate the run up in inventory we have been seeing lately.

  9. I have a feeling that should we see a decline in YOY prices in this area, people will still say the following:

    1. It still worth more than what I bought it for
    2. Don’t worry its only temporary
    3. Its only because undesirable houses are bringing the market down
    4. It’s because more condos are on the market
    5. We had bad weather all year!

  10. “…buying a home with a view in some of the best neighborhoods in Seattle for under 300,000?” -Jon

    If you explain to me what has materially changed about Queen Anne, Magnolia, Capital Hill or Seattle in general, that would warrant regular humans being able to afford a first-time home in 1997, but not in 2007, then I’ll try and answer your question.

    Feel free to discuss any and all factors that you can think of that would effect the price of a house. Compare population, family incomes, rents, the number of jobs. Whatever. Be specific, however, and state actually numbers. Then we can discuss the real reason.

  11. My philosophy is that we cannot predict whether interest rates will go up or down. As a result we cannot predict whether home prices will go up or down.
    If all you are doing is buying real estate hoping the price will go up, then you aren’t “investing”, you are merely “speculating” in future appreciation. You are an “appreciation-lord”.
    Real Estate should either be consumed (i.e. you live there) or when purchased for investment purposes one should look to the cash flowing from the property. Your CAP rate is now, tomorrow we will all be rich with future appreciation – yah right.
    I don’t believe there is a point in attempting to second-guess the market. At any point in time we don’t know whether prices will go up or down. Thus, lets concentrate on what we do know (1) what income will come off of this property and (2) using my effort and knowledge how can I “add value” to a property that other people are not aware of (such as rezoning the property, doing a remodel, etc.)

    That all being said, I am part of the Bubble Crowd who in the back of my mind thinks Real Estate is going to take a big bath – but I certaintly won’t be playing roulette with my prediction.

  12. Alan-

    I am 100% behind your comment. I think that the term ‘bubble’ is being over used and should be defined as those who are over leveraged. If that is the case, the bubble is here… but actually it has been here forever.

    I use the example of 10% gain over a year, but in reality, 10% is eaten up with sales costs, so after a year the gain is ~0%. If someone is over leveraged and has “no skin in the game” and are more than likely on an arm product that balloons, then there is a real problem.

    I was meeting with a local bank for one of our projects last year and the president told me about a number of million dollar homes that were being repo’d and were empty of furniture…Lowes plastic tables and seats. The reaon was because during the late 90s, early 2000s everyone was leveraging to the hilt and buying the arm products… when the arms expired the payments JUMPED and they could no longer afford the monthly payments.

    That is the bubble I see as being here today. Not a housing bubble, but a mortgage bubble.

  13. Matthew-

    I like #5

    If anyone says that to me I will laugh, but I will say housing starts have slowed (by 3 months at most) because of the winter weather.


  14. biliruben-

    I don’t have the exact numbers nor the time to find them, so I will answer your comment from a naive point of view.

    The changes in the past 10 years are supply and demand. There is a substantially larger amount of money out there and less supply (especially in the areas you talked about above). As Alfred Marshall talked about in Principles of Economics (I was an econ major), the greater the demand, the price must raise to equal the demand.

    As population, incomes and wealth increase, so has property values. Again, it all comes down to supply and demand, if the demand is out there, prices will continue to raise. If the population or incomes do a 180, then prices will follow.


  15. People got really spoiled by the rapidly escalating prices, and it seems like they’re almost in denial that things have leveled out. The fact of the matter still remains that the real estate market in the Pacific Northwest may slow or level out for a time (although we were “a little bit late to the party” not having the same run up as investors elsewhere due to the dot-com crash in 2000) but it only means we are going to have (are HAVING) a softer landing. SO while you may not get as big of a bang for your buck if you’re purchasing property with the intent of “flipping” it quickly…the US Census has repeatedly ranked Washington in the top ten states for domestic migration (the number of people who will move there from other states). So flippers, investors and homeowners alike shouldn’t be worrying themselves with this overly dramaticized BUBBLE talk. So we’re all not making money hand over fist. Big deal. I agree, the “mortgage bubble” is the only bubble there really is. But I suppose I have to quote my husband when he says “perception is reality”…the more buyers hear Matt Lauer beat the BUBBLE talk to death on the today show, the more their anxiety to buy will increase…
    I have an idea, everyone ZIP IT.

  16. Jon…I have a B.S. in Economics also and am quite aware of the Econ 101 principals of economics.

    We are currently facing something that (as well versed as you are in Econ 101)…is not the norm….so supplying the most basic “supply/demnand” chart isn’t going to cut it.

    You state how much more money there is now in society so that there are now more $$$’s chancing fewer goods (QA,Magnolia,etc houses in this instance)

    Lets take a look at “money now”

    It is an elusive term…but if you paid attention in class…you should have full comprehension of M1, M2 and M3

    I think that now is a good time for people to start asking questions about where this money comes from and how “economics” actually work. How much has the Consumer Debt level increased from 2000 to 2007? Has there been a corresponding increase in M1 and M2?

    Did you know that they are no longer publishing M3?

    Does it make you wonder why?

    Sure…an optimistic attitude is a good one when it comes to sales…just look at ‘Glengary Glennross’…but this isn’t about sales anymore…it’s about Economics.

  17. From bunner:

    “I have an idea, everyone ZIP IT.”

    She’s right – be vewy, vewy quiet, and maybe we won’t notice all the people in Seattle forced to sell their houses and condos because their interest-only ARMs are resetting this year.

    BTW, how’s Seattle Eric doing? – he doesn’t seem to be on your blogroll anymore.

  18. EconE-

    I LOVE your comment. M1, M2, M3 are no longer. I am not saying that is right, but the reality is we now need M4, which would be M3 plus the Stock Market effect.

    This is a conversation that I think about all of the time (honestly). It blows my mind where some of this money is coming from. Google buying YouTube is a great instance. To purchase a company you just dilute earnings a bit and but when you have a company with a market cap of over 140 billion, what is a couple billion?

    Google is the one that many see, but what about B of A buying MBNA. That was an ~87 billion purchase and the stock may have moved a fraction.

    So to answer your question, ???????, I think we need to add M4, because I have NO IDEA where! If we are in somewhat of a closed system and $1 from me would go to someone else, the balance sheet probably won’t balance.

  19. Jon –

    From a certain perspective, you are correct. Not about population and income (though wealth is unclear), because both have shown very negligible increases over the last 10 years. In fact incomes have actually declined since 2000, when taking into account inflation.

    You are however correct if you consider the availability and credit, and the demand that it spurred. In my opinion, without income and wealth to back that high-leverage credit, that demand is not sustainable.

  20. Biliruben-

    I believe with the availabilty of credit and what are now the new used car salespeople… SOME mortgage reps… credit is going out to what seems like anyone. Here is a great example.

    My uncle purchased a condo in SoCal around 2000 for about 200k. He sold it in 3 years later for 385k. Which wasn’t crazing considering the appreciation of the CA market… but what was crazy was the buyer and the mortgage rep.

    Long story short, she was a house cleaner buying with a no income qual loan, 103% financing, negative am and a quick close. The worst part was the morgage rep did not have a clue in the world how to close a deal. They basically read the terms off and signed her up. The craziest thing was the loan went through and closed on time (thanks to a great listing agent).

    The point of the story, as long as there are those mortgage programs that will basically “lend to anyone the law allows” there will be this increase. So the real conversation should not be seen as a housing bubble, but rather a lending bubble.

    As soon as the lending power dries up, the market will quickly react.


  21. Agreed.

    We are seeing the first stage of that, as the subprime lenders go belly up at a remarkable rate, and the lending standards subsequently tighten.

    I don’t know how fast these things are going to unwind, but I it’s getting harder to deny that they will unwind.

  22. Jon…you misread my comment.

    and then you added the irrelevant M4 .

    My comment was not that “M1, M2 and M3” are no longer.

    My comment was that M3 is no longer published (meaning data accessible to the public). Not M1 or M2.

    You say that you think about this all the time.

    Do you *really?

    I would have been under the assumption that you would have known the relevance of what I mentioned and would have had something more relevant to contribute to the “conversation” than talking about Google’s overpayment for Youtube.

    but since we’re on the subject of Youtube…let’s end this friday on a happy note with one of the best Youtube artists videos ever…enjoy.

  23. EconE-

    Easy, this is a blog post, not a personal attack! If you would like to hear my personal views in more detail than a blog comment (not even a post), please shoot me an email and we can talk.

    Maybe I am reading your comment wrong again, so forgive me if I am, but you talked about me knowing the relevance of what you mentioned… more relevant… If you were an econ major too (sorry a BS in econ) you should see that comment was addressing the fact that the 1.67 billion purchase price has to come from somewhere, in fact the stock has only apprectiated since that purchase, not adjusted for a 1.67 billion dollar purchase. It seems that something is created out of nothing… in other words, where are these dollars coming from?

    You may want to reread what I wrote though, I said Google was an example… not the law. I was on your side there, not against you.

     On another note, great video.  If you REALLY want to end your Friday right…


  24. Granted the last Econ class I took was in high school (Chem and math in college) I can’t begin to add data and theory to the above discussions, however I can add relevance. Relevance coming from 35 years of watching the real estate market and interest rates rise and fall. I was selling in 1980 at 22% interest when we had 14% inflation and I think it was a 150 trillion deficit. As inflation came down, interest came down and the general rule of thumb was 2-3 points between inflation and interest. Therefore, although it was tough when the Feds raised the interest rate, it cooled down inflation and after 25 years, we’ve never had to live with that mess again. I have been concerned with the recent deficit, but it seems to be curing itself with the growing economy.
    So, I do think you can predict the interest rate, it’s inflation that’s hard to predict but it seems to be under control for a long time. IF we ever see a return of high inflation and therefore high interest rates, then we will very likely have a bubble burst. Without that, I don’t see it. Don’t forget that new construction prices lead the market values and new construction is a factor of increasing wages, materials and the ever increasing government regulations making housing more and more unaffordable. If all those things go away, and houses don’t cost more and more to build and land becomes more easily developed, then maybe we’ll build more affordable housing. Without that or without inflations or if Microsoft and Boeing go bust, I don’t see any bubble bursting around here.

  25. I pretty much disagree with everything you just stated Eileen, but I’ll just correct the most obvious error:

    In 1980 the total national debt was just less than 1 trillion, but grew to 4 trillion by the time Clinton got in office. The deficit might have been around 150 billion, I suppose. We ship almost that much in unmarked bills to Halliburton’s representatives in Baghdad now, and the lawmakers laugh it off. As a percentage of the GDP, however 150 billion in 1980 was huge.

    I won’t even get into the fact that The Fed changes interest rates in order to curb inflation, or discuss the merits of that policy. Nor will I discuss your odd views on the causes of unaffordibility of houses.

    I’ll simply note that it’s a bit more clear to me how it could be easy for some in the industry to miss what I consider very clear economic indicators that speculation was the primary driver in the run-up in housing prices.

  26. Heh…nice video…lol…however the artist is hardly the creative genius that Lasse Gjertsen is….but that’s not important.

    Eileen…the prime rate in 1980 was 13% and was increased to 13.5% in the Fall of 1980. Morgage rates did not reach 22%.

    When you refer to “deficit”…if you are referring to “deficit spending” as it is known…or the Federal Deficit…in 1980 it was just under $79 Billion.

    Federal Debt…which is the accumulated total of our deficit spending had not yet reached the trillion dollar mark although it was just a couple billion short.

    Currently…the Federal Debt is a little under 9 Trillion….if you would like to keep up to date with it you can always check this site…

    So…not sure where you got that $150 trillion number or the 22% interest rate.

    My intentions are not to attack anyone here but rather to provide a larger picture and address certain factors that go unnoticed for the most part by the general public. Major things are happening in our world that people pay no attention to…no…I’m not talking about Anna Nicole Smiths Passing or inter/intra-country conflicts…more of stuff that falls into the boring Econ category.

    For example…Chinas Stockmarket very recently had a 5% drop…it turns out that people were buying stock with borrowed money. 2 days ago…the Government stepped in and it is now forbidden to loan money for stock purchases. I for one will be following that situation…most people won’t even think twice about it…but…being that they are a HUUUUUGE economy…it really isn’t something that should go unnoticed.

    I also like to watch the action of the Central Banks…much of their activity is shrouded in secrecy…but it is interesting to see where the big $$$’s are moving.

    Enjoy your weekends…looks like it’s gonna be pretty nasty down here in L.A….highs in the 60’s….Brrrrr….LOL.

  27. Oh…and Jon…I’m with you…I would LOOOOOOVE for there to be an M4 designation…those would be some juicy numbers to follow.

    but I’m still left scratching my chin over why M3 is no longer published.

  28. EconE-

    I am glad badgerbadger was able to bring us back together 🙂 Next time I am in LA we will have to get in touch and talk M4 numbers 🙂 (couldn’t help the double emoticon).

    All in all, as republican as I am biliruben has a point… lets pop the Halliburton bubble!

  29. Why did the stock prices for BoA and Google not change when they shelled out bilions for purchases? I think the reason is fairly straight forward why the underlying stock didn’t change after the outlay of 1.67B. The market is clearly pronouncing that they think 1.67B was an accurate present value that represents the future cash flows of the purchased company. In fact, the market thinks the future cash flows (or the purchasing companies use of the assets) is worth MORE than 1.67M… hence the rise in stock value.
    Did I misunderstand the question, Jon?

  30. Wanderer-

    No you read the statement correct. I understand they (whichever company) sees future revenue worth the purchase price, that is not the statement. The comment was that they paid that price and the company did not change in value a bit.

    They are purchasing the company on what they feel it will bring in the future. Like any company, it costs money to make money. So if it costs 1.67 to buy future cash flows, that should deplete the value of the company by some amount… not increase the value.

    That would be like me buying a home that is worth 600k today and paying 1 million (assuming a 5 year future value)… Then the bank paying the full purchase price but only asking me to finance the current 600k. Makes sense it will be there at some future date, but not today.



  31. Jon,
    I’m not sure how to explain this in a blog post. Either we just aren’t talking about the same thing, or we have different understandings of present value of future cash flows.
    The 1.67B does not represent a summation of asset values as in your house example. If you were to go pay cash to acquire a company, the best way to (arguably) place a value on it is to sum up all of the present values of the anticipated free cash flows. Note that this does NOT involve summing up the asset values today and adding cash flows to that. Of course the future cash flows may include a liquidation value of assets sometime in the future, but I digress. In the end, the market is absolutely saying that 1.67B is essentially equivalent to all of the future cash flows that the purchased company represents.
    An interesting corollary to this concept is relating the purchase price of a home to the present value of the anticipated cash flows if it was rented out. That is no trivial matter considering you have to determine an appropriate discount rate, tax effects, mortgage rates versus inflation, etc. etc. In theory, those two methods should yield the exact same valuation… perhaps with some premium for ownership over rental. I assure you (admittedly weak without numbers) that until recent years, those two methods of valuation have moved in lock step. Every increase in home prices SHOULD be a sign from the market that rental prices are going to do the same thing for the area to justify. This relationship has been disconnected. One of the 2 variables has give if you believe in the world of finance… and I do.

  32. Wanderer-

    First off you are making my example no fun by punching holes in it… It is much easier if you just accept it 🙂

    Joking… I understand YouTube’s purchase price does not represent a summation of assets, much like the value of a home (see a detailed blog I wrote of Google/YouTube deal here

    Unlike buying a company at a multiple of earnings (or with YouTube lack of earnings, so either market share and name recognition or earnings potential) when you purchase a home you are buying for the current value. But much like a company, a house appreciates (as a company increases revenue and grows). So in my looooooooose comparison of the two, appreciation can been seen as earnings growth… but in homes you do not pay a multiple.

    Comparing the purchase price of a home to the present value of the anticipated cash flows if it was rented out is great, but does not bring in to account market factors most notably geography. Either way, I believe we are on the same page… I am just not as eloquent as you and am not using the best words… then again I was an econ major not English.

  33. Well, this is a hot topic, it is good and this is the type of talk that is needed. Like quantum physics economics always has an opposing theory.

    I am interested in post #27 about China. I agree with Jon in the fact that the mortgage industry has a lot to do with the current market situation, but more on that in quantum minute.

    China’s government has as of Thursday U.S. time ruled on foreign investors purchasing housing and has placed limits on amounts of property owned and has set guide lines as to what it takes to qualify for purchase. One house and one must work or go to school in China and this will dampen speculation. What is a problem for the Chinese is that they are trying to launch a bunch of banks, and have bought a lot of paper based on Fannie Mae and other secondary market mortgage backed goodies. They will be watching us just as close as we will them.

    While I am not an econ student, I do wonder what happens when you produce more paper money then you have in gold reserves… is it inflation? I think Germany did that once. Ok so we don’t use gold anymore… I think that is what the mortgage industry did only with home equity, but they also could not help themselves in future prospects. I say that based on a Ditec commercial that I saw today, first time that I have seen it air. Two years ago the mortgage industry said “Hay lets sell a loan that will require a refi in two years and make another round in commissions

  34. Well spoken Shane.

    Interesting that you mention gold. China handled gold in a different manner than the rest of the world for a very very very long time.

    In fact…until 3 years ago…it was illegal to own gold in China. All the mines had to sell the gold to the government at 90% of the world price. Rather than investing in gold…the Chinese public chose to put their money into the stock market and real estate and also heavily leveraged themselves to do so. The Chinese government also declared that they want to be a net purchaser of world gold and are currently working on setting up a “gold exchange” where a person can invest in as little as 50 grams of gold.

    If you follow the historic price of gold…adjusted for inflation…the current price is waaaaaay low. If the price of gold rises…the net worth of the worlds central banks “hoard” rises in value. I wouldn’t be surprised if in 2008 people are looking back saying…do you remember when gold was only $1000 an oz?

    But…who really knows?…smoke and mirrors…all of it.


    “China’s government has as of Thursday U.S. time ruled on foreign investors purchasing housing and has placed limits on amounts of property owned and has set guide lines as to what it takes to qualify for purchase. One house and one must work or go to school in China and this will dampen speculation. What is a problem for the Chinese is that they are trying to launch a bunch of banks, and have bought a lot of paper based on Fannie Mae and other secondary market mortgage backed goodies. They will be watching us just as close as we will them.”

    Now the implication here is…what if the Chinese Government feels that our housing market is not stable. Could there be a possibility that they may all of the sudden force…by law…their own population…one that has been a great source of demand for our real estate…to liquidate their U.S. residential real estate holdings and invest the money within China in order to help their own economy? Who knows…but they seem to be acting very quickly on many fronts.

    Why was China invited to the G7 finance ministers meeting this weekend? Anyone know the fullllll skinny on that?

  36. Shane & EconE

    Thanks for your detailed comments. It will be very interesting to see what happens. If China DID make a law to pull out of the US, besides the tension that would cause to the US Government, it (in my opinion) would cause a major slowdown/correction if you will… much like Greenspan saying “irrational exuberance”

  37. Hi Jon,

    In general, I agree with most of your comments, but I do not agree with your quantitative methods. Return on Investment (ROI), yield, discount rate or interest should be calculated using the Time Value of Money and discounted cash flow techniques for any periods beyond one year. An increase in the asset value of 88% from $119,600 to $224,900 is not a ROI of 88%. The correct calculation can be performed two ways.

    2000 median value $119,600. 2006 national average $224,900.

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