July 25, 2006

"Always" and "Inexorable"?, Chapter 2

(c) copyright View from Silicon Valley, 2006. All rights reserved.

Sometimes it's useful to stop and examine the arguments of people who disagree.

-----Original Message-----

From: VF Silicon Valley

Sent: Saturday, June 24, 2006 7:03 PM

To: XXXX

Subject: FW: A median-priced house in Silicon Valley -2006 edition vs. Rent increases

Hello:

I was kind of expecting you might have a counter-argument here? Show us what we're missing? Maybe turn it into an on-line debate on the web site?

Regards,

View from Silicon Valley

-----Original Message-----

Sent: Wednesday, June 28, 2006 5:57 PM

To: VF Silicon Valley

Subject: Re: A median-priced house in Silicon Valley -2006 edition vs. Rent increases

Since you didn't answer my original question about your rent history, I assumed you might not be seriously interested in positions other than your own. But I'll take a shot.

Regarding your doubt that an upward trend in rent is inevitable, can you provide any data or references to any market where rents are less today than 10 years ago? Of course there will be periods of decreases, but these are always short-term. And specifically, what is your rental rate history?

In addition to my personal experiences that local Silicon Valley rents have begun to rise, here is a site that tracks rents nationwide. Their 1Q06 summary

shows rents increasing in many markets after a long period of stagnation:

Regarding your comment about rent increases causing vacancies, it has been my experience that landlords will make larger rent increases (5-10%) during normal

tenant turnover (renters stay an average of 18 months), and smaller increases (2-3%) annually for existing tenants. In the case of my apartment-hunting

friend, she has gone for nearly 3 years without an increase. I'm sure the landlord is counting on the fact that such a long-established tenant would

tolerate a large increase. And they were right, she has decided to stay and pay the increase rather than move.

Regarding negative cash flow, I contend that overall rate of return is a better measure of investment quality. Negative cash flows can always avoided simply by paying all cash for a property. But that doesn't mean it is a good investment. Rental property in SV is currently a poor investment because of the high ratio of purchase price to rental income. In contrast, I am currently shopping for investment property in Charlotte, NC, where purchase price is typically 75% less than SV, but rents are only 50% less.

Regarding attempting to "time" the housing market (i.e. buy low, sell high), I contend that being in the market is more important than timing. I remember

reading about a study of stock market returns over the past 30 years that showed 90% of the gains occurred in just 10 of the 360 months of the studied period. If you had been out of the market during these 10 months, you would have missed out on 90% of the gains for that 30-year period. I'm sorry I don't have the specific reference, I'll try to dig it up.

"At the risk of wandering off the topic, it is interesting to observe a median buyer at the peak in late-1989 did not get back to even until ~mid-1999."

I found a very interesting report which provides data for 66 price correction events in the past 20 years. This data shows the mean duration of a correction is 14 quarters, and the maximum duration was 29 quarters. The report also noted that the most overvalued markets produced larger corrections, but were also of shorter durations.

(see Appendix C: Past Price Corrections)

Given this data, I believe a 10-year holding period is sufficient to ride out any future market correction.

I have also been looking for data about past corrections that examine the different segments of a single market. My gut feel is that in any correction,

the top half of a market experiences a greater correction than the bottom half. Therefore, owners of homes below the median will experience a smaller decrease. But I don't have any data to support this theory.

Considering the seemingly stratospheric housing prices, can they go still higher? There are factors exerting both upward and downward pressure. Some of

the upward pressures include:

- Short of filling in the Bay, there is just no more land to build in the Bay Area.

- SV residents received a disproportionate share of the wealth from the Internet boom. The effect of this wealth injection is still being played out.

- More single people own their own homes, doubling the buying power of new couples who purchase a home together.

- SV residents who have owned homes for 5-10 years have enough equity to move up without incurring the outrageous mortgage payments that a new buyer would

face with only 3-5% down payment.

- Immigrants arriving with significant wealth.

- Immigrants living in extended family households that provide daycare for children, multiple income streams, etc. This is a factor in the construction of larger new homes.

- Immigrants are less likely to suffer from American Consumerism, and are more likely to save and be willing to devote more of their income to long-term

purchases such as real estate.

- Real estate continues to be a popular alternative to those who distrust the financial markets.

Some of the downward pressures include:

- Obviously, rising interest rates. Also, there could be a backlash against predatory lending if politicians can "make hay" of it for the 2008 elections. All that is needed is a few high profile cases where homeowners suffered foreclosure of a home with significant appreciation that was sucked away by the lender through negative amortization. If such a tactic succeeds, lenders could overreact and radically tighten lending requirements.

- Large numbers of SV residents cashing out and moving to other areas, such as Sacramento, Oregon, and Las Vegas.

- The demise of manufacturing in SV and advances in telecommunications have made the remaining jobs essentially portable, and vulnerable to being siphoned

off to less expensive areas, the Stockton-Sacramento corridor being the largest beneficiary.

- Despite Governor Arnold's efforts, California's business appeal continues to wane. A recent article in Inc. magazine chronicled the move of Buck Knives

What will the SV market do this year or next? I have no idea, and I don't care. I am certain only that prices 10 years from now will be equal to or higher than now.

In my opinion, setting yourself up so that you can ride through a downturn while reaping the benefits in the meantime is a better strategy than waiting around to try to "catch" a possible downturn.

Because I already own my primary residence, I have the luxury of looking for investment opportunities in areas I consider to have better values. But in my

opinion, the benefits of home ownership outweigh the disadvantages enough that the best time to buy your primary residence is always NOW. A major portion of

the economy, financial markets, and tax structure are biased in favor of homeowners, so why miss out?

Regards,

XXXX

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Opinions expressed are not necessarily those of View from Silicon Valley. The opinions are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.