Speculative selling in the LA housing market

I’m getting out before the crash.

Assuming that the deal doesn’t come unstuck between now and the June 15 closing date, I’ve just sold my house. My current place is pleasant to live in and very convenient to my job (about a 12-minute commute, with no freeway driving), and I’m not planning to change jobs or marital status.

I’m selling for purely speculative reasons; I’m going short the Los Angeles housing market. That is, I’m planning to rent, and perhaps to buy back in when housing prices bear a more reasonable relationship to incomes.

If I bought the place today at what I just sold it for, and financed it 100% at the 5.75% a fixed-rate mortgage now costs, my pre-tax interest payments would be about two-thirds of my pre-tax UCLA salary. That seems excessive.

Los Angeles housing isn’t a bubble in the sense that Washington, DC housing is reported to be: in L.A., unlike DC, you can’t get appreciably cheaper housing of equivalent quality by renting. Still, the current sales prices in relation to incomes make sense only if people buying now are reckoning on price appreciation, as I did eight years ago.

I turned out to be right, back then. The Los Angeles housing market has treated me well. Subtracting out the money I put into renovations (which probably wasn’t a good move in purely financial terms), the net sales price is roughly 90% more than I paid for the place eight years ago.

But I was buying just after the trough of a slump that had taken prices down about 30%, and in an environment where long-term interest rates seemed likely to fall. It didn’t take much nerve to make a big bet on Westside housing.

Hanging on today would be a different matter. The leverage that worked for me on the way up (I put down only 15%, borrowing the rest from my employer) will work equally powerfully on the way down. And down is the only direction I can see, unless fixed mortgage rates miraculously remain at under 6% as short-term interest rates keep rising, or short rates inexplicably flatten out.

And that’s putting aside the risk that foreign central banks will finally get nervous about their exposure to the dollar and sell Treasuries in such volume as to force the Fed to really stamp on the brakes.

If prices start to drop as interest rates rise, there are lots of people who will (1) have trouble making the payments on their variable-rate mortgages and (2) find themselves “under water,” with negative equity in their houses. Sounds to me like a recipe for panic.

It’s hard to imagine housing prices doing what the NASDAQ did — after all, the LA economy is strong, lots of people want to live on the Westside, and they’re not making any more land here — but 30% doesn’t seem to me a safe upper limit to set on the size of a possible drop. (After all, if the rates on ARM’s go from 4.5% to 6% — not at all a far-fetched number — it would take about that much of a drop in prices just to keep payments even.)

That makes me want to go short L.A. housing, or at least hedge my currently excessive long position. If the financial futures markets were better developed, I could hedge against the risk of a price drop (or long plateau) without physically moving. But the HedgeStreet market is still quite thin, and the financial products promised by the partnership between Robert Shiller’s MACRO Securities Research and the Chicago Mercantile Exchange appear to remain, for now, nothing but promises.

So I’m heading for the sidelines, putting my money where Brad DeLong’s mouth is. If the current fiscal and trade deficits are unsustainable, especially with national economic policy run by the cast of a clown show, then they won’t sustain themselves forever. In housing, as in equities, bulls can make money and bears can make money, but hogs get slaughtered.

Footnote The housecooling party is tomorrow, Sunday, from 2-8 p.m. If you’re within striking distance, please drop by: 15131 Mulholland Drive, just west of the corner of Mulholland and Woodcliff.

Update Peter Cohan points me to a more analytic take on the “bubble” issue by investment adviser Darren Pollock. Pollack points out that:

— Almost a quarter of housing sales are now to investors rather than owner-occupants.

— The CEO of one of the big housing producers dumped a quarter of a billion dollars’ worth of his company’s stock while going on TV to tout it.

— U.S. housing is now a haven for flight capital.

— The foreclosure rate is already rising, and hitting new highs.

Note that the real estate section of a newspaper, like the financial section, is mostly supported by advertisers whose businesses are part of the sector being reported on. That’s likely to create a substantially bullish bias in both cases.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

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