Saturday, July 04, 2009

Why the Buying Frenzy?

After years of being bugged by my allergist to move some place with a hardwood floor, and outgrowing our small apartment, I've finally bought a house. (The close is next Friday) When I was shopping around, however, I noticed that there seemed to be a buying frenzy for houses under $700k in the Bay Area.

A year or two ago, David Ziegler wrote a wonderful post about housing as an investment. In it, he noted that the historic price/rent ratio is about 21. A $700k house would have to rent out for $33,333 a year, or $2777 a month to be at this ratio. Not surprisingly enough, that does appear to be the average going rate for a 3 bed/2 bath home in the area at the moment. In other words, for a change, housing in the Silicon Valley area does not appear to be vastly over-valued by historical standards, which partially explains the current feeding frenzy, which I think is pretty inane --- one colleague told me that she had bought a house with cash, but only so she could rent it out --- I think any rationalization of that approach to housing as investment went out the window (to be fair, she was under undue pressure from her parents, which is hard to resist at any age).

Personally, I think that house prices have room to drop --- historically, markets don't just correct to a historical level, they over-correct, which means they drop even further than the historical average (which was just an average). While historically, more than half the de-valuation of the housing market comes from inflation rather than nominal price declines, the state of the economy is such that inflation is unlikely in the near future, so all the decline has to reflected in the price. Since house prices are sticky on the down side, this explains the proliferation of houses sitting on the market longer, followed by "price reduced" signs.

Furthermore, rents will also drop in a recessionary environment, which will tend to bring the price/rent ratio back up. I'll refer interested readers to the very competent blog entry by Calculated Risk.

Given that I believe all this, why am I buying? As David Ziegler points out, I don't view the home as an investment --- it's entirely a consumption expense. I'm moving to a bigger home in a neighborhood that's acceptable, in the hopes that the value of the home to me outweighs the price I pay over the long term. Given this, I bought as little house as I could (studies show that you get used to a nice house, but if your commute is hellish, you'll never get used to that!), and used very little leverage. And if you were to ask me, that's what I would advise you to do as well.
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