Trying to price a home in a massive bubble is similar to cleaning the windows on an airplane that ran out of gas, in midair. There is a sense of desperation to do something but the hard brutal reality is that there will be a significant crash. Every bubble in history from tulip crazes, the South Sea Bubble, 1920s Florida Real Estate, and the recent tech bubble all ended in the same way. Why will this one end any differently? Human psychology for our own protection won’t allow many to fully understand the magnitude of the impending challenges since it will be a futile effort. Our own psychology seems to grapple with the future; if anything, we gravitate to story telling with a clear beginning, middle, and end. Yet that would assume we know exactly how this story will unfold and we have many case studies in the records of history that show us a glimpse of our future. Yet do we have the strength to stare into the crystal ball and accept our fate? Probably not and all these futile efforts by central banks are simply avoiding the inevitable by spreading the risk around and infecting areas that had little to do with this bubble; the desperados in Wall Street realize that the day of reckoning is coming and they are trying to unload as much as they can before the clock strikes 12. There will be no J.P. Morgan stepping in to save the day.

In today’s article, we will examine popular housing price measures to demonstrate how inaccurate they are in coming to a consensus on current housing prices. You will see how pro-housing measures inflated prices during the good times while being hammered now that the market is correcting. Like eyewitnesses to a crime, everyone looks at the incident through a different lens of experience. In this case, we had many people that stood to benefit in pumping higher prices and their judgment was clouded by the glory of high commissions and infinite earnings. Now that we are fully in a correction phase, we still have people thinking this is a minor setback on the road to real estate glory.

Contrasting C.A.R. Numbers with DataQuick

The California Association of Realtors represents 185,000+ Realtors in the state of California. They report on a monthly basis California sale trends and prices. Their numbers are derived from 90 Realtor Associations according to their press releases. Let us take a look at year-over-year numbers for three counties:

Location	Nov 2007	Nov 2006	Year Change
Los Angeles	$520,960	$590,790	-11.8%
Orange County	$661,580	$699,200	-5.4%
San Diego	$535,780	$578,120	-7.3%

What may jump out at you is the year over year price decline but take a look at the prices for November of 2006. Almost $700,000 for Orange County? Approximately $600,000 for Los Angeles County? You would need $200,000 a year to adequately afford these homes on conventional mortgages. And we know how many people followed tried and tested standards in the recent epic housing bubble. Let us take a look at another source of housing data for California, DataQuick for the same time periods:

Location	Nov 2007	Nov 2006	Year Change
Los Angeles	$499,000	$517,000	-3.5%
Orange County	$582,750	$623,000	-6.5%
San Diego	$440,000	$487,000	-9.7%

So are we down 11 percent or 3 percent in Los Angeles County? Is San Diego County’s median price $535,780 or is it $440,000? How many Twinkies fit in a mini Cooper? Do trees have spirits? Without a standardized method of discerning price, we might as well ask any question that hits our fancy. And you wonder why we are in a massive bubble here in California? When is the mainstream media finally going to admit that homes have to reflect local area incomes? It is so incredibly obvious and just as they missed it in the beginning of the bubble they are missing it once again during the “crisis” period. They can play a role by managing expectations of the public but during the bubble phase they pumped the mania and now, they are adding fuel to the panic flame. This type of reporting and standardization is the precise reason we are in this bubble. No hurdles. No enforcement. Never crosschecking the facts. Remember the bidding wars where people actually offered X amount above the asking price out of fear of losing a home? What is happening in the industry is many of these organizations have their own methods of tracking home prices and as you can see the numbers for the same month are off by $100,000 in certain cases!

Case-Shiller Index and OFHEO HPI

Most of the above look at recent home sales, which is very misleading during the peak part of the bubble since homes that don’t sell are never factored into the equation and normally the meat of story isn’t reported. In this case, many sellers were holding out for peak prices that appeared in the years of housing bubble legend. During this time all you heard is the record breaking year over year median price gains while inventory continued to build up and sales dropped off a cliff. In fact, in 2006 sales were a leading indicator of what we faced in 2007 but again the mainstream media kept running with year over year gains and allowing more people to jump into the saturated market with the false belief that things were good. It is important to question where information comes from. It is a good thing that they are now giving the appropriate coverage to the current housing market. Yet I am shocked at the lack of basic income analysis when all we hear is Wall Street brouhaha and how we are going to have a bailout. Listen, when the average income of an area is $60,000 a median home price of $600,000 is absolutely crazy. That should be the headline story.

But let us move on to a more accurate measure of market trends, the Case-Shiller Index. This index looks at same home sales over time and uses the year 2000 as a base point. The importance of this index is that it has a reference point to measure recent price gains. After all, $600,000 homes aren’t expensive if the local area income is $300,000 just as $50,000 homes are extremely overpriced if the local area income is $7,000. So let us use Los Angeles and San Diego as references again but with the Case-Shiller Index numbers:

Los Angeles: -8.8% (2000 base 100; 2007 stands at 249.50)

Orange County: -11.1% (2000 base 100; 2007 stands at 217.02)

As a reference, let us look at a not so bubblicious city Charlotte, North Carolina:

Charlotte: +4.3% (2000 base 100; 2007 stands at 133.98)

You also need to remember that Los Angeles and San Diego were much higher priced than areas such as Charlotte when the base year was set in 2000. Simple rules of compounding would suggest a higher initial sum will grow much quicker especially when we had absurd appreciation rates. And by the way, Los Angeles takes the trophy for most overpriced metro area in the Case-Shiller Index latest report.

The next measure is put out on a quarterly basis by the Office of Federal Housing Enterprise Oversight (OFHEO) and they call their measure the House Price Index (HPI). Let us take a look at their numbers for the three above regions:

Metro Area	1 year price change	5 year price change
Los Angeles-Long Beach-Glendale:	-.07	107.86
San Diego-Carlsbad-San Marcos	-5.07	61.75
Santa Ana-Anaheim-Irvine	-3.49	86.09

There is a slight problem with these numbers for California. The index only measures loans securitized by Fannie Mae or Freddie Mac. The conforming mortgage loan limit as you are all aware for single-family homes in 2006/2007 is $417,000. What does this mean? Well looking at the other measures of California prices and the Real Homes of Genius throughout the state, this excludes pretty much every home sold in the last few years, especially those financed with exotic mortgages in large metro bubble areas. In other words, an incredibly large amount of data doesn’t show up in the HPI.

So Much Information, So Little Time

This may be overwhelming for many looking to purchase a home in the future. So many things need to be taken into context before purchasing a house. As common sense and your gut told you we were in a bubble buying a home shouldn’t be a complicated exercise in financial engineering. As long as you know what to look for in the data and where the numbers are coming from, you will be fine. The dangerous part is when you rely completely on one source, such as rating agencies, for all the answers about a product or home. As you know, we have been in a bubble here in California since 2000 and the data is pointing toward California heading into a recession in 2008. This only suggests that we are a very long way from bottoming out in California. Calculated Risk has a great graph and article lining up the current prices in Los Angeles to the pervious bubble. I still get e-mails from people looking to buy. You are a renegade. You want to buy even in the face of Rome burning. You take the contrarian philosophy of buy whenever everyone is selling to another dimension. What are three things you should do before buying?

Play house. I’ve given this recommendation to many and it seems to work. If you are planning on buying a home in a year, calculate the principle, interest, taxes, and insurance for your potential home and save the difference from your current rent into a savings account. If you find this manageable after one year, you can afford the purchase. And use a 30 year fixed mortgage damn it! Saving the difference serves two purposes. First it forces you to financially deal with the new purchase. Next, you will have additional funds toward a down payment when you do decide to buy.

Market Analysis. How are schools in the area? What are local area incomes? Is the neighborhood safe? What do local lease rates go for? This information can be found for free or a very tiny amount of money and will save you incredible headaches down the road. Given the current market, you may need to stay put for a few years so it will help if you buy a home you are comfortable with.

1/3^rd Rule. Yes, I’m taking it to the old school. You shouldn’t spend more than 1/3^rd of your gross monthly income on housing. If you make $100,000 a year, you shouldn’t spend more than $2,777 on your PITI. Clearly very few people follow this rule in California. Heck, we had some people spending 70 to 80 percent of their income on housing. Now that rates are resetting there is no wiggle room whatsoever and the only option is foreclosure. This isn’t glamorous during the boom times but rest assured in a down economy this is an absolute must.

And a final thing, recent sales comps mean very little in a falling market. As you can see in our quest to determine housing prices via multiple measures, each one has a different number on the current market. Yet the trend is undeniable and prices are declining. If you are going to buy a home in the current market, offer less than the current price. The price you offer should derive from your numbers 1 through 3 above. These measures are timeless and work in declining and booming markets. A flipper or speculator will find these suggestions absurd but if you simply want a place to live, this is a quest for you to live by.

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