Thursday, January 24, 2008

California Housing Crash

"Our friends said we were crazy. ... We got nearly three times what we had paid for the place nine years earlier. It seemed to us like a staggering profit--and a sign that the market had been pumped up beyond reason. ... For a while, we wondered whether we would prove to be the crazy ones as home values in Southen California overall continued rising through last spring. But a closer inspection of real estate sales data shows that signs of trouble were already appearing when we sold. ... The music's volume went up as real estate agents said that if we stuck to our plan to sell and then rent, we could be priced out of the hot Southern California market for good. ... Now that the bubble has burst, my friends think I am a master of market timing. Those who haven't had their financial legs taken out from under them by the real estate crash are asking when they should buy investment properties to ride the next big wave of rapid appreciation. ... The idea of an ever-rising real estate market was a favorite topic in much of the news media. ... About the time I was getting out of the market, Mark Kiesel was thinking about unloading his Newport Beach home. An executive vice president of the Pimco investment firm, Kiesel's day job involved studying the housing market. ... 'Basically, prices were inflated by incredibly cheap financing,' Kiesel said. ... He and his wife, a lawyer, invested their proceeds in energy, metals and mining stocks. ... They are still renting the apartment. ... As a general rule, financial planners don't advise people to sell their house at a profit and invest in stocks or mutual funds", Peter Yang (PY) at, 20 January 2008.

Bravo PY. I bought a Hollywood Hills condo in April 1998 which I sold in December 2006 for 391% of my purchase price. Since then condos in my old building have fallen 8%. Now a war story.

In 1996 I approached some of my tax clients to syndicate some Los Angeles (LA) area apartment buildings. Why did I think they were cheap? They were available at 12-14% cap rates. In 1996 financing them was difficult as every bank I approached demanded 30% down. So? If you buy a property with 30% down and pay 8% for the mortgage, with a 12% cap rate you make 21.3% on your money. How? .7 x .08 = .056; .12 - .056 = .064, .064 / .30 = .213. It looked good to me. This calculation excludes potential property appreciation. None of my clients would do it. They were scared. In 2002 some of them asked me, "What's good? Surely you know. What should I do now?" I told them, "I haven't a clue. Good opportunities usually look bad, but if I saw something really attractive, I would say so". Since 1996, LA area real estate cap rates have fallen and rents increased, such that the properties are triple their 1996 prices! Had we bought the properties in question, we would have realized a 33.4% internal rate of return for nine years, assuming we sold the properties at the end of 2005 for triple the initial purchase price. Not too shabby. But we didn't.


dontbelievethegeneralconsensus said...

Re your oil remark, I'm not sure what I am supposed to look at. That oil is cheap? Don't get me wrong because of my directness. I disagree with you but I like your blog. I like that you take a contrary perspective, question authority and realize what the dirty dozen on Wall Street has been doing.

Do you know a primary reason the dollar is declining? Because the dirty pigs you write about have shorted with massive leverage in the long commodities trade. That trade created a massive pool of dollar liquidity that shows up in the money supply. And, because the speculation is at never seen levels, so too are the monetary measures. The Fed has kept money tight for years. It is the banks creating ever increasing liquidity by higher and higher levels of leverage in the forex market as their commodity trades unfold. Shorting dollars with billions of dollars of leverage artificially created billions or trillions in new dollars and put undue stress on dollar supply/demand. No one knows the scope because of the forex market reporting structure. This isn't the Fed's fault. That's absurd. What happens to the dirty dollar when they need to rebuy those short positions when their commodity trades go bad? And, they will for reasons to lengthy to type on here. They then need to buy back levered dollars in massive amounts. Dollars they probably don't have. There are other dynamics involved but dirty dollar no more. Now, we see dirty Wall Street. Commodities are expensive. They will get cheaper.

Independent Accountant said...

You are entitled to disagree with me. Disagreements make markets.
The reason the dollar is declining is: the Fed is creating too many of them. Period. If interested, read "The Theory of Money and Credit", von Mises, 1912, for example. Or anything by Henry Hazlitt, like "The Failure of the New Economics", 1968. It is clear you do not understand monetary theory.
If the Fed kept money tight, we would never have seen 1% interest rates during the Greenspan era.
Again, you are entitled to your opinion about the Fed. I'll say again, just so you can't mistake my position: the Fed will destroy the banks or the dollar. It's that simple.
Speculators can do nothing to affect the value of the dollar over the long run. Only the Fed controls that.
Another book suggestion: "The Mystery of Banking", Murray Rothbard, 1983.

Tom Stone said...

IA,I'm glad to hear you got out in time.I know several people who bought at 2% cap rates,and worse.I advised against it,and am not interested in saying "I told you so",but it does impede conversation.Real Estate numbers are pretty simple,and it always surprises me how few people are willing to do the math,and act on it.

Independent Accountant said...

Thanks for the kind thoughts. Here's another "war story". I had a client who owned a Hollywood Hills house in 2005 worth $1.2 million. He asked me should he sell. I asked him how much he could rent it for? He said $5,000 per month. How much are the real estate taxes? He says $18,000 per year. So I said, "Your net rent is then $42,000 per year"? He says yes. I say that's a 3.5% yield. He says, "So"? I tell him it doesn't make sense to hold an asset with a 3.5% yield. He says I don't understand. I say, "What don't I understand"? He says, "The house is going to $2 million". I say, "How do you know"? He gets frustrated and leaves. Then he took his CPA business elsewhere. That makes sense. I questioned his "religion", i.e., California real estate only goes up.

dontbelievethegeneralconsensus said...

You don't get it. Show me the money stock measure controlled by the Fed that shows the Fed printing money? You can't. Because it's obvious you don't understand how the Fed creates money or what money stock measures they control. I am well aware of Rothbard's work. I own his book.

I still like your blog but monetary policy is not your core competency.

Independent Accountant said...

What does the phrase "controlled by the Fed" mean? According to, M3 no longer published by the Fed,is growing at 17% per year recently. Is that a high enough growth rate for you?
The Fed creates money, primarily by creating bank reserves. What is it you think I don't understand? Educate me please. I will gladly accept your tutelage.

dontbelievethegeneral..... said...

You proved my point. You are completely clueless. M3 is not a measure of Fed liquidity. Federal Reserve money growth has been 2% per year over the last three years. You have much to learn. But, that's okay. You are in good company with self appointed experts that now populate the blogosphere. You read a book by Rothbard, Mises or someone else who explains general monetary theory and you are a genius. I can assure you that you have no clue what you are talking about.

My original post is completely accurate. Ask a derivatives risk manager to review this discussion and they will confirm what I have said.

Sorry, you are now off my read list. It only took you a few days to prove you aren't worth listening to. Sorry. That's the free market.

Independent Accountant said...

Good bye. You are entitled to your opinion. What derivatives managers think means nothing to me. Are you a "financial engineer" by trade? What do you do for a living? 2% per year? Huh? Gold is $911 as I write. Why? The Euro is $1.47, why?
In your initial comment you wrote, "the dirty pigs you write about have shorted with massive leverage in the long commodities trade". What does that mean in English? You wrote, "The Fed has kept money tight for years". Huh? Clearly you and I live in alternative worlds.

Independent Accountant said...

I suggest you go to on 27 January and read Ben Stein's column. I'm sure you'll find much to agree with. Do not go to Yves Smith's 27 January post about Stein's column, because I'm sure you'll find much to disagee with.