Bubble News--Heebner Predicts Huge Drop in Prices:

More evidence that the smart money is betting against a "soft landing," from today's Wall Street Journal (subscription only):

To get a lay of the land, we tracked down Kenneth Heebner, who since 1994 has managed the $1.2 billion CGM Realty Fund. It has the best 10-year record of all real-estate-focused mutual funds, according to fund tracker Lipper Inc., up an average of nearly 22% a year during the past decade, well more than double the broader market. The fund also has one of the best one-year records, up 32% through June 30.

Mr. Heebner, 65 years old, is better positioned than many real-estate fund managers to speak about prospects for the housing sector. His fund has viewed its mission more broadly than most rivals, so he isn't shy about ditching real-estate stocks. Among big holdings for CGM Realty during the past year: coal-company stocks, a hot category that qualifies in Mr. Heebner's view because coal companies own a lot of land. He also runs three other mutual funds, including CGM Focus Fund, so he spends a lot of time looking beyond houses and hotels to other parts of the economy. These three funds have among the best five-year records in their categories.

Here is our conversation:

WSJ: How is the housing market?

Mr. Heebner: A significant decline in prices is coming. A huge buildup of inventories is taking place, and then we're going to see a major [retrenchment] in hot markets in California, Arizona, Florida and up the East Coast. These markets could fall 50% from their peaks.

Combine this with, among other things, the plunge in homebuilder stocks and the end of the condo conversion craze, and a rather pessimistic picture emerges.

The interview is also available as a podcast, dl'able through (at least) itunes -- I listened to it this morning on the way to work.
7.5.2006 1:35pm
Positive Dennis:
I am in Real Estate and the answer to this is Location Location Location. 50% seems a little high even for California. What usually drops in such a situation is not the house itself but the value of the land underneath. I hope they are wrong as I have two houses to sell in California.

Positive Dennis
7.5.2006 1:38pm
Anderson (mail) (www):
Ah, but is Heebner still practicing reality-based economics?
7.5.2006 1:55pm
John T (mail):
Of course, Professor Bernstein, the article about the decline of condo conversion is about the condos being rented instead-- and about rents rising rapidly. That that would happen was inevitable, and would happen whether there would be a soft landing or not.

A situation where housing prices rise rapidly but rents do not is not sustainable. Rents must rise or house prices must fall, or both. The WaPo article you linked, by showing rapidly rising rents, actually decreases the chance of a hard landing, in my mind, compared to what I thought before. I still think it's somewhat likely, but less than I did before.
7.5.2006 2:17pm
Pete Freans (mail):
Maybe I can finally afford a house "down the sure" in Jersey....Owe! Unbelievable!
7.5.2006 2:17pm
DavidBernstein (mail):
John, given the current price/rent ratio, building owners need to believe that the ratio will contract dramatically and soon to cancel condo conversion projects. Rents rising 7% a year, if that's true, wouldn't come close to justifying this, unless prices are expected to decline sharply and rapidly as well.
7.5.2006 2:21pm
Positive Dennis:
Let me add that there are two deflationary actions by the Federal Government. The Steel Tarrifs and the Softwood Tarrifs will soon (maybe alrady) be gone. A 20 to 30% reduction in wholesale prices for these items will reduce the cost of new houses and reduce the sales price of older houses as a result.

Positive Dennis
7.5.2006 2:22pm
As I have mentioned before, I would like to respectfully disagree with Professor Bernstein posting on this subject without disclosing, as he has admitted, he has a direct financial interest in the decline of D.C. area housing markets. Obviously, Professor Bernstein is free to post as he sees fit (and posts such as this one are a good contribution to the VC) but I find he constant posting on his belief in the housing bubble without concurrent disclosure that he is a renter hoping for a asset price collapse to be an undisclosed conflict of interest that, in other contexts, I assume many posters and bloggers here would recognize. Regards.
7.5.2006 2:31pm
And, of course, Mr. Heebner, who manages a real-estate fund that apparently has no current stake in the housing market, has no incentive to be talking down housing stocks so that he might add them to his fund on the cheap.

7.5.2006 3:06pm
guestilito (mail):

And, of course, Mr. Heebner, who manages a real-estate fund that apparently has no current stake in the housing market, has no incentive to be talking down housing stocks so that he might add them to his fund on the cheap.

But Heebner's interest is obvious from his position and disclosed in the article. That Prof. Bernstein is a renter planning to settle in DC is certainly relevant. I don't think it matters much, since he's simply posting links to news or third party opinions, but it is nice to know.
7.5.2006 3:24pm
Houston Lawyer:
We all have an interest in the housing market, whether as potential buyers, sellers or both. Here in flyover country, we have been amazed for years at what others pay for real estate. Yesterday, I looked at a 4800 square foot home with a 3 car garage in a master planned community about 15 miles from downtown. They wanted $397,000 for this, or about $100,000 more than a similar house would sell for 10 years ago.
7.5.2006 3:53pm
Still Learning:
Thanks to anonassociate for an important point. Most people who talk up a real estate bubble are those who never bought, are always afraid to buy, and from families who never owned a house but always rented.
Luckily I saw how profitable real estate was as a child, when the upstairs tenants brought us checks every month for my grandmother, and I learned they were enough for the mortgage so that we didn’t have to pay anything.
I bought my first property when I finished college and the rents plus the $20,000 profit I got 2 years later covered my law school expenses and helped me buy a house at law school that I rented extra rooms to other students for more than the mortgage. The profit from that I used to buy my next house in Florida for $28,000 which I sold for $195,000 after living rent-free for 25 years. In my entire life of 54 years I have paid a total of $1,350 in rent (18 months at law school paying $50 a month for a room and 3 months at $150 while looking for a home in Florida).
Of course when you don’t have to pay rent, you can save the money and buy a car for cash so you don’t have to have car payments either. Life is good when you don’t have to pay rent or car payments. America, what a country!
7.5.2006 4:07pm
ras (mail):
I guess housing, as in ownership, will soon move back into the CPI, then. House prices that have already peaked can hold steady or decline (even just modestly), which would give the govt more room to inflate its way outta debt elsewhere.

You can bury an awful lot of debt with 7% inflation per year disguised as 3. If you were instead to deflate and actually write off all the bad debts, too many voters would lose their houses and never forgive you for that. Inflate a little and they will be happy, plus govt eliminates almost half its own debt in just two presidential terms.

Foreign bondholders will be ticked (to put it mildly), but they don't vote, and the Admin can always find other ways to compensate the "good" ones, giving themselves additional leverage over China the rest.
7.5.2006 4:14pm
Houston Lawyer (off the top of my head) that is about a 3 percent per year increase. Admittedly I am not an expert on the Houston real estate market (and I am assuming that is the area where you live given your name). That increase strikes me as reasonable. I just sold my father's house in South Texas and got about $10,000 less than what he paid for it 20 years ago. From my understanding, Texas real estate is just now becoming more attractive after many years in the dumps.
7.5.2006 4:18pm
Joel B. (mail):
Pricing especially on Housing is awfully hard to get exactly right. Is the price runup in silver or gold a bubble? Something else? Is the price runup in oil a bubble something else? What does land, oil, silver and gold have in common? That they are hard assets. Are hard assets going to go down in value? Stay up? Mildly correct? Will we see $4 silver again? $20 oil?

I don't know...and how can I. For housing prices to genuinely go down, the value of land and homes will have to go down. Will they? Hard to say.
7.5.2006 4:24pm
brett (mail):
> I find the constant posting on his belief in the housing bubble without concurrent disclosure that he is a renter hoping for a asset price collapse to be an undisclosed conflict of interest

I find it ghoulish, creepy, and frankly revolting. Bernstein obviously has some personal and/or financial interest in a housing market collapse -- the tone of these posts is actively hopeful that a collapse will happen. The fact that that would mean financial pain for a lot of people, not just real estate speculators, apparently doesn't concern him. These aren't "what is happening in the housing market" posts. These are posts that actively try to convince people that the housing market will collapse, despite all evidence to the contrary.

I wish the other Conspirators would step up to the plate and tell Bernstein to knock it off.
7.5.2006 4:34pm
Joel B. (mail):
Just curious but am I the only one was like who the heck is Heebner? There's so much noise around here it's strange.

I don't really care so much about David's interest in collapsing prices, I mean what are people going to do? Flee the market because a member of the Volokh conspiracy is trying to convince others (and more likely himself and family) that they should keep renting, what do I care? It's normal human behavior. David may be right, housing may collapse, it may not, it may restart too, the one key ingredient in a housing price collapse that has been missing ever since the beginning of the "bubble's burst" is a slow job market.

Look, if someone wants to take real estate advice from a law professor, more power to them it's a free country, but if all he's going off of is that housing seems to darned expensive...get in line. Life is too darn expensive, at McD's a cheeseburgers costs me $1.10, and I can get a Double Cheeseburger for $1. It's stupid and it's goofy, but that's the way it is. Welcome to inflation.
7.5.2006 4:43pm
As always prices are set by how much people think they can spend a month. If interest rates go up then (at least in the short term) prices go down, but the overall cost of the loan will be the same.
7.5.2006 4:57pm
The people that will be hurt by the housing market decline are those have arms, are living above their means, and those trying to get rich quick. Housing is always a long term investment.

To those who think that the market is not in decline, why is inventory double what it was last year and prices are down from a year ago?
7.5.2006 5:10pm
DavidBernstein (mail):
I'd take the complaints about "disclosure" a lot more seriously if the complainants revealed whether they were owners or renters, or work in the real estate industry! I remember one guy who kept complaining here in the comments, who turned out (as another commentator found via a web search) to be a speculator.

It's not a secret that I'm a renter, but I'd be happy to have a disclaimer on every post IF I believed that my posts have any impact on the price of housing. Does anyone really believe that?!? On what basis? I don't remember anyone complaining when I first started writing about the bubble, but prices were still going up!
7.5.2006 5:15pm
ras (mail):
Housing prices likely won't "collapse," they'll just stagnate while inflation steadily returns them to reality, at least in real terms.

A genuine collapse would be catastrophic for the economy, forcing the rapid liquidation of the bad debts and therefore the loss of (millions of?) family homes, not to mention that the govt itself, in the ensuing recession, would be forced to cut back its own spending drastically.

Compare that scenario to a decade of liveable inflation, happy voters who can pay off the mortgages with cheaper dollars, and continuing money for the pols to buy votes with. [Besides, inflation is not the govt's fault, after all; haven't we all been taught that it's the butcher, the baker and the candlestick-maker getting greedy that causes inflation?]

Manipulation of the CPI has worked well for years to help maintain confidence; it's a proven approach. Why wouldn't they do it again?
7.5.2006 5:23pm
@ DB: It's not so much a need to disclose to avoid having an undue influence on the price of housing. It's more that the slightly desperate tone of the posts makes more sense with full context. I hadn't realized you were a renter -- I suspected that you just had acquaintances who were investing in real estate and you were jealous of their successes. The posts take on added poignancy when it turns out you're a renter. It means that you -- like many others today -- missed out buying when the prices were right and interest rates were low, and now may be unable to catch up enough ever to own close by a major metropolis on your salary.

Like you, I'd like to buy a house and hope that the market bursts. But it is a little silly to keep ginning up any evidence you can find . . . .
7.5.2006 5:24pm
John T (mail):
Prof. Bernstein, you'll note from the article:

The rent increases are confounding industry expectations that rents would fall because of the huge number of new condominiums, many of which were sold to investors who have put them up for rent. Experts say prices would rise even faster without the additional condos.

I agree that 7% yearly may not be enough to sustain the total of the bubble rise in the DC area, but it is at least more sensible than what we've seen before. Rising rents + huge increase in supply due to conversions back to apartments + decreasing vacancy rate is not enough information to tell us what's going on. It at least means that some of the housing price increase was valid, even if not all of it.
7.5.2006 5:32pm
John T (mail):
I'll note that I just graduated and moved to the Fairfax County area-- and I'm renting, because I agree that it doesn't make sense to buy right now when the rent to mortgage payment ratio is what it is.
7.5.2006 5:33pm
Anon E. Moose:
Still Learning:

Great example, both of how well you've done for yourself, and of the fallacy of the anecdote. You've taken advantage of favorable opportunities to enrich yourself. Prof. Bernstein's underlying point [if I can persume] is that such opportunities are no longer available at current valuations.

One could read your story and conclude that real estate always goes up, is always a good investment, irregardless of valuation. In fact, many people think that with or without having read your post. My question is, if you could rent for $1 a month, or only rent out as a landlord for $1 per month, would it still be a good deal to buy an any price? Obviously no, so then there is some level of valuation that makes buying unattractive.

What if the tax adjusted interest costs of buying a home exceed those of renting one by 100% (as is the case in many areas of WDC and elsewhere)? What if the market rents don't cover the mortgage, or even come close? There is only one past, and it affects all alternatives equally. The question then becomes, faced with the current costs of buying v. renting, where do the economic advantages lie?

A relative likes to tell me that I'm only paying my landlord's mortgage. My response is yes, but I can't get the landlord's mortgage anymore. For me to buy (from the current landlord or an equivalent owner) would increase my housing costs 150% over my current rent, even after accounting for tax benefits, principal accrual, and making reasonable historical-based presumptions about real estate value and rental rate appreciation [i.e., those going back more than 4 years].

If one goes shopping for a home in today's market like most people seem to ("Oooh, that's pretty... What's the payment going to be?") they deserve what they get (IMHO, screwed).
7.5.2006 5:37pm
Professor Bernstein, I am frankly quite disappointed with your reply, essentailly a variation of "you don't do it so why should I?" This hardly contributes to elevating the discourse. As I have said before, I don't disagree with the idea that NoVa housing may be overpriced--but I find your contant hyping of the idea without disclosure to be misleading, at best.

Since you insist, and since it appears important to your for some reason, my wife and I have owned our home in Lyon Village since 1997, and are not planning on moving anytime soon. Regards.
7.5.2006 5:39pm
davidbernstein (mail):

I'm not desperate at all, as on my and my wife's income we can easily afford a very nice house, even in a bubble market like Northern Virginia. I'd like prices to come down somewhat, but I don't think my posts will have any impact on that.

But how about "some love" for giving readers info that they weren't getting from the MSM? If you look back at my posts, I've been well ahead of the conventional wisdom curve on this.
7.5.2006 5:40pm
Professor Bernstein, while you certainly were ahead of the curve with respect to housing prices last summer (though I don't believe that SFH prices in Arlington have actually declined) at this point the idea of a housing bubble has sufficiantly permeated the MSM, I think.
7.5.2006 5:50pm
davidbernstein (mail):

If you're not planning on selling your place any time soon, the best thing for you would be a nice steady decline in prices, followed by a huge jump right before you decide to sell. Why pay extra property taxes in the meantime? (A plunge in prices would be even better from that perspective, but might bankrupt Arlington County.)
7.5.2006 6:02pm
Professor Bernstein, since the only place we would move to is Great Falls, where prices more or less move in sympathy with Arlington, I am fairly personally indifferent to NoVa housing prices in general. But I don't agree at all with your greater point--the abysmally leftist Arlington County Board would surely react to a drop in prices (more accurately, a drop in appraisals) with an increase in the tax rate--they have gotten so addicted to spending and their feel good programs that I have no doubt they would make up the difference on my back somehow. Regards.
7.5.2006 6:09pm
guestilito (mail):
DB) Since your post created this mini-forum on the housing bubble (and comments don't appear on the front page), knowing your interests re the bubble is more important than knowing those of the relatively powerless commentors. As you know, it's standard practice for journalists to avoid even the appearance of impropriety. Whether or not your championing the bubble has some affect on the market, it'd be gracious to add disclaimer/disclosure to future posts on this topic.

FTR, I rent in a market that makes NoVa look cheap.
7.5.2006 6:39pm
Chico's Bail Bonds (mail):
As I see it, there are four categories of people: (1) those who buy housing, (2) those who rent housing, (3) those who are homeless but would like to eventually buy or rent housing, (4) and those who are homeless and would under no condition buy or rent housing. Anyone in categories 1 through 3 has an "interest" in the housing market. Only people in category 4 don't. Don't you disclosure police think readers would have just assumed DB was not in category 4?
7.5.2006 6:55pm
“If you're not planning on selling your place any time soon, the best thing for you would be a nice steady decline in prices, followed by a huge jump right before you decide to sell. Why pay extra property taxes in the meantime? (A plunge in prices would be even better from that perspective, but might bankrupt Arlington County.)”

Are property tax rates set differently in VA than elsewhere? I am curious, since many people erroneously believe that is how property taxes work in the New England states, where I am familiar.

Here the local legislative body sets the annual budget (within certain parameters such as MA prop 2½). Then the tax rate is computed from the total property values divided by the budget. If property values go up faster than the budget, the tax rate drops. If the budget stays flat (ok, this is just a hypothetical) and property values drop, the tax rate will automatically go up. The only way the overall real estate market effects your individual tax bill is if your house value appreciates or drops faster or slower than the other properties in your town.

The above statement presumes that there is some fixed tax rate in Arlington County, VA, and the taxes collected come in at whatever the tax rate times the total property valuation is, so the property tax automatically goes up when the property value goes up and down when values go down. Is that really true? It would make local budgeting pretty hard, since property values can be far more volatile than sales or income taxes.
7.5.2006 9:49pm
Oops, I got that backwards. Of course, the rate is computed as the budget divided by the total community property value, not the other way around. Of course, the whole thing gets a little more confusing when there are different tax rates for commercial, industrial and residential properties, deferrals, exemptions, reduced rates for open space or agricultural properties, etc., but the concept is the same.
7.5.2006 10:02pm
Russ O'Corragh (mail):
Houston lawyer:
You may be amazed about what people in other parts of the US pay for housing but I am not. I sold my Minneapolis home for approximately half what I paid for my near-beach condo in a North San Diego County town. The condo is approximately 45 percent the size of your quoted Houston 4800 foot house. My 2200 square feet also cost about one-half again your example house. two years later it is booked at twice that. On Saturday morning we drove two hours to a splendid camp site at 7500 feet in mature pines for three days of shooting ourantique cartridge rifles with a group of fellow shooters, then turned around and spent the Fourth of July a few blocks from my place surfing and clowning around with my grandkids from our screen tent pitched on the beach. Temperature in both places around 75-80 degrees F. It was an exquisite day (and no mosquitoes). Fireworks later in the purple sky. I've been to Houston in the summer, and its a good thing that all those late 19th century engineering geniuses figured out how to deliver power and heat-cycling machinery to Texas. Terrific people (my wife is one) but damn....
So trust me, things may go falt or even decline out here a bit, but it ain't gonna tank. In any event, I'm keeping my place even with another in New Mexico, and there are a hell of a lot others like me. If you build it, they will come.
7.5.2006 11:25pm
Jhp3rd (mail):
Here in southern Maryland, the local property tax rate is a fixed percentage of the appraised value of the real estate. Appraisals occur annually of one third of the real estate, so an individual is assessed once every three years. Inflation is forecast into the appraisal so that the appraised value grows during the three year period. Since two thirds of the local tax base is a known quantity, the local government has a stable income from which to budget, however housing prices in the DC area have moved so fast that appraised values have reached mandatory inflation caps and the local government has reduced the tax rate repeatedly to avoid severe impacts on fixed income retirees.
7.5.2006 11:25pm
Truth Seeker:
DB said

But how about "some love" for giving readers info that they weren't getting from the MSM?

A little disingenuous as the WSJ is MSM.
7.5.2006 11:32pm
Debauched Sloth (mail):
At some point, the criticism of Prof. Bernstein for not disclosing his renter-status crossed the line from silly to meanspirited, which seems unfair. First, no one seriously believes Prof. Bernstein is trying to influence the NOVA real estate market by manipulating VC-reader behavior, right? Second, no one claims they are relying on Prof. Bernstein's posts to make decisions regarding that market. It seems the only other reason for disclosure is to help readers evaluate the quality/reliability of Prof. Bernstein's assertions. If so, wouldn't logical consistency require that someone posting about, say, the Second Amendment "disclose" whether he or she owns guns, studied constitutional law, cite-checked her authorities, works for law enforcement, etc.? Yuck. Instead, why not simply assume that people who care enough to blog on a particular topic often have strong personal feelings that render them less than objective. Caveat lector.
7.6.2006 12:06am

Thanks for the information. It still isn’t clear to me though – if the real estate market drops, can a county increase the tax rate for the next year to maintain constant revenue, or do they have to suck it up and take a revenue drop? If they can raise the rate, then it is still similar to what happens here (rates are set up here annually for the whole year).

Unrelated, I also think the sniping about Prof. Bernstein’s supposed conflict of interest has gotten a little silly.
7.6.2006 12:38am