The Next Housing Bubble Is About To Pop All Over You

Flippers. Record home prices. Stock markets at record highs. Record low-interest rates. Just add some sad tales about young couples making $250,000 per year in Silicon Valley who still can't afford a million-dollar bungalow and you've got 2007 all over again.

We cannot seem to get out of the terrible loop from real estate bust to housing bubble. Playing the residential property market is the one drug addiction that's still socially acceptable. Despite what just happened a few years ago and is still lingering in much of the country, the housing boom is back.

"While flipping is re-emerging nationwide," Marketwatch.com reports this morning, "brokers say it is happening most in California, where home prices have risen sharply over the past year."

Bay Area median prices have already topped a half-million dollars, which is where they were in 2007 before prices collapsed by 56 percent.

The Bay Area's median sale price first passed the $500,000 threshold in May 2004, when it rose to $501,000. It continued rising and held well above that level for four years, then dropped below $500,000 in June 2008 as home prices tumbled. From its $665,000 peak in June/July 2007 to its $290,000 trough in March 2009, the median plunged 56.4 percent, or $375,000. As of last month most of the Bay Area’s peak-to-trough loss had been regained. The median was up $220,000 from its March 2009 trough, meaning it had made up about 59 percent of its loss.

The median home price in San Francisco hit $1 million last week.

The housing news is the same in New York and Los Angeles and Washington, D.C. Everything is booming. New urban construction is everywhere, even in a notoriously hard-to-build-in city like San Francisco.

Bidding wars are suddenly common again. "We're accepting offers next Wednesday at noon," says a realtor about a mediocre house that was almost certainly underwater and on the verge of foreclosure a year ago.

"More people are borrowing from their 401ks," a mortgage broker in Orinda told me in April. "It's a great way to get your down up to 20 percent. And you get to pay yourself back with interest."

When is tapping your retirement money ever a "great" idea? When do the "old definitions" of reasonable housing costs get replaced by new definitions, created to excuse insane behavior? When there's a real estate bubble, that's when.

An annual income of $250,000 seems like a lot of money. But home prices in the Bay Area are so high that the old definitions of “a lot” don’t hold true anymore. You could buy a much less expensive home, but then you have to start worrying about the quality of your kids’ schools and the length of your commute. All in all it’s a tough conundrum.

The surge in coastal-city real estate markets made sense until this year, when home prices in places like Silicon Valley and the wider Bay Area surpassed the previous bubble highs.

There are reasons to believe densely populated urban wealth centers are a long-term trend. Telecommuting—never a good way to claw through your fellow humans on your way to the top—has officially gone out of favor, as tech companies build architectural trophies for on-site workers and Yahoo chief Marissa Mayer formalizes the trend of bosses wanting employees to actually come to work. Wealthy Millennials are repulsed by the very idea of getting in a car, and want only to live in places where they can drunkenly stagger from one urban playground to the next, with free bicycles and 24-hour public transit always at hand. The rich cities are getting richer, the flyover suburbs and never-fashionable exurbs are getting poorer.

People who can afford it are voting with their money to live in cities. Some of this is political, because cities are far ahead of Washington when it comes to sustainability and cutting down on fossil fuels and showing off by bicycling from the car-share lot to the farmer's market to the public school that's actually propped up by a rich parents' foundation that holds gala black-tie auction/wine events and never feels the pain of budget cuts.

And it's a good way to live, especially compared to the previous upper-middle-class dream of a big ugly stucco atrocity an hour's drive away from the nearest non-chain restaurant or museum or train station. Still, the bubble is ready to burst.

It makes sense to buy a place in San Francisco for half a million dollars, when average rents there hit $2,700 for a one-bedroom—if you've got the income, good credit, and $100,000 on hand for a 20 percent down payment. As a homeowner, you get a mortgage deduction, and at a 30-year fixed mortgage at 3.6 percent will cost you only $1,800 a month. Add all the taxes and insurance and you're still paying less than the average San Francisco rent.

But all of this changes when a "normal" house costs a million dollars in San Francisco (or Brooklyn or Santa Monica). Even the modestly rich with a $250,000 household income have trouble coming up with $200,000 for a down payment, and now they can't get that conforming mortgage with the lowest rates because the amount they're trying to finance is $800,000—the Fannie Mae loan limit for high-cost areas including San Francisco is $625,000 for a single-family home. This means that beyond the $200,000 down payment, you'll need another $175,000, through a second mortgage or a "bridge loan" at 9 percent or through tapping out your retirement stocks, if you've got that much to bleed.

Now your mortgage payment is officially insane: A first-mortgage monthly payment at about $2,800 for 30 years, plus your five-year second or two-year bridge loan at somewhere between $2,000 and $5,000 per month, plus your taxes and insurance and earthquake insurance and HOA or co-op fees, etc. Home ownership goes from being cheaper than a $2,700 apartment rental to costing $10,000 a month.

After payroll taxes and retirement and health care and flex accounts, take-home pay in California or New York on a quarter-million two-earner income is just under $13,000 a month. Now our well-off hard-working couple of Silicon Valley people have less than three grand a month for food, car payment, baby clothes, utility bills, yoga, wine, etc., or $675 a week. That is not enough money.

And then the market goes off the cliff, which is basically happening right now.

There is not a lot of pity in America for the affluent couple in Manhattan or Mountain View trying to stretch a $250,000 annual income enough to afford a pleasant house in a thriving metropolitan area that has everything. With unemployment still high and real unemployment still pushing 14 percent, people at the top of the ladder struggling to find a suitable million-dollar home are left to commiserate with each other. It is the new humblebrag, and also the 2007 humblebrag from an olden time before Twitter had named this practice.

But the only way a million-dollar median home price is sustainable, even in the very short term, is when you have an endless supply of six-figure two-income earners who are willing to drain their 401k accounts and clip coupons just to have a modest house somewhat close to where they work.

For now, these buyers are competing with investors and flippers—and it only adds to the psychological terror when people who are trying to buy primary residences, with pre-approved loans, are getting outbid by all-cash buyers. If we've learned anything from the real estate crash of the Great Recession and the periodic housing busts that have reliably occurred since the 1800s, it's that the people who buy at the peak are the ones who get screwed the hardest.

A huge collapse hurts everybody, as the 2008 crisis reminded people from Malibu trophy property owners to sunbelt suburbanites. Regional hits, like the collapse of the 2000 dot-com bubble in the Bay Area or the half-century-long decline of Detroit, can happen even when the overall economy is strong.

Minus another global financial collapse or a sudden surge in interest rates—or some complete unknown horror like a worldwide pandemic or hostile space monsters landing on Earth—the Bay Area contagion may not infect the broader U.S. market. But how much comfort will that bring today's peak homebuyer when values drop by 20 percent, consuming the exact amount of savings and "bridge loan" money they spent to get into that former million-dollar home?

Real estate is a good investment as a place to live whenever it costs no more than leasing a comparable house or apartment. As soon as it costs more, you're buying in a bubble.

[Photo by Jim Cooke.]