bostonbubble.com

[john p]

I've been thinking recently about how when the economy is either in an upswing or down swing how asset values go up and down and then their behavior when it is a mixed market (some up, and some down).

They say all boats rise when the tide comes in, this is true for the most part.

Think of this though,

Last year:

Imagine that your company made an 8 percent return and an alternative investment may have gotten 9 percent. From an investors perspective the alternative investment would be a better deal right?

This year:

This year, your company slows down a bit and you only get a 7 percent return, you're a little worried right?. How about if that alternative investment that was getting 9 percent is now getting 4 percent. Even though your company dropped one percent, it is now a much, much better investment than the alternative and before you know it, you're going to get more people investing in your company because it has a better yield.

Now, what if the you are one of the few sanctuary investments in that time period? You're going to have tons of investors competing for a piece of that better return, that surge of investment creates a second wave of stock price appreciation, and then you get the late adopters that make it melt up even further. Now what happens next year when your P/E ratio drops because of your inflated stock price. Hell, you could have a better year next year but your stock's value might drop because the alternative investment that everyone threw away like an abandoned Christmas tree after Christmas is now a better value.

When the stock market tanked in the early 2000's, real estate was the better alternative investment. Sometimes the fundamentals have to be looked at in context as to what the flavor of the month is.

I think you need to look at the surcharge of nomadic pools of investment money and keep in mind that you can get flash flooding in unexpected areas. It's kind of like how new restaurants get lots of traffic initially, but the old faithful places build steadily. The old faithful restaurants might have a bad month or two if they are near a new restaurant that has opened up because of the curiosity factor, and you know something, they need to be aware of that.

Anyway, try to push a bubble out of a sticker. Those little bubbles/buggers can move around on you.

[admin]

I get what you're saying about an investment's attractiveness being relative to the alternatives. That's the way I try to think about investments, rather than judging the return in isolation. People viewing things that way may have been one of the catalysts for the housing bubble, though I think that in doing so it is important to approach it much more conservatively than other investments for at least two major reasons: liquidity and diversification. Housing is very illiquid - you can't easily trade it like stocks and bonds when the relative attractiveness of the alternatives shifts again. Your investment is also highly concentrated in a single asset with housing, whereas diversification is usually an important property for an investment to have. I suppose buying REITs would address these issues, but that's not what (most) people did.

- admin

[john p]

This of this though, think of the nature of the metro-Boston housing stock and how that has transformed over the years.

Most of the now vinyl sided triple decker neighborhoods all in and around Boston were beautiful victorian, and beautifully crafted buildings. Extended families lived in these large homes and you also found more bigger families.

As the highways came and the automobiles offered a larger commuting range, it was almost a status upgrade for families to be able to move out to the suburbs. Because everyone was trying get out of the cities, if someone came into some money, they certainly wouldn't spend it on restoring a building there, but using the money to buy a place in the suburbs. Then, when you add in the fact that many of the cultures of the Boston were ones that had much larger familes on top of lots of the manufacturing jobs going overseas and down South. So, as the area got more and more crowded, the jobs were leaving. So, the area got depressed and crowded. This is why people fled the cities for peace and quiet and space. Add to this, rent control, and you have thousands and thousands of housing units either in families or in rent control.

Even in my family, I had three cousins, each that owned one floor in a triple decker. Two of them sold to one of my cousins who stayed in the place. He asked me if I wanted to rent one of the floors at one point because he wasn't sure if he wanted just anyone living there with his family. Anyway, I found him a young family to rent from. Once he started getting cash flow from one of the units, it became clear that it would be a great income property. They ended up building a house in a leafy route 2 suburb (one of the top school districts in the State).

Admin, what I'm trying to say in this is that you're right, housing isn't very liquid, but from a lot of these families that had these places in the family for decades, turning two familes or triple deckers into condos was a way that a family could cash out of a property. When you had brothers or cousins owning a share of a multifamily, they finally had a chance to get their money out. Add in the capital gains tax shelter, and everyone was bailing out of these triple deckers that could. When rent control ended, rents skyrocketted and these people that inherited these multifamilies either rented or sold to a developer that wanted to convert these places to condos.

Now think about how this messes up fundamentals for house price to earnings ratios. People making short money could sell their triple decker and be able to buy a nice house in the suburbs. Before, more family members were housed in fewer units. Now, more people had their own place. So, someone that owned a couple of floors in a triple decker would get more income from these places than what their salary gave them.

Then you get these people divesting competing with eachother. So they end up putting on new vinyl siding and cleaning up the places. People that used to rent were now buying. Eventually they were putting granite counter tops in them and trying to market to the yuppies that were now priced out of the suburbs. As Boston became safer and safer and they built the Big Dig, people stepped back and said, hey this City is beautiful and they started to develop the Charleston Navy Yard, North End, rediscovered the Back Bay and even built new luxury units.

What is weird, is that natives of Boston hear their older relatives dissing the City and their colleagues from other areas embracing them and city living.

Now, because the Dorchesters are more and more expensive to rent, you see lots of lower income people heading down to Brockton, New Bedford, Lawrence, Lynn and Worcester. Because the lower income folks can't live in/around Boston, costs of basic services cost more, kind of like New York. This makes the cost of living go way up, which then inflates salaries for the service industries. This is why we have so many illegals here, because the only way you can cut costs for these services is if the people getting paid don't have to pay taxes. Waltham is a perfect example of a city that has a blend of illegals and yuppies. It is a very interesting blend, but is a manifestation of these two forces. Now, that gasoline is so expensive, many of the lower income people that were commuting to cheaper areas can't afford it anymore.

Anyway, this sort of socioeconomic local perspective shows how the overcrowding of the cities led to the sprawl of the suburbs, and the opportunites to divest these family properties created competition which eventually improved the quality of the housing stock, and as some of the suburbs and highways got crowded themselves, younger generations found the cities more appealing. This comparison of alternatives combined with the collective social perceptions of these areas have made some interesting shifts in evaluation.

If I have an agenda it is basically that we get to a balanced market where it doesn't pit our existing working class against illegals that don't pay taxes, and we can begin to address regional planning issues that keep the housing in check where we don't get cost of living bubbles that would end up making our region less competitive.

[balor123]

Policies that don't cause cost of living bubbles and that make our region more competitive aren't popular for two reasons. First, people like free money and hate policies that threaten it. They want to move up the housing ladder and they need significant appreciation on their current house to do it. Second, people hate losing money. So housing prices are insanely expensive and you can't really afford the house you bought but you already bought it. You prefer to further inflate prices and let some other sucker take the loss when prices come crashing down.

A well planned city puts policies in place to prevent speculators from entering the market. It expands when there the cost of living starts to rise. Boston and surrounding areas are not these cities because they don't uniformly implement such policies and Bostoners are happy the way things are. Expansion only occurs at a rate that doesn't threaten housing prices.

The problem is fairly straightforward. If you want a growing economy with more jobs, then you have to provide more housing for people to fill those jobs. Waltham is a relatively progressive city but even here I still see office space growing at a much higher rate than housing.

[john p]

I think your points are the major reason for the bubble, but policies like rent control contributed as well in my view. The local factors in real estate have some impact. When you think about it, Florida and Arizona actually had a ton of new housing stock so older homes were always a second option to the new stock. Boston went into existing stock and turned three families into condos. We didn't build as much as renovate in many areas. At least the people in Arizona have overpaid for a new place, I feel bad for the person that paid $450 plus for one level in a triple decker and like 1 parking spot. For that money you could have had a 3,000 s.f. home in other areas of the country. I never got how people would pay that. They say that Boston is beginning to correct; when you look at price bubble, that might be true, but if you look at VALUE BUBBLE, and see what you get in the different regions, I think that Boston was way overpriced in certain neighborhoods in and around the City.

As far as the well planned city, I just would like to see a balanced highway system and rail system and each area have some sort of cool vision. I don't care if a neighborhood is a working class one, I just like to have it planned in a way where it could have a cool personality and one that people took pride in and reinvested in. What was good about this bubble was that you saw certain areas get investment that typically got neglected. Parts of Chicago, which I just recented were great.

I'd wonder what your view is as to if the cost of capital will remain relatively cheap as it kind of is now?

[balor123]

High rents are indeed part of the problem and I fully agree with your assessment about other states. Some people would call those triple deckers part of New England charm They're just trying to make themselves feel better of course.

I don't care much for separating different classes either but that won't change as long as the suburbs remain independent of Boston proper. Labor policies and geography make it difficult to design roads and railroads better.

I agree that the bubble did a lot for inner city but it has hurt the suburbs. Though I'm not quite sure why, it seems that during the bubble lot sizes increased in some neighborhoods.

I think that the low cost of capital is helping people who own houses in several ways. Those with ARMs can move to fixed mortgages and home buyers can afford to pay a larger amount for houses. It is also having some undesirable effects though. It is causing inflation. Houses are devaluing relative to other goods. Since the inflation isn't being caused by rising wages, affordability isn't improving. The result is a softer landing, where homes devalue for a long period of time rather than all at once.

Increasing the money supply is equivalent to taking money from those with dollars and giving it to homeowners. This increases the cost of business elsewhere, weakening the dollar internationally and the economy as a whole. Fortunately, it seems everyone is in the same boat but productivity is going down. In theory a weak dollar should strengthen business by making goods cheaper, but that relationship only holds if we can actually deliver goods and services at cheaper rates. Since transportation is expensive it isn't quite having the desired effect.

These low rates cannot be maintained for much longer. Mortgage rates are constantly facing upward pressure due to the risk of long-term inflation. More importantly, no one wants to buy American bonds at interest rates that everyone knows will go up in the medium term. Business had largely centered around the dollar in other countries but we have lost their confidence and we may never be able to regain it, especially as other countries become stronger economically. Combined with other factors having the same effects (war, stimulus checks, tax cuts, bank/mortgage bailouts, discount window), we are in quite a mess. I do not take any position on these issues, I'm just pointing out their effects.

I expect that the economy will stagnate over the next few years, causing further pressure on house prices. At a glance, the government appears to be focusing on fixing short term problems at long term expense. I don't see much value in the housing industry and the banking industry will recover so I kind of wish that the government would let them collapse but it's not good for votes and crashes are in general not good for business.

[john p]

If you take your global comments in context with the "Asset Bubbles in a Mixed Market" I wonder if you think that other countries investing in the Dollar and US based assets contributed to the bubble of the dollar?

I know that the emerging markets are sucking out money from US investment because they offer a greater return. I am wondering how long you'd guess this rebalancing of currency and evaluation will take globally? I have a feeling that there will be a correction process globally and I even wonder if Gold may be overvalued because that is a sanctuary investment?

As far as the triple deckers go, the one thing you can't take away from them is that the density offers you lots of human interaction. If you take the time to say hi to people and get to know them and you add to the local color, it can be really really fun to live in those areas. You end up hearing more jokes, you learn how to break balls, and everyday in and out stuff is met with others lives that overlap in that particular area. Great views and nature are great, but living among other people is a great thing too. When I was in Manhattan I thought I wouldn't like it as much because there wasn't enough nature for my taste. What I found out was the "nature" I experienced was the human interaction. That was the refreshing energy source that someone might get overlooking the ocean. My problem with the triple deckers was that once the working class people couldn't afford them, they lost some of the hot ticket cool people that gave them the charm. As long as the people moving in aren't stuffed shirts hopefully some of the coolness will wear on them.

[Boston ITer]

I guess I'm finding this thread a bit offset from my life's view of things.

Realize, I'm of the new Boston frame of view which is that the city and region expanded from the vision of a Ken Olsen, the founder of Digital Equipment Corp. Likewise, that era, starting from the early 60s, made the "Massachusetts Miracle" which is was in many ways, except for mainstream and alternative culture, greater than the New York of Andy Warhol and the Son of Sam .

Since Boston was generally culturally conservative, the wild ones went to Montreal (erotic/artsy) and NYC (clubbing/playhouses) for their adventures but the steadyfast hard workers worked at DEC, Data General, Biogen, J Hancock, Teradyne, Gillette, Polaroid, etc, and made the region one of the most properous in the nation. In essence, these were income generating industries and employed many skill levels, all the way from floor sweepers to help desk to Phd holders with a net surplus of money entered the region. The end result was a growth of nearly two million residents, for eastern MA, and a massive development of all the suburban regions with a type of zoning for industry in towns like Waltham and Watertown.

All and all, the well off sections of Boston stayed well of (B Hill/BB) but other areas: JP and east Boston became neglected and became more and more like Dorchester or Southie.

Now, in contrast with the above, today's Boston doesn't have a sustainable economy. Many of the blue chips are gone and when State St finally acknowledges their losses from the MBS/CDOs, they'll be going the way of Fidelity (or Putnam), out of town (or business). So, we can talk a lot of revitalized downtown neighborhoods, etc, but will all these residents be independently wealthy, like half of NY's entertainment industry residents on the west side? I think not, those I* wealthy neighborhoods are the ones near Brattle St, circa Harvard, and that's a pretty established elitist pool with academic/financial strings. What that's implying is that the housing debacle could easily go the way of Japan but w/o the stability of companies like Mitsubischi and Toyota keeping a floor on the middle class.

[john p]

Awesome post; totally different but accurate perspective. I think you're right, technology created the "Massachusetts Miracle" in the 80's, the tag line that Dukakis said he created.

Once people have made their first million, it grows and grows if you invest it. Once you make a certain amount, you end up getting more growth from investment incomes than you get from wage increases. Even if the market loses jobs, there will be plenty of people that live off of investment income. This is part of the reason why I see this as a "mixed" market, on the one hand you have investment rich, and others who need wages to survive are being flooded out by inflation. While many move to sanctuary "higher ground" areas, I wonder if the best deals are elsewhere.

Once times get really bad, you'll see those "sanctuary" areas within the cities start to get muggings because the surrounding areas are financially suffering and they are stressful unhappy places.

[Boston ITer]

[john p]

The hookers, pimps and drug dealers used to hang out near the theaters and in the Combat Zone. That's not wicked far for a guy that's tuned up or strung out to walk up Mass Ave to Marlborough Street.

A lot of people want the poor to suffer because they can get entry level housing cheaper. If people get thrown out of their houses it will get ugly and there are some ugly realities that come along with that, that most want to filter out. I'd say be careful what you wish for.

I'm not saying that this will happen, even if 10 people get stabbed and mugged in the Back Bay, that sort of stuff doesn't go down in Burlington, VT like you mentioned and if you have worked really hard for the good life, why would you chance being one of those statistics?

[Boston ITer]