15 min read

What drives house prices?

Interview: economist & realtor John Wake, Real Estate Decoded
What drives house prices?

In this edition I interview John Wake, a former economist-turned-realtor and owner of Real Estate Decoded. We talk metrics, some recent history of real estate prices, and what might be coming up.

Here's the audio. The full transcript is below.

Laziest Landlord: Good afternoon, John. This is Manu, the Laziest Landlord and I'm here with John Wake today.

John Wake: Hi Manu.

LL: Pleasure to have you as part of this, John. And John, before we get started, I'd love to just get a brief intro about you for the readers and listeners of Laziest Landlord, because you have an interesting background.

John Wake: Yeah, I'm an agricultural economist by training. I got an MS, a master's degree from University of Florida. I worked for the Foreign Agricultural Service at USDA and analyzing import and export data, and eventually worked at the American embassy in Paris for a couple of years, three years. And then bailed out, quit and came back to Arizona and worked for the Arizona Department of Agriculture. Did that for a while, ended up getting into real estate. I was just into data. I was … In Arizona, there was data at that time. This is like the year 2000. I wanted to know what did the house sell for. I don't want to trust real estate agents on what the house sold for, ‘cause who knows what cockamamie thing they could come up with. So I've started it and I would buy the data from the county and then put it on websites so people would subscribe.

So it was kind of like Zillow. Very much like Zillow, but, you know, four years before Zillow started and doing that, doing via email. And that got me started and the idea was that I would sell advertising to real estate agents, but it wasn't working at all. I was not making any money. And then I thought, oh, you moron. I get all these people emailing me saying they want to buy a house. Why don't you become a real estate agent and start selling houses? So even though I was a numbers geek, I ended up selling and a lot of my clients were numbers people, like engineers would be a typical client. And did that for a while, I'm not so busy into selling anymore, but I really like analyzing the data because when the market crashed in Phoenix, I did not see that coming. My estimate in 2006/7 was that the market would be flat for maybe four or five years. And that and real inflation adjusted terms, it would get back in line. But obviously that didn't happen. Prices for like 60%, 60% from the top to the bottom, it was in some numbers, some scores went down 80%.

LL: That’s incredible.

John Wake: And I'm still trying to figure that out. And that's kind of a post-traumatic economic distress syndrome, trying to figure out what the hell, what the heck happened with the economics back then.

LL: It's funny; I'm an engineer by training. And so now I know why I like the real estate decoded Messiah. It spoke to me particularly.

John Wake: That's great. That's like there was a while they were, half of my clients were engineers, honest-to-God engineers and the other half tended to be just numbers people, like financial advisors and things like that.

LL: So could you maybe describe what you do and a little bit about how you value house prices ‘cause I think that's the interesting question and why I was really interested to talk to you.

John Wake: I'm still trying to figure out what’s going on with house prices. And one of the things that I did recently was just looking at, well, the prices and fees are up like 20% in the last 12 months. And I did not see that coming either. The glass ring, my guess it was a lot of people start selling, but that the absolute opposite happened. There was people selling, but a lot of people started buying and then there was a commerce out of Australia, I was following who's the only one I know that called it last spring. And he was saying is because the interest rates were down, but that was going to cause a big boom in prices. And he turned out to be right. And so then I started to refocus on how important interest rates were into the whole buy cycle. And so now it's just razor down so low. It took them a long time to sort of filter down to the mortgage rate. But that was what, I’d say that's the number one factor on why prices were sky rocking, was the lower, the lower interest rates, for sure.

LL: So can we talk a little bit more about that? So you've used lots of different metrics I see on your website. And it sounds like you've honed this down to talking about the, would it be fair to say the value of the house, or how do you think about income, interest rates? What are the drivers of it, or what's your best guess as to what drives the value of house prices?

John Wake: Yeah. Well, the other thing I ... Well, you got the income, obviously if your income or the income to the name in a zip code or a Metro go up 10%, but prices go up 10% really, prices haven't really gone up because your income went up the same amount. So that's why I'm including an income or interest rates is because when it goes down, you can buy the same house for the same amount of money. And your monthly payment is less. What ends up happening though is over time, the people who get in early get the lower rate, but then they bid up prices. They are, it's like an auction and they just say, I can pay, you know, 20,000 more. So over a period of time, home prices get bid up that amount.

The other thing that I didn't mention was just is not so much economics as behavioral economics, I suppose. As once home prices are increasing fast, like they are now, you get this feedback loop or people thinking, hey, I should buy, I can pay more now because prices are going up so fast. And so just having a quick decrease in interest rates, leads to a quick increase in price, which leads to this social flame feedback loop, some get overshoot prices and what to kind of expect will happen. Is prices are going to go up higher than they were before, even when you're gone for the lower interest.

LL: Is that what you're seeing happened in Canada? That's an area I keep my eye on and I'm just astounded by what's happening in Toronto. I don't know if you have a view, but I'd love to hear it.

John Wake: Toronto is or Canada is nuts. Yeah, and one of the things that they avoided … Canada used to be my hero because we got a lot of Canadian line down here in Arizona in like the year after our bill statements. And a lot of them came, they were paying less. It was like oh, I had a no mortgage and I paid it off. And so now they're my second home, the winter home down here. But in Canada they didn't have the reset. They didn't have the crash probably because oil prices were so high in 2008 and nine that their economy was so strong, kind of similar to Wall Street, with their exports to China at the same time. So they didn't get the correction they needed. They also would, they have a big problem with a lot of people like Chinese, particularly, just parking money in real estate in Canada. It's a way to keep out of the hands of their government in China, but it's also, so it's not, it's really bank. It's not really using homes for housing.

So I think that's a lot of what's going on in Canada. Is it’s a shame because I'm worried that they're going to end up being house bore where you can't buy a house, unless your parents can help you pay for it because prices are so high. And then you get this inequality between people, which is not good.

LL: So let's dive into that a little bit more because, you know, you talked about obviously interest rates going down, the greed somewhat ticking back up now, but that's very recent, obviously. But what happens with down payments? Because that's the other thing that seems to be a factor here, at least in my mind is great, you've bid these things up, but then the amount that you need to put down just continually increases. Does that have a drag factor on overall housing prices? What do you think to that?

John Wake: Yeah, well, in the US, to go way back a long way, like in 1950, to buy a house it was 20% down, was kind of the minimum. And then as time went on, now it's like, I think 5% is the most typical. And you can get down to three so people can buy, which just causes prices to go up. Because one, let's say you were thinking of buying and then you see prices going up fast. It's like, oh, I can get it. Let's buy now before prices go up anymore. It's the FOMO, the fear of missing out. Before the price go any higher, we're going to buy. And we only need 3% down. So instead of saving up for a larger down payment, they get in as soon as possible when prices are increasing, which and of course increases demand and increases prices further, which another feedback loop.

So that is, and particularly for investors, since I know you, that's your main thing is investors can come in pretty low as well. That varies a ton by country as well. So there's so … It's funny that you can't look at country by country, all the different, there's not like the IMF or somebody just laying out all the differences in the different countries in their mortgages and particularly how their mortgages are laid out. A lot of countries like we, and we'll have a 30 year loan is very common, but only 75% of the countries in one IMF study I saw weren’t 30. They were less than 30 years, was the typical mortgage. There was like a, gosh, I can't remember, like 25% were less than 20 years. 25% of the countries in this one study. Anyway, there's a zillion things going on. That's the length of the mortgage, what’s the down payment. I think it also adds when you make the payments low, you tend to get people who aren't, maybe they don't have the skills needed that they would have. Let's say, if you have to save up a 10% down payment, you may not have the same financial skills to get to three. So some people are buying at three that wouldn't have been able to get to 10 because they weren't ready for that kind of a … Their financial skills weren't there yet. If you made them get to 10, then of course there would be less for, those people who get to 10 are more likely to see ‘cause they have the skills. They also have the down payment and they'll be fewer foreclosures to drag down the market during that down cycle.

LL: It's an interesting point that you make around the differences between how mortgages work in countries. I don't think people fully appreciate how different it is in terms of length of mortgage, down payment, variable versus fixed, amortize it. It is quite stunning, even between Canada, the UK and the US, three, you know, relatively simple, similar countries, how different each of those operates. So I think your point is well made. Let me ask you to look into your crystal ball. And the million dollar question, which is, as you look at the US today, you talked a little bit about Arizona, which cities, which States, if you were buying, let's park the investment, but if you were buying, where do you think prices are going to go up in a healthy way?

John Wake: Yeah, wish I do. I love the market ‘cause it keeps surprising me, but right now what’s kind of the old wisdom is where are people moving? Where's the demand increasing because people are moving? Also, where are the good jobs? So that would, I should give you a warning on that. That being in Phoenix, people have been saying since I was a little kid that oh, this is great because people are moving here. And I remember the guy, an economist, he's really good, probably the most famous real estate economist in Phoenix saying in like 2006 or seven, yeah, or maybe six. He saying, yeah, we're fine because people keep moving here and guess what? They stopped. It had that’d been going on since after World War II, people were always moving here and then it slowed down and actually there was a year or two, where actually the population declined in Phoenix. No one foresaw that. So you got to be aware that there is that downside risk. The unexpected things happen with population, but I think that's a lot safer if you just say, hey, look, we see this trend. People are moving in these areas that really lowers your downside, the risk. But it could happen.

LL: Yeah. Having said that, then people moving, obviously New York City and San Francisco have both had a bit of a torrid time in the last 12 months. Do you see that trend continuing if the thesis is where people are moving because people are definitely exiting those two places or have been recently.

John Wake: Yeah, it was funny. I was just looking at something this morning about that looking at Metro, New York, not Manhattan, but Metro New York, prices have been trending down on a cost per income ratio, have been trending down. So that would fit the thesis that people are not moving in, the more people … Anyway, it's kind of a weak market. People aren't moving there. Yeah, well, I don't know what's going to happen, partly because gosh, you would think that with the work from home thing, that more and more people will be leaving San Francisco. ‘Cause a lot of it is just stuff you can do on a computer. I mean, that means Austin would be good. I don’t know, Austin prices are way up too.

LL: Interesting. Let's talk a little bit about the investing side then, as you said, this is why most people read and listen to Laziest Landlord. How do you think about investing in this market? I'd love to just get your take based on your point of view.

John Wake: Yeah, I was thinking about a couple of years ago. It was like late in 2018, I was at a seminar for property managers and they were saying a lot of their people they worked for were selling their investment properties. So this is late 2018 and their advice was, hey, you know, if you don't love it, sell it. But no one guessed at that time that, that was kind of the peak of though interest rates. Since then interest rates have just gone pretty much down for more than, for two years. So that kind of changed the dynamics and who would have guessed that prices would have gone up 20% in the last 12 months. I mean, just beyond. I keep thinking of my entire life, I'm always thinking interest rates can't go any lower ‘cause I'm from the older generation where I remember the 70s and how traumatic that was. And I keep thinking, oh, prices can’t, I mean, interest rates can't go lower and they keep surprising me.

But I should say right now, I don't think they can go lower, but it's always surprised me for the last 30 years. So maybe they'll somehow surprise me and get down to less than 2% interest rates. So that would change things as well, but where to invest, I don't know where it's going to happen, where it's going to be. The best I can see is go to a place without where tends to be people are moving. That's a battle. I'm sorry, I can't, I just … I'm sorry, I'm babbling.

LL: No, look, that's fine. Let me ask you, when you think about the values of single family houses versus multi-family, do you think that they value in different ways based on the way that you do your data and house price trends?

John Wake: I don't follow multi-family very much at all. My thoughts on a multi-family, just from observing is the people have been seeing for a couple of years that there've been a ton of investment in multi-family, but it tended to be luxury, but nevertheless, it was a ton of investment. And a lot of those projects are still being completed. But there's not a lot more going into multi-family as far as construction goes. So that would suggest that it could be weak. My biggest thing, and this is for family and multi-family is just looking at the demographics, it kind of looks like the demographics are, but there's a little bit more first time home buyer aged people heading in the market, so maybe 2025. So having that just a little bit extra push is really favorable to the market. But then after about 2025, 2026, there's fewer, a little bit fewer first time home buyers hitting that age. And that goes on for years.

And at the same time, boomers are going to start dying off. So I'm seeing the general tailwind we've been having for prices is going to become a little bit of a headwind for decades essentially after that. And so that's, so I would say if you're going to invest in something, make sure it's something that you're not depending on appreciation so much, unless it's going to be in the next few years, but after that, it's probably going to be more, you know, just a cash flow rental income. And I wouldn't be banking on appreciation after 2025 or so. And that's unless you're in a great market, you know, and everybody's moving there.

LL: Right. I'm always surprised at how much people do bank on appreciation versus cash flow, but that's my personal viewpoint. And I know everyone has a different one on real estate investing when it comes to multi-families. The point that you made around demographics, do you build demographics into some of your analysis at all today? You talked about interest rates and things like that. Do you think about demographics beyond the kind of more casual reference you've just made to it now?

John Wake: No, I just do it casually. I don't know how to incorporate that in. That would be a really complex model to get that. But just looking at the numbers, in fact, during the boom during the early 2000s, that was a time when there was a bit more of people hitting first time home buyer age. So that was there was a lot of things going on at that time, but that was another tailwind that had pushed prices up. And so we're going, and then it slapped off and there was a bit fewer per year. And now we're back into and have been for a few years of having more first time home buyers hit, the more people hitting first time home buyer age now until 25. Right. So but it's not, I'm not incorporating it in the numbers. I'm just sort of looking at it and guessing.

LL: Right. Last question, maybe John, if you, when you talk to people who are prospective buyers, whether it's single families or all multi-families, but when you talk to prospective buyers, what's the one thing you try and educate them on that you think there is maybe a fallacy out there from the way that you certainly do the analytics on your websites?

John Wake: Well, typically what I've been doing is to buy what I call a 10 year home, a home you'd be happy to live in 10 years. So even if it's kind of sad from our experiences in 2005, et cetera, that you can have a home that even if things go to hell in 10 years, it'll be back to where it was in worst case scenario. And so you're still secure there. And so that means if don't buy a home and if you think you're going to have to move in a few years, something like that. If your job moves you around a lot, because the market is tanking, you're in a bad situation, you have to sell that. But a lot of people, what they did is they became reluctant landlords, which, and you could still do that in the future as well even if you got caught with a home that was depreciated.

I certainly don't see any depreciation until maybe … Prices, my expectation is through this year 2021, prices are going to go up and probably into next year and then after that, I don't know, it could level off. But for our investors though, a big thing is like selling at the top. When do you, they say in stock, that's a really risky strategy, but selling at the top, if you have at least several properties, that seems like a pretty good strategy, is trying to predict when is the top? And typically what happened in our 2005 or whatever, that boom, prices topped out for like a year before they started to fall. Actually more than a year before they started to fall. So I think that's common, but just be aware also that during the savings and loan bust in 1990, I remember somebody telling me this, and I looked up the numbers, that they were thinking at the time, hey, you can buy now. You have plenty of time to sell because it takes time for prices to fall. And he said in 1990 in California, they peaked in like January started to fall in like March. So that caught a lot of people off. So in that case, you would want to be looking not so much as prices, but just sales. Prices may still be going up but if the number of sales is falling, then that's a scary sign that is losing upward momentum.

So anyway, I expect prices to go up and flatten out. But nevertheless, you could, you got to be aware that sometimes if you're trying to be a top picker that they can come down quickly. In that case, I haven't done this yet, but I would say the first thing to look at is look at sales, the number of sales.

LL: That's a great way to kind of run out of the conversation and end it. John, thank you for the insights and for those of you who don't know, John Wake, you can go to his website at realestatedecoded.com. I promise you, it's a fascinating look and I've gone there on many evenings, geeking out as an engineer. So thank you again, John.

John Wake: Yeah. Good. And so could check me out @JohnWake, Twitter.

LL: Terrific. Thank you, John.

John Wake: Thanks. Take care.

You can also find John's website here

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