Robert Campbell, author of The Campbell Real Estate Timing Newsletter, a subscription-based bimonthly newsletter, says that his biggest concern about the California housing market is creative financing.

In his November, 2005 edition, Campbell writes, "Creative financing can be very dangerous when the price of the asset loses significance. People start believing that it doesn't matter whether a home sells for $200,000 or $400,000 because the monthly payment is the same. Sorry, but when mortgage loans are based on fictional values as opposed to true values that are supported by economic fundamentals, financial bubbles can develop that eventually implodes."

Markets are mean-reverting, which he says explains why booms are followed by busts. Prices will fall and revert back to true economic value if they have become overvalued in a boom. He considers vital signs to be: existing home sales, new home building permits, notices of default, foreclosure sales, and interest rates, but looks at many more indicators to arrive at his market timing solutions.

Like other investors, Campbell compares housing to stocks, and believes that when investors push prices up beyond the fundamentals of earnings, stocks invariably make a correction and return to the mean. Housing's "P/E" ratio can be valued in a similar fashion to stocks. The price of homes is compared in a ratio with the income needed to buy them.

Using that calculation, California homes are overvalued, he says. "In September 2005, the median price of a CA home was $544,000 and the median household income was $60,300. This puts the P/E ratio at 9.4, which is a level of extreme overvaluation based on 26-year norms. From 1996 to 2005, CA home prices rose by $366,000, a phenomenal 305 percent rise, while CA incomes rose by $17,000, a 40 percent rise."

To calculate how housing prices would fall if they were to revert back to the 26-year average for the P/E ratio, Campbell multiplies $60,300 by the average P/E ratio of 5.2. If the market reverts to the mean, housing in California should cost about $314,000, which makes it susceptible to a stomach-lurching 42 percent drop.

"Pushed to extreme levels of overvaluation by greed and easy money," writes Campbell, the California real estate market is now a bubble. Housing prices have risen to a price/earnings ratio that is significantly out of balance with sustainable economic fundamentals. When a bubble bursts, history shows that , at a minimum, prices will retreat back to levels that are consistent with long-term norms. Sometimes, however, over-inflated asset prices fall to P/E ratios that are below the long-term norms, when this happens, the stage is set for the next great buying opportunity." P/E's were at their most favorable in 1985 (4.1) and 1996 (4.1). If incomes rise 4 percent annually, creating an average income of $70,500 in 2009, home prices should fall to $303,150.

That would represent a 44 percent decline from today's median home price of $544,000.

If that's not enough for speculators to mull over, Campbell has more.

California homes have always sold for a significant premium compared to other U.S. homes -- 63 percent more since 1968. In Sept. 2005, the median U.S. home was $212,000. The same home in California should cost $346,000 (212,000 x 63 percent, add result to 212,000.) If the median home in CA is $544,000, the market is overpriced by $199,000.

With market bottoms in 1983 and 1996, the market premiums were 63 percent and 50 percent, for an average of 57 percent. That means the current market would have to drop 39 percent to meet that lowest average. Using a 38-year historic norm, housing prices would have to drop 36 percent to $346,000.

Now, if only someone had a boom calculator that could price in human nature because it's highly unlikely that with today's easier credit, that investors, speculators and homebuyers would ever let the real estate market get that low again.

Published: December 27, 2005

Use of this article without permission is a violation of federal copyright laws.

Blanche is a renowned author of five real estate books. Her newest, Bubbles, Booms and Busts: Make Money In Any Real Estate Market, McGraw-Hill, was rave-reviewed by The New York Times. She was also selected from hundreds of real estate experts to contribute to Donald Trump's book, Trump: The Best Real Estate Advice I Ever Received: 100 Top Experts Share Their Strategies, Rutledge Hill Press, and is featured on page 68. Order Now Review - Honors In 2006, Blanche was selected among scores of candidates to author two consumer real estate guidebooks for the National Association of Realtors: The NAR Guide to Home Buying, and The NAR Guide to Home Selling, Wiley & Sons. She is currently planning two new books for the NAR and its members.       Known for her keen insight into real estate industry issues and for her ability to make complex subjects easy to understand, Blanche is a sought-after keynote and continuing education speaker. Real estate organizations from MLSs, to brokerages, to franchisors, to associations hire her to provide up-to-the-minute analysis of real estate industry news and advice on how to improve revenues. Her passionate delivery, peppered with stinging wit, is a huge hit with audiences and fans. Don Klein, CEO Greater Nashville Association of Realtors, Blanche Evans, Richard Courtney, president 2007, GRAR "The GNAR membership meeting last week featured Blanche Evans as the keynote speaker. Her comments and insights resonated extremely well with those in attendance and we have had many requests for copies of her PowerPoint Presentation. She was a terrific part of the membership meeting and convention program!" - Don Klein, CEO Greater Nashville Association of Realtors Coverage from WSMV, Nashville - 8-14-2007 That Interview Guy - Get Inside The Head Of Today's Generation 2007 AE Institute Session - To purchase 2006 AE Institute Session - Parts 1 2 3 4 5 6 7 8 9 HouseValues Mastermind call - Parts 1 2 Blanche's fireside chat with Jeremy Conaway, HAR - Click here. For more articles by Blanche, click here.