Housing Bubble

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(This was originally written in July 2005, but still has a lot of relevance)



On someone's website:





"Besides once in California, which completely recovered in a short period of time, by the way, can someone please show me an example of a "Housing Bubble" that burst that did not completely recover within a few (i.e., 3-10) years?



"Housing Bubbles" were invented by stock brokers, and real estate remains, and will almost assuredly remain, your absolute best investment."







(me again)



Actually, California pricing has reliably gone through cycles within my lifetime. We have hit the peak of the fifth one I remember (1991 was the last peak, which makes this the longest period between peaks ever. Previous peaks were mid 80s, about 1978, about 1970, and one when I was very young), and started a downslide. Right now it is primarily the higher end properties which have been hit, but it's starting to push the middle down as well. It is important to note that with the exception of the slide of 1929 to 1932 (when real estate prices fell, as well, and didn't come back to 1929 levels in most of the country until after the war), the stock market has not had a slump which it didn't come back from within ten years, either. Furthermore, when you consider returns uncorrected for leverage, the stock market reliably outperforms real estate over the long term.



In fact, nobody that I'm aware of has said that anyone who intends to buy and hold for years cannot make money - a lot of it - in the current market, even if prices do fall for a while. The problem is in the formerly large number of people looking to buy a property with the intent of "flipping" it for a quick profit. As the ability to buy your average property with the goal of selling it in six months for a substantial profit even after paying transaction costs is just about dead, so too are those deals that would have been made by those buyers. This has the effect of reducing marginal demand, and voila!, the prices are starting to slip. I (and every other bubble proponent out there that I have read) am confident that the prices will come back eventually. The question now, as in the stock market bubble that ended in 2000, will be how long it will take to come back and how far down it's going to go. Right now, lots of people are still down more than 50% from the stock market peak in March 2000. If they need to retire, or need the money for some other reason now, they are stuck. The same goes with housing, which due to the increased leverage of the investment can be much better when it's good to much worse when it's bad. There are at least three "short sales" (where proceeds will not cover obligations) in process in my office right now. If you can't hang on, it does not help you that prices will come back eventually. There's an awful lot of "Negative Amortization" loans out there that will be coming up on recast in the next 18 months, as well as "interest only" loans where the people just cannot afford the amortized payment. Be prepared for problems when they do, as this is going to significantly enlarge the supply (Inventory in many markets is over 200 percent of last years levels already, and mean time on market is even higher as number of transactions slips). The fact that prices have slipped will place many people temporarily upside down, and so unable to make their payments and unable to refinance when their loan adjusts or starts amortizing. Expect foreclosures to further increase the supply of available units.



If you are heavily leveraged on a short term loan (total loans against property total over 70% of current value, and most especially over 80%), I seriously suggest refinancing it into a longer term fixed rate loan now, while appraisers can still find justifiable comparables that use peak real estate values. It is entirely likely that any property which has changed hands in the last couple of years, at least here in urban or urban fringe California (and many other markets, as well), is going to end up upside down for an unknowable period of time.



I am a Loan Officer and Real Estate Agent, and still have current financial licenses which I have not yet abandoned. Real Estate Bubbles are not "invented" by stock brokers; the just ended bull market run in housing was the longest in recent memory partially due to peripheral psychological factors on behalf of investors "chasing returns" in what many will tell them is a "safe market", as well as things having to do with the financial aftermath of 9/11 as well as overcompetitiveness on the part of many pieces of the financial market, most particularly the subprime and Alt-A market. As a particular prediction, when the fall off from the current market is over and done with, I wouldn't expect there to be any lenders willing to go 100 percent on the value of a property for quite some time. There are many people out there too young to remember previous housing cycles, and partially for this reason and partially because the housing markets are more heavily leveraged than at any point since the Depression, I expect to be in for a couple of UGLY years.



I would be delighted to be wrong. Nobody will be happier than me if you can crow at me in a few years time "Told ya!" But I see what I see, and I won't lie about it to anyone (especially not clients) simply because it makes it easier to earn a commission. If you happen to be in the real estate business, be very careful what you tell your clients, or, at least in California, you'll likely wish you had.



Both real estate and the stock market go through periodic downturns. The question is not if, but "when" and "how much" and "how long." You always need a place to live, and you can make money if you invest prudently in any market, and the permitted leverage upon real estate together with favorable tax treatment gives it an advantage that's hard to beat. I had clients make double digit positive returns in each of 2000, 2001, and 2002 in the stock market, too. They were the ones who didn't get greedy (2003 was a rising tide that lifted all boats. It isn't genius when everybody makes 25%). Even in this market, you can make money on real estate, just like you could in the stock market when it was sliding.



In both cases, "time in" counts for more than "timing", but that's not the mentality you encounter in the average client. See my post Getting Rich Quick In Real Estate and Cold Hard Numbers for more information, but although real estate can be the best possible investment if you handle it correctly, it is not liquid. In fact, it is just about the least liquid investment you can make. You cannot go to your real estate person, as you can to a financial person, and say "liquidate it for cash" and expect to have a check for market value within a few days. You have to find a willing buyer. This is one reason for the existence of the "bigger fool theory," and sometimes that bigger fool doesn't come along when you need him to.






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This page contains a single entry by Dan Melson published on July 14, 2007 10:00 AM.

Getting Rich Quick in Real Estate was the previous entry in this blog.

Buyer's Appraisal versus Seller's Appraisal is the next entry in this blog.

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