The Investment U e-Letter: Issue #442
Monday, June 6, 2005
Housing Bubble: The New Real Estate Conspiracy
By Dr. Steve Sjuggerud, Chairman, Investment U
You don't believe that housing bubblenonsense do you? Don't you know... it's just a conspiracy..."
I can't wait to see where this one goes. The local real estate agent continues...
"You see, the guys on Wall Street are angry. We've been taking all their business for five years. So now they're striking back. The Wall Street guys claim there's a housing bubble because they're after your money. They're trying to get your money out of real estate and back into stocks."
I laughed on the inside. And I knew I had to share this with you.
Conspiracy theories always seem to show up in the financial markets. We've had them for years in gold and in the stock market. I guess it's now real estate's turn. Today, I'll briefly show you why I think real estate is in danger, and what I'm doing with my own real estate dollars.
A Housing Bubble Conspiracy In Real Estate?
This local agent has seen what's happened here on the Florida coast Here's the latest anecdotal evidence on the purported housing bubble
- I had lunch with a friend today who bought a few acres here four years ago for $75,000. He told a realtor he'd take $465,000 for it, net, and the realtor said he'd sell it.
- I was over at a friend's house yesterday. He lives in a relatively new neighborhood with about 25 homes close to the beach. He probably bought it around 1999 and said he "has $180,000 in it." Another house in his same small neighborhood is for sale today - for $999,000.
If my friend paid $180,000, then that house for sale today was likely less than $300,000 back in 1999. Now they're asking $999,000 - for a cookie cutter-house, in a cookie-cutter neighborhood, with nothing special about it.
It's a frenzy in Florida now. "Get in before you can't afford it anymore." That's the name of the game. Don't worry. Reality will assert itself...
Some "Real Facts" on the Housing Bubble
So that's some anecdotal evidence. Now let's look at some housing bubble facts
For hard evidence, Jim Grant reported some fascinating numbers in his latest issue of Grant's Interest Rate Observer. Jim says that from 1983 to 1998, housing sales stayed relatively constant, representing between 8% and 10% of GDP (the economy). Then things took off
As of the latest numbers, home sales as a percent of the economy are at 17%. For the statisticians out there, that's 3.4 standard deviations from the mean. For the non-statisticians out there, speculation in home buying is literally off the charts. Said another way, it's not a Wall Street conspiracy that speculation in housing is at a statistical extreme; it's a fact.
Grant simply can't fathom the speculation in the housing market. Grant brings up a point about this: He basically says if you buy a house hoping to flip it within a year, you're hoping for miracles as you have to sell the house at a profit of greater than 15% more than you paid for it, just to cover the expenses incurred along the way (commissions, property taxes, taxes on the transaction, the interest incurred from holding it a year, maintenance, etc.)
It's hard to be a short-term trader of real estate, when every flip has a 15% hole in the bucket. But all over Florida these days, people are lining up to give it a try.
The talk of "conspiracy" shows up whenever an asset gets really out of line with reality for long periods of time. The story usually starts with some basic truth, and then twists it completely out of reality. It's happening now in real estate.
It's the New Real Estate Conspiracy.
And like most financial conspiracies, it's complete garbage. Again, it's not a Wall Street conspiracy that speculation in housing is at a statistical extreme. It's a fact.
What I'm Doing With My Money
Personally, instead of taking equity out of my house to buy more properties, I'm doing exactly the opposite. I've done what I've recommended my readers do which is pay off at least half of your mortgage. Personally, I'm going to keep paying mine down to zero. No matter how you look at it, housing is still debt that you owe. As you might guess, I'm not interested in looking at any U.S. housing property, period.
Please note, I'm not part of "The Real Estate Conspiracy" that this real estate agent is worried about. I don't work for Wall Street. I don't get paid a commission if you buy a stock (or a house). I simply look for cheap, overlooked investment ideas. Right now, it's impossible to call real estate "cheap and overlooked."
Nobody can say when it will end, or if the housing bubble will burst. Heck, tech stocks were expensive and likely "in a bubble" in March of 1999 - and they managed to double from March 1999 to March 2000. So there could be plenty more gains on the way, before the fun ends. Before the statistical extreme reverts back to the mean. But it will end. It makes no sense that the median household can't afford the median home where I live.
I'm quite okay missing out if the housing boom continues. Why? Because real estate can't be dumped like a stock when you need to get out. So I'm content that I'm out of the game, doing the opposite of everyone I know, reducing any debts (including my mortgage) toward zero. It may sound crazy to you, but I'm comfortable with it.
My Plan: Follow Eduardo's Lead
One of the greatest investment lessons I've learned is from Eduardo Elsztain. Eduardo has amassed a collection of Argentina's greatest real estate assets over the course of 20 years as head of Cresud (Nasdaq: CRESY).
Eduardo's technique for acquiring fantastic real estate properties at fire-sale prices has been simple - he's had tons of cash available to buy properties when nobody else had any cash.
It's worked time and time again for him. Argentina has had many up and down cycles. Eduardo has bought when things look terrible, and sold when things look great.
Right now in the States, things look great. So Eduardo would sell. Amazingly, nobody can even remember the last time when residential real estate prices actually fell nationwide. But they still can fall
For decades up to 1989, the Japanese felt the same way real estate looked great, it had never declined. And then their housing bubble burst. It fell for years EVERY YEAR for the last 15 years, real estate housing prices in Japan have fallen.
I'll follow in Eduardo's footsteps, and have a pile of cash available to buy up the bargains when prices are cheap and landowners are ready to just get out.
Hmmm maybe a trip to Japan is in order.
Today's IU Cribsheet
- For more on real estate investing - and whether or not a housing bubble bust is headed our way - check out Investment U e-Letter # 423 - The Real Estate Bubble End Result: Is a Bust Headed this Way? Also, for specifics on recent U.S. home prices see the National Association of Realtors Housing Affordability Index (you need to have Adobe Acrobat Reader installed to view this chart): http://www.realtor.org/Research.nsf/files/REL0502A.pdf/$FILE/REL0502A.pdf. The NAR has a great website, to http://www.realtor.org/