Real Estate: Apocalypse Now

Courtesy of The New York Times

What has caused the great industrial conglomerate of General Electric (GE) to be trading at a single digit today? It is because of their stupid decision to get into financial services by establishing and using GE Capital to manipulate their earnings. So much for beating Wall St. consensus by one cent for consecutive 30 quarters since 2000, while their stock has been dropping from $60 to <$10. I guess everyone playing this game of financial manipulation and distortion has to pay for it sooner or later.

Then what has caused the financial apocalypse? It isreal estate. The New York Times put out a great chart in 2006 (2-1/2 years ago, with little attention from readers until now) during the peak of the real estate market, as shown above. It gives a very long history (116 years) of American home values (inflation adjusted). Currently the Shiller real estate index is around 160, down from the 200 peak when published at that time.

I indicated here in late January that the banking index can drop another 50% (which is getting close today, a month later, by acting as a leading leveraged indicator to the continuously falling real estate market) and remain flat for the next 20 years (still yet to be seen). This real estate chart shows the same story. The Schiller index is likely not getting any support until around the 110 level, falling another 30% from today’s level, and 50% from the 2006 peak. And it can remain flat for the next……(I don’t even want to say it).

Just remember that the historical home value index, with inflation adjusted, had stayed flat from the mid-1940s to the mid-1990s. So much for the myth of home value always going up. And who said we never had a down year in the national housing market since the great depression?

As with everything else happening in the world, like a pendulum, the higher it goes, the harder it falls.

Comments

[Big K:]

Homes are really just a pile of bricks and sticks. I never understood why homes got so ridiculously overpriced. I looked in Florida 3 years ago, right at the peak, as it turned out. There was a scarcity of homes for sale in desirable areas, multiple bidders, and prices were sky high. I mean half a million and up for an ordinary home, and if it were on water, then a million and up. These are just regular 3 BR, 2.5 BA homes. Fortunately, I realized that I couldn't afford that, so I ended up not buying anything. The atmosphere at that time was if you had something there, you were lucky. It gave people the opinion that no price was too high to get into the club. As my real estate agent drove me around, she pointed at various lots saying, "that's mine, that one over there is mine too,,," I even joined lotteries to be able to purchase a unit in new condo projects, and lost! Thousands would join in, and there were only a few hundred units. Not everyone could be so lucky to join the club. Now I realize I was lucky to have lost those opportunities. Time to get real about real estate.

Feb 21 01:16 PM

[TKO:]

Your interpretation is compelling at first sight, but I believe you are looking at the wrong variables here. When I choose to buy a home, I will look at my income level and determine the 'band' of home prices I can afford. We all need to live in a home, one way or another, and we will most often choose a home that is most desirable out of the homes in the 'band' of prices.

The view that homes are investment vehicles are totally wrong. They should be viewed more as an alternative to rent, which is an expense.

As for a better graph of the real estate picture: static.seekingalpha.co...
I give credit to Tim Iacano for his article: seekingalpha.com/artic...

If we take a totally different angle and compare median home prices to median household income, and factor in a historically low interest rate at this current time, real estate almost seems undervalued.

The truth lies somewhere between your interpretation and Tim's interpretation.

Feb 21 01:42 PM

[Moon Kil Woong:]

The problem was not housing prices. The problem was that the home market became noting but a vehicle for highly leveraged speculation from homebuyers who couldn't afford what they bought all the way up to brokerages, insurance companies, and banks that gambled packaging loans, mortgage derivates, etc. and dumping them on Fannie Mae and Freddie Mac (essentially the taxpayer because the taxpayer is represented by those who are stupid and/or greedy and easily manipulated by lobbyists).

Feb 21 02:16 PM

[ArnoldCountry:]

I think the analysis by Tim and Mr. Tan are extremely sound. One big problem with analysis is that it is a view of the past. Tim is one of my favorite contributors on here but I think even he would say that what will come to all of us in the future is, at best, an educated guess using the past and current data to assist with that guess. In some ways we have all created a perfect storm with this crisis. The combination of Wall Street, lending methods, guidelines, building, regulation, securities, insurance, and most anything else you can think of have all worked together to create this situaiton. The past tells us that when we hit bottom we will stay at bottom for a while, how long is anyones guess. My best guess at this point is that we are going to be in this perfect storm for a while and when the storm ends, we will hit a period of calmness and sometime we will recover. I have great respect for the opinions of many of the authors on here and whether I agree or disagree with any of them, they all make interesting points which help me craft my own opinions of which I make decisions on. I thought this was a good article in articulating good data to me. I liked it... but Tim still makes one hell of a great case. I suggest we take a look see each month on how this is all going. If you like roller coaster rides, this housing crisis wins.


On Feb 21 01:42 PM TKO wrote:

> Your interpretation is compelling at first sight, but I believe you
> are looking at the wrong variables here. When I choose to buy a home,
> I will look at my income level and determine the 'band' of home prices
> I can afford. We all need to live in a home, one way or another,
> and we will most often choose a home that is most desirable out of
> the homes in the 'band' of prices.
>
> The view that homes are investment vehicles are totally wrong. They
> should be viewed more as an alternative to rent, which is an expense.
>
>
> As for a better graph of the real estate picture: static.seekingalpha.co...
>
> I give credit to Tim Iacano for his article: seekingalpha.com/artic...
>
>
> If we take a totally different angle and compare median home prices
> to median household income, and factor in a historically low interest
> rate at this current time, real estate almost seems undervalued.
>
>
> The truth lies somewhere between your interpretation and Tim's interpretation.

Feb 22 11:22 AM

[Mad Hedge F...:]

In case you missed the business section of the San Francisco Chronicle, there is a fabulous graphic illustrating the hard times for the city’s commercial real estate market. The epicenter of the melt down is Tishman Speyer’s 556,000 sq. ft. 555 Mission Street, which opened in late 2008 during the worst possible market conditions, and remains 70% empty. What is really impressive is how bad the implosion of the legal profession is hitting landlords. The dissolution of Heller Ehrman has emptied 350,000 sq. ft. 333 Bush Street, while 388,000 sq. ft. 101 Second Street has been vacated by the dissolution of Thelen LLP. Conditions will worsen as more new buildings started during better times come on the market.

Feb 22 01:01 PM

[Dave Shafer:]

Sorry Mr. Tan but that chart is irrelevant sitting by itself. You see real estate is both a consumer item and an investor item. Therefore, it is the supply and demand issues that determine price. Now admittedly, easy credit perverted the supply/demand curve leading to our current issues, but at its base it is still a consumer item or an investor item. The question that needs to be asked is will the demand for a place to live go down, stay the same or go up in the future? And further, will more people be able to buy or more people have to rent? As a consumer item, I don't see "owning your own home" being any less desireable today than it was in 2000 or 1960. But the truth is that when reasonable credit underwriting is in place, we hit a wall of practicality at about 63-65% home ownership. The rest of the populace then needs to rent. So given small increases in population there would be small increases in demand for both rentals and home ownership and vice versa if we were at that 63-65% range. Since we are not quite down there yet, we can assume an increased demand for rentals and a lowered demand for personal residences over the next couple of years assuming static population.

Any rational discussion of real estate values needs to talk about population shifts/increases/decre... in any given area and incomes in that same area. Population increases and decreases will determine whether the overall demand for a place to live goes up or down, while income will determine the pricing of personal residences as well as constrict rents achievable and therefore pricing of investment property.

Your chart would be much better if it also overlayed a family income line on top. You would be on to something if you then added in population shifts for each individual market.

Feb 22 01:14 PM

[henarl:]

constructe: All of those problems that you enumerate in your comment were caused by individuals who were personally profiting (or who thought they would) short term, without concern for the longer term consequences to other people or society as a whole. This is an inherent part of human nature and will continue to be for the foreseeable future, We can expect more bubbles, crashes, economic failures, etc. for probably the remainder of human history.

Feb 22 01:25 PM

[MarkitWacha:]

Good article. I think that there are some factors that people are overlooking. For instance, real estate prices are driven by supply and demand. On the demand side, there are investors, and there are people who need a home. In this real estate contraction, investors have been rejected by the banks, via a limit to how many houses a single investor can get a loan for. Chase won't write a loan if it's your 5th house, for instance. That's a new dynamic. On the other hand, there has been increased enforcement of the current law regarding illegal immigration. When no immigration reform was passed a few years ago, the enforcement was stepped up. That drove out many families from the exact same states that attracted them in the first place - California and Florida. Is it just a coincidence that subprime loans became toxic in these same areas when immigration law enforcement increased? If the feds are successful at forcing out 10 million illegals, think about what that will do to housing prices. In my opinion, it's just another case where government has failed.

Feb 23 03:41 PM

[Mad Hedge F...:]

Here is a novel plan put forth by a hedge fund in Florida, Derivatives Bridge, LLC. Securities backing performing mortgages worth 100% are being sold for 20% because there is no market for these securities. Have the government buy these securities for 60%, rescuing the banks, and then sell them back to the original homeowner. The homeowner then is able to refinance his home, see his mortgage principal drop by 40%, restoring his net worth, and purchasing power. The cost to the taxpayer is zero. This is already possible in some countries like Denmark. If someone offered me a deal like this I’d take it in a heartbeat, even if I had to clean out the sofa cushions and raid my kids’ piggy banks. They say necessity is the mother of invention.

Feb 26 08:22 AM

[Evan G.:]

I agree that a 'home' isn't an investment. However, this article inadvertently illustrated the advantages of income-producing real estate.
Here's a simple example:
In 1945, a person could buy a rental house *with leverage* and have the tenants cover the mortgage, taxes, insurance, maintenance, replacements reserves, and 'property management'. Despite the fact that inflation adjusted home prices "stayed flat from the mid-1940s to the mid-1990s", your wealth has been magnified through leverage and protected from inflation. It would be interesting to see a graph of gold prices adjusted for inflation over the same time period.

Feb 27 05:06 PM

[Evan G.:]

...Learn something new every day...during the glory days of a 'Gold Standard' the price of gold was fixed at $35/oz from 1946 to 1971.

Mar 02 09:02 PM