What's the Worst Case Scenario for Real Estate? 34 comments
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What is the worst case scenario for real estate? Over the long haul there has often been a debate about whether equities or real estate is a better investment. What about considering that the worst case scenario for real estate is no worse than the worst case performance for stocks? That is not such a far fetched thing to contemplate.
David Rosenberg, Chief Economist for Canada's Gluskin-Sheff, had an interesting graph last week (here).
The differential between stocks and real estate over the ten years ended July is huge. For real estate to equal the return on the S&P 500, the sector would have to lose 38% ([1.62-1]/1.62) to get to break even and then another 16% (26%/1.62) to equal the return for stocks. In other words, real estate would have to lose 54% of its value in July 2009 to equal the ten-year performance of the S&P 500 index.
Many analysts have reported that commercial real estate is just entering a major devaluation phase, whereas residential real estate has already experienced significant declines. For this reason, while it might be of value to consider whether or not a 64% decline might occur in commercial real estate, it is unreasonable to ask the same question about residential property.
First, lets consider relative valuations in 1999. Most areas of real estate had much less valuation bubble built in in 1999, compared to stocks. So, my back of the envelope SWAG says that part, if not all of the ten year loss in stocks might be attributed to the relative over valuation in the summer of 1999. Secondly, the loss shown for the S&P 500 is and index loss and the total return would include dividends, which zero out most of the 26% loss shown. So on a total return basis, stocks are back to ten years with zero return and real estate "only" has to lose 38% to get back to the same return as stocks.
Commercial Real Estate
Commercial real estate has a return based on rent or lease fees minus maintenance and carrying costs (mortgage interest, insurance, etc). If that net return is 5%, the compound ten year return is 63%, almost the exact amount shown in the graph. To get to zero total return that same amount, or 63% of the initial investment must be lost. If we consider the average mortgage to be 80% (again, my SWAG) the loss in value is only about 13%. So, for commercial real estate to have a ten-year investment return equal to stocks, the price for a mortgaged property would only have to drop by 13%. For smaller mortgages, the property market value would have to drop more: for a 60% mortgage, the drop would be about 25% and for a 50% mortgage, the drop would be about 37% in market value.
Considering the outlook for commercial real estate, it is quite likely that the graph shown, when redrawn in 1-2 years, will show commercial real estate investment with a similar near zero ten-year return.
Residential Real Estate
The best comparison here is made by simply comparing the current market price of a home to that in July, 1999. The zero total return for stocks is equaled by a residential property when the current average price returns to the 1999 price. According to the Case-Shiller National Index, the average U.S. home price at the end of the second quarter, 1999, was $94,750. As of the end of 2Q/2009, the average national price in the same index was $135,000. This means a drop of approximately 30% would be required to get a ten-year return on a home to equal that of the stock market!
This is an astounding number, larger than any other estimate that I have seen and much larger than estimates I have made from other data. It is 5% greater decline than the estimate given recently by Meredith Whitney. Whitney's estimate garnered headlines for its extreme size. Well, it's possible to come up with an even larger estimate.
Conclusion
I consider this estimate about real estate prices to be interesting, but semi- frivolous. Stock prices will go up or down from July 2009. We know that stock prices went up some more after July 1999, and then went down a lot into the middle of 2002. This means that the 10-year return on stocks will change significantly over the next three years as the starting value changes, depending also on the future price patterns coming.
Semi-frivolous or not, it is something to think about.
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I agree. you have to start from where you are - and evaluating the past performance will not show you the future.
but i wonder if gold is not in a position for a repeat performance.
I'd watch gold very closely 2018-19 for an exit point.
The economic, business, risk, and international flow of goods and services conditions and consumer attitudes that existed until Sept 2008 are highly unlikely to be replicated in the next decade. As the circumstances will be so different, I think, so will the performance of different asset classes be markedly different in the years ahead ,compared with historical experience
,
2. Real estate, whether, residential or commercial, is not a single asset class. The markets are zip code or at least cluster of zip code oriented. Given the growing demographic and economic divergence between different regions of the US, it seems to me that, in a few years, the population/economic growth regions of the US will show much higher returns on real estate, especially rental and lower to medium priced owner occupied real estate than, say, California, the Midwest or New York and New England.
Thus, some real asset categories in the South, Southwest and Mountain states may evince quite to very attractive 10 returns, starting from a 2010 base while other categories(eg high end homes and category1 CRE) in California or Michigan may have zero to negative returns even from the lower 2010 base.
3. Several energy assets may well outperform most, maybe all, major asset classes over the next 10 years and ought to be analyzed and considered separately from other commodities. Selected agricultural and water assets may also have substantial upside , starting from a 2010 base.
For instance, has it occurred to anyone that Gold (due to its relatively high price) is now discarding many of its usual industrial uses, and pricing itself as a jewelry item out of the planetary middle class?
And that assumes that its current difficulties exceeding $1000 resistance continue in some form or another.
The vision of Gold as once again resuming its historic role as currency - or at least a solid exchange item for gold-backed currency - sometimes ignores the fact that without the yearly consumption of tons of gold in industry and jewelry it becomes overly reliant on political and emotional drives to maintain a steep increase in value.
IF for some crazy reason the world rejects the idea of returning to a gold standard for the primary currencies, the picture could become cloudy indeed.
There can be no doubt that the sclerotic foreclosure system and the effort on the part of banks to delay the last step in the foreclosure process to avoid impairments will ultimately unleash neighborhoods of foreclosures and flood a fragile market which will push prices further downward after enjoying a breather in a free fall. We could be looking at another contraction of four to six points in the CSI, hastened by expiration of the tax credit that punishes renters.
Looking forward, we have to curtail production until there is some semblance between supply and demand; once equilibrium is found, prices are highly unlikely to increase at the granular or macro level at the pace they did in the recent past. That was a result of a confluence of historically unique conditions that are unlikely to be seen. Barring history repeating itself, home price appreciation, when it occurs, should be muted.
Interestingly, yesterday after Commerce reported the increase in housing starts it was also disclosed that Robert Toll (CEO of Toll Brothers) sold a total 1.6 million shares of his company’s stock.
what is your definition for SWAG?
thanks in advance
Completely agree with the conclusion. Perhaps a comparison between the 1997-2009 stock market and the 1995-2007 real estate market (not sure about the exact years) would factor in cyclicality a bit more.
Sorry for the delay is answering - I was out of town for a family wedding and just returned.
I am showing my age. When I was much younger the term SWAG was in common use. It stands for "Simple Wild-Ass Guess."
seekingalpha.com/insta...
STOCK MARKET RETURNS
1923* DJIA @ 75.23 - 1929 DJIA @ 331.65: BUBBLE INFLATION CYCLE: Positive 400%. Positive 67% per year.
1929 DJIA @ 331.65 - 1947 DJIA @ 175.66: BUBBLE DEFLATION CYCLE: Negative 47% : Negative 3% per year.
1947 DJIA @ 175.66 - 1965 DJIA @ 854.36: BUBBLE INFLATON CYCLE: Positive 386% : Positive 22% per year.
1965 DJIA @ 854.36 - 1983 DJIA @ 1045.07: BUBBLE DEFLATION CYCLE: Positive 22%: Positive 1% per year.
1985 DJIA @ 1045.07 - 2001 DJIA @ 10,604.59: BUBBLE INFLATION CYCLE: Positive 915%: Positive 51% per year.
2001** DJIA @ 10,604.59 - 2019: BUBBLE DEFLATION CYCLE (through 2/09 DJIA @ 7850.41): Negative 26%: -3% per year. I will update this again in 2019 (if I am able).
On Sep 20 11:54 AM Ricard wrote:
> "I consider this estimate about real estate prices to be interesting,
> but semi- frivolous. Stock prices will go up or down from July 2009.
> We know that stock prices went up some more after July 1999, and
> then went down a lot into the middle of 2002. This means that the
> 10-year return on stocks will change significantly over the next
> three years as the starting value changes, depending also on the
> future price patterns coming."
>
> Completely agree with the conclusion. Perhaps a comparison between
> the 1997-2009 stock market and the 1995-2007 real estate market (not
> sure about the exact years) would factor in cyclicality a bit more.
I don't have the data you are looking for. It is an interesting question, so I'll keep an eye out for a lead I can follow.
On Sep 20 10:07 PM John Lounsbury wrote:
> Michael - - -
>
> I don't have the data you are looking for. It is an interesting
> question, so I'll keep an eye out for a lead I can follow.
Actually, chartoftheday.com has done that too. I extended the idea to look at the average price of houses compared to other commodities as well, seekingalpha.com/artic...
A formula for making money in the residential real estate market of the past 7-8 years was to build a house for $300,000 around the turn of the century (probably still worth about $300,000 in many places) and install an extra $100,000 worth of gold fixturing (worth about $400,000 today). Market value today about $700,000 for $400,000 invested.
Of course, I jest. You could come right back and tell me that I could have sold the whole contraption for $800,000 to $900,000 2-3 years ago if I was so smart. And I would have turned all the appreciation in gold into a $500,000 home capital gains exemption so it would be tax free.
Another frivolous example of how to get rich with 20/20 hindsight and ridiculous hypotheticals.
Thanks for your comment. I hope you don't mind me doing something ridiculous with it.
On Sep 20 10:43 PM lower98th wrote:
> I am pretty sure that soon someone will post a chart of housing prices
> over time in gold.
My friend also owns the kalarhythms.com site. If you go to these sites, you will be blown away with both site's endless content.
Also: cycleslibrary.org
Another good article, John, about depressing truths.
The Foundation for the Study of Cycles has recently entered an exclusive agreement with Weiss Research (Dr. Martin Weiss) for the marketing of their market timing related tools: www.moneyandmarkets.co...
On Sep 21 02:27 PM Mayascribe wrote:
> Michael Clark: Have you ever heard of cycles.cc ? Very much
> into what you're writing about. Been around for 50 years. They are
> holding an international conference in New Mexico this coming November.
> A very good friend of mine now runs it. Saturday, he called me for
> angles about how the business and market cycles relate to the Mayan
> calendar, especailly the 12/21/12 date. We talked for quite a while.
> This is a scientific site, not spirituality oriented.
>
> My friend also owns the kalarhythms.com site. If you go to
> these sites, you will be blown away with both site's endless content.
>
>
> Also: cycleslibrary.org
>
> Another good article, John, about depressing truths.
The cycles I write about came out of the blue last year when I was working on a book about the financial crisis. I was aware of cycles before -- but not their seeming precision.
On Sep 21 02:27 PM Mayascribe wrote:
> Michael Clark: Have you ever heard of cycles.cc ? Very much
> into what you're writing about. Been around for 50 years. They are
> holding an international conference in New Mexico this coming November.
> A very good friend of mine now runs it. Saturday, he called me for
> angles about how the business and market cycles relate to the Mayan
> calendar, especailly the 12/21/12 date. We talked for quite a while.
> This is a scientific site, not spirituality oriented.
>
> My friend also owns the kalarhythms.com site. If you go to
> these sites, you will be blown away with both site's endless content.
>
>
> Also: cycleslibrary.org
>
> Another good article, John, about depressing truths.
I've been learning about these cycles through my way-high IQed friend, David Katzmire, for about 10 years. When he used to live nearby, before his move to New Mexico, I'd invite him over, throw a couple two-story high Porterhouses on the grill, and we'd eat and drink beer long into the night, and discuss cycles.
David explained the new software to me, and its capabilities to predict trends. I'm going to look into I can get an insider discount on it.
By the way, did you hear on CNBC how politicians, and their assistants, as well as lobbyists, are exempt from insider trading laws? Another piece of our corrupt government being revealed...