Real Estate Investing is on a precious cross road

I have a friend up in New England who can afford to have some of the world’s leading economists on retainer and this weekend he is hosting Nouriel Roubini , David Rosenberg, Gary Schilling ) and Marc Faber for a téte å tete cozy round table conference up at his estate in New Hampshire.

My friend asked me for a question to put in front of this illustrious quartet of doom and gloom economics, to which I happily and possibly too quickly obliged. Reason why I say that is because I tend to look at things from a macro (global) economic point of view, rather than an investors point of view, much to my wife’s chagrin occasionally.
My approach to macro (global) economics is driven by my concern that attitude and confidence perception too often are the wrong market indicators, but gladly promoted by the main stream media, who are better served by a population optimistic about the future.

The philosophies and observations of these 4 economic superstars have no real contradiction opportunity as they all deal in doom and gloom. Maybe the details vary slightly but the considerations are all based on contrarian investment principles.

My question was: “While the housing market is still mostly deflating and the balance of cost of living is already inflating, would it be worthwhile to separate indices for a clearer view (indicator) on long term recovery? The principle of Stagflation does only partly cover this scenario as it is mostly related to production.”

Discussing hyper inflation, deflation or even stagflation in a closed circuit economy is like looking for used coffee grounds in a crystal ball.
On clear days the market senses the severe over-extension we have put on economic resources and the overall economy in the past 30 years. And in spite of all the air that has been deflating from the balloon, realities are that there will be a new spike of Adjustable Rate Mortgage resets in the line up for later this year and 2011, followed by a commercial real estate refinancing crisis coming up in ’12 and ’13. So clearly I’m with those who think real estate will not bottom until 2014 at the earliest. That means we’re looking at deflationary tendencies in the biggest economic contributor sector.

So why a does a projected long-term bearish situation all at once look bullish? Most definitely not because an imminent recovery is at our doorstep. That is not why real estate investors are starting to buy. But investing is a forward-looking activity and investors who tend to do well over the longer term are able to see the present clearly … rather than predict the future.

And the present for real estate looks extremely compelling: sky-high yields, properties selling below replacement value and financing rates that make it far cheaper to own than rent in a growing number of cities and communities.
In January of 2005, I first warned some of my constructing friends of the rapidly developing property bubble. By the end of 2005 I had sold my real estate holdings and warned my friends again that if they were going to keep anything to only keep cash-flow properties with fixed-rate mortgages.

I wasn’t clairvoyant. I could simply see the present.

I looked at my partners’ children who started their family lives off with $200,000 and $500,000 home purchases as they quickly became part of a generation of people who couldn’t afford the very homes they lived in. Speculation drove the markets, yet investors/developers couldn’t realize a cashflow as they depended on equity as income. It was unsustainable – the very essence of a bubble.

Now in mid-2010, we’re looking at the complete opposite: growing cash flow, a crossroad situation where it’s getting cheaper to own than rent in certain markets and an economic environment where people are extremely fearful rather than stupidly greedy and expectant.
And yet, the question remains when will the market bottom. Today, you can find properties in good areas selling for 60% to 70% below peak values (something I told my realtor friend Nick two years ago) and even 30% to 40% below current, depressed appraised prices.

A valid question is now: could properties go down more?

In Florida areas, California, Nevada, Arizona, Michigan, and other regions real estate could fall another 10%, 15% even 20%. Unfathomable? Maybe, but it certainly looks like it may be possible.
But until then…we should look at what happens to a world where real estate is enroute to zero? What will happen for example to the stockmarket?
Well here is a tidbit of fact: Over the last century, we have never had a sustained bull market in stocks in the face of a long-term decline in housing prices. So much for the bullish sentiments in the recent 12 months
Commodities? Can they go up while real estate stays down indefinitely? No way. A building is made up of just about every major commodity you can think of … aluminum, copper, wood, concrete, steel, and petroleum products.
So if all these things stay down, what will inevitably happen to consumer prices? Deflation is the most likely answer. And if we go into deflation, what is good to own? Cash and bonds. And with real estate turning out cash flows as they are doing in some areas now, cash is becoming king.

Now let’s look at a completely opposite scenario where the bailouts and stimulus programs lead to hyper inflation.

Especially after already falling 30% to 50% or more, properties should do very well in an inflationary recovery. It’s virtually impossible to have high rates of overall inflation without having high rates of inflation in housing. They are uncertainties such as property taxes and insurances, but in general they can be amortized in rental yields so that we’re looking at a long term lock in fixed loan rate at a very low percent, while inflation keeps climbing.

Of course it’s all a matter of timing and focusing.

I do think we’re near the bottom of the real estate market, but I’m not best guessing the exact bottom. Nobody is able to do that and bottoms will be reached at different times in different markets. Exactly wanting to pin-point the bottom demands an ego beyond the urge of greed. The values today are too good to pass up.
Who is going to call the bottom anyway? The same experts who couldn’t see the top … who were totally oblivious when we said we were going into a bubble?

Fact is that most real estate investors would be happy if real estate stays down for the next three to five years.
The opportunity to buy as many ultra-cash-flow properties in good locations would be a national sports. The only thing to do would be to lock in low, fixed-rate loans for extended periods and make sure the properties perform — increasing free cash flow by hundreds or thousands of dollars with every new purchase.
Sky-high yields, big discounts to replacement value, prices that make it cheaper to own than rent, extreme pessimism in the market and the ability to lock in 400% long-term capital gains as a minimum through fixed, ultra-low-interest-rate, amortizing loans.
An unprecedented combination of factors is why I believe now is the best real estate investment opportunity we will probably ever see in our lifetimes.