Even with dropping home prices, decreasing incomes and high unemployment we're looking at a real estate bubble that won't fully burst.
Like my friend and fellow contributor Mark Dennis has been approached on numerous occasions about the right time to buy real estate, I am constantly bombarded by readers, friends and family on both sides of the ocean why I have not gotten back in the saddle of real estate after I offloaded all my real estate assets between 2002 and 2006. My reasons for this conscious reluctance are mostly embedded in age financial liquidity requirements. I’ll get back to that later. For now I want to talk about the real estate bubble that won’t fully burst.
Philosophically, culturally and financially the American Dream has always centered around the attainability of prosperity in which home ownership played a major role. As much as the claim goes that Americans have a love affair with automobiles, I think they put homeownership on a pedestal beyond sensible adoration. Still after half a decade of declining real-estate prices, oftentimes wiping out all already remortgaged equities, I can’t believe how many people are still excited about the real-estate sector as they purchase their houses salivating over the potential of higher prices ahead. Recent surveys expose that 4 out of 5 Americans consider it financially smarter to own than rent. Many are still in the speculation mode as they search for deals among the heavily discounted homes, waiting for a rebound at any moment. Really, Americans have never fallen so deeply in love with any other asset class.
Sure, the country has had its flings with other bubbles such as a full fledged mind-boggling romance with the tech sector? However, that experience was different; it was based on lust rather than love. Lust for the big profits. After the tech bubble burst, the average investor wanted to hear nothing about a company name ending with “.com” – even when great opportunities came around. What started as a hot affair ended in years of bitterness and feelings of betrayal.
Not so much with housing! After years of disappointment and anger, our hearts still seem to skip a beat at the proposition of rising home prices, however local and location related the opportunities are. Would I buy a distressed property in New York City. Probably yes, because the laws of supply and demand in that city are extremely favorable compared to for example rural anywhere USA. Would I buy a distressed property in the Washington DC area? Only if I can unload it in the next 3 months. Washington DC is hot, because the government has managed to politicize the economy for now, which means that large governmental control is desired, attracting hundreds of thousands to the area in search for a government job. This formula runs out of space when economic output cannot sustain the burden of a bloated government any longer, at which time the DC area will turn into large suburban ghost towns. On a side note, I watched the first episode of NBC’s new series “Revolution” and wondered in what existing suburban ghost town they filmed this episode. If you get a chance, tune in, it’s worth looking at your potential future, of course without all the personal drama that script writers need to add to the scenes to keep the audience interested.
In any case, the entitlement culture “because I deserve it” was born sometime in the 1980s and grew exponentially since then fueled by cheap money and easy terms. And in spite of sobering events of the first decade in the new century such as 9-11, Katrina, tsunamis and the 2008 crash, entitlement, like a birthright, still draws many Americans to potentially bad financial decisions with the promise of luxurious lifestyles in fast cars. After the Y2K tech burst, our crush on technology and internet turned into hate for a while, and some of the recent Facebook victims, may once again experience anger; but those crushes usually pass.
But with real estate, emotions are still burning hot. There is something different about real estate as an investment or consumable asset. It’s our obsession with consumption – and as a result, debt – which makes us so vulnerable to its temptations. The thrill of a real-estate investment holds our hand and tells us, “It’s OK to spend more and get a bigger house.” If you don’t believe me, turn on the tube (sorry…. HD flatscreen!) and watch an episode of House Hunters on HGTV. The majority of these “hunters” choose the most expensive option out of three (practically always substantially above their set budget) and justify their choice in terms of resale value (profit). Very dangerous considering that recent statistics have shown beyond a shadow of a doubt that median household incomes between 2007 and 2012 have dropped from $54,489 to $50,054, a decrease that does not even include potential inflation corrections. Source
I always try to be realistic and fair about life’s idiosyncrasies, which includes the human propensity to overcompensate. And real estate is definitely an area where we like to overcompensate for what presumably ails us. Real Estate pulls our heartstrings; it’s the place where we look for happiness, family, values, relaxation, peace, raising children, showcase our life’s accomplishments and so much more. Bringing all these emotions into a buying decision is almost a guarantee for a heartbreak somewhere down the line. And when it does, it’s always devastating.
So here are three of the major reasons why real estate gets us every time:
1. Real Estate implies simultaneous consumption and investment. This is one of the only investment vehicles where you get to consume while also investing in hopes of a future gain. Besides real estate, almost nothing else offers this combination. If you buy GM or Ford stock, they’re not going to send you a new truck to drive around for a few years. If you put $50,000 in Exxon or BP they are not going to give you gasoline “free” to put in your vehicle.
2. Real Estate allows some justification for bad financial decisions. For example you know you can only afford the $300K house to live in, but if you look at it as an investment, then the $400K house becomes an even better deal. In the long run, real-estate values must always go up, right? So by purchasing the $400K home, you’re making a sound decision for the future. Real estate allows us to flip our logic on the correct decision. The larger home becomes the forward-looking purchase; the house within our means becomes the poor decision.
These blinders are even more useful when purchasing a second home. You might not be able to make it to your Amelia Island condo more than twice a year, but if you look at it through the rosy lens of investment, it’s all right. It’s not just a rarely visited condo which you don’t really need, it’s an investment, including all the fees, maintenance and property taxes! Therefore the magic of real estate allows us to transform excess into wisdom.
3. Real estate allows us to invest without saving. The whole principle behind saving and investing is to consume less today with the promise of prolonged consuming in the future. Real estate allows us to completely avoid the first half of this equation. We can borrow money now (sometimes with no money down) and can still invest for the future. With real estate, we don’t have to consume less for the promise of greater future wealth. In fact, we consume more by purchasing yet another product, a house. We used to buy a home to raise a family and over the years a well maintained property became a lifelong savings account. Selling the home when retirement arrived, was a way to cash in your savings account for the golden years. That is no longer the case when real estate is “abused” as a speculative producer of income.
Reality has come home to roost
Real estate became the modern American dream in the 1980s. It became a way to continue spending and living frivolously beyond our means, while at the same time deluding ourselves that our extravagant lifestyle was an investment.
And truly that is the epitome of bubble thinking. If you’re planning on retiring in some decent level of comfort in the future, there’s only one way to go about it. That involves curbing your spending today and investing wisely and diversified for a better tomorrow. I know. It’s a tough pill to swallow, but that’s just the truth. And that is why real estate is not in my foreseeable future. There are still too many corrections in the pipeline. Just to mention a few. Fernandina Beach, like so many cities, counties and states are struggling to make their budgets balance in a tough economy and do not hesitate to raise taxes while limiting services to a population that is increasingly wondering how to pay for it all. Direct and indirect taxes are now confiscating almost 2/3 of our annual incomes. Insurance companies, pressured by a growing number of natural disasters are seeking compensation in premiums or pull certain homeowners packages out of the markets. Utilities, especially those depending on oil are looking at substantial rate increases. Many grids and utility structures are reaching the end of their functional life cycle and we’re looking at major expenditures to keep them offering the level of service we have grown accustomed to. Life is getting more expensive by the day and especially ownership in real estate takes the brunt.
Will I avoid real estate altogether and cut my love affair with it forever? Not necessarily. If I find a great investment, I’ll probably go for it. But I’ll be very honest with myself and purely approach it as an investment. If a real-estate deal is the best investment available (versus other properties, as well as all the options of asset diversification), go for it, but keep in mind that real estate is not a short term liquidity anymore. Don’t be deluded by one of the three reasons above.