Lessons from the Real Estate Crashes!

• Investing

As the real estate crash wears on, old dogmas are falling one by one. Giddy realtors and politicians have long tried to convince us that "house prices always go up" and that "your home is your most valuable asset".

 Well sometimes house prices fall. Actually that has always been the case, as real estate tends to move in cycles of mania and depression (and long periods with little action). The long run price appreciation of real estate is about in line with inflation, which is what you would expect since a house is an unproductive asset (really just a shelter) and we are not running out of new places to build homes (so supply is generally not constrained). 

But sometimes an article or point of view appears that really accentuates what is going on. Such a piece appeared in the June 10^th edition of the Los Angeles Times. Ominously titled "Median home prices drop below 1989 levels in some parts of Southland", the article describes the disaster that has befallen on parts of California.

There is a virtual treasure trove of truths sprinkled throughout this article. As always, history is best illustrated by poignant examples, and the note has plenty such.

"First time buyers [...] are nabbing houses for less than what their parents paid in the late 1980'ies", the article begins. And then some numbers: The 92410 ZIP code in the city of San Bernardino had an April 2009 median price of $61,000, down 84% from the peak of $370,000 in 2007 (that's TWO YEARS ago!).

The article continues: "Some buyers who thought they were getting bargains didn't. In Lancaster, Beatrice's eldest son, Daniel, bought a house near his father's for $175,000 in April 2008; comparable properties are now selling for about $95,000".

And finally a jab to all the people who bought based on the self-serving "advice" of realtors and mortgage bankers: "The families who were buying out there were the one's who couldn't get in anywhere else, Husing said. They were paying stupid prices".

So here we are, in early 2009, and the real estate fantasies are quickly unraveling. Yes, you can pay too much for a house. Prices don't always go up. In fact, sometimes they crash so badly that you lose all of your investment, even over a 20-year period.

Moreover, do you remember all the people in early 2008 who said that "now is the time to buy"? I sure do. Many of them were realtors who were desperate to unload their grossly overpriced properties (or simply in denial). Well, had you heeded their advice and bought a house a year ago you are now most likely sitting on a heavy loss. What makes you think their siren song of "now is a good time to buy" is any less false this time around?

Almost certainly, house prices will continue to go down for quite a while (for more on this, see my recent article). The wheels have fallen off the wagon and it's too late to put them back on. Rising unemployment, shrinking consumer credit, stricter lending standards, a huge housing inventory - all of this will force prices lower in most parts of the country. Add to that the fact that we have not even fully retraced the 2000-2006 national price bubble yet, and you have a fairly safe bet that prices are going down for the next year or two.

The best comparison is probably with the Japanese real estate and stock market bubble in the late 1980'ies. Remember that one? It was the mother of all bubbles. At the peak, the land under the emperor's palace in Tokyo was valued higher than all the land in the state of California combined. (Read that sentence again). The Nikkei stock market peaked at 38,000 in late 1989; it is now trading around 10,000 (still down some 74% TWENTY years later).

If you are still delusional about asset prices and think you can buy real estate (or stocks) at virtually any price (because they "always go up in the long run"), think again. The Japanese story should be plenty of warning. Will it get as bad here? In some parts of the country it already has. One thing is fairly certain: Prices will need to fall further before this crash is over. All the excess and exuberance will get flushed out of the system and the bubble of 2000-2006 will most likely be completely eviscerated. Only then can we come back to a sensible market.