This Real Estate Market - About To Burst?

The big news on the real estate scene is that the bubble is going to burst. This is not new news, I am one of a few who have been saying it for 3-5 years, and of course history has proven us wrong. I, for one, am willing to admit that I called the top of the market, incorrectly. Does that make me wrong? The truth is it didn’t. It meant only my timing was wrong; history will still prove that the real estate bubble will burst.  

All through real estate history, there have been hot markets and dead markets. The hot markets have always taken the market to new highs, and the dead markets-as opposed to calling it a bad market, have usually not gone down to the most prior low. Let me give a real example. In the 1975 Recession I bought a simple 3-bedroom house in Arcadia- a middle class neighborhood, for $19,000 that was worth $32,000 after I fixed it up. At the top of the 1980 boom that house was sold to an investor for $125,000. At the bottom of the 1983 recession that house was worth about $85,000. Again at the top of the 1990 market that house could of sold for $250,000 but wasn’t. . At the bottom of the 1993 crash I sold that house for $207,000. I am guessing that today at the top of this boom this house is worth $400,000 or more. 

As you can see, it you bought at the bottom and sold at the top you got very rich. Also true is if you bought at the top and held on until the next top, you still got very rich. Unfortunately those two scenarios are usually not what people do. They over extend themselves and buy, at or near the top, getting adjustable loans with adjustable payments.  Dozens of my close friends bought RE in the late 1970’s, late 1980’s, and within the last 3 years. Now, as in the earlier years, they purchased multiple properties by extending themselves on all of their RE (Real Estate), in hopes of bigger and bigger profits.  When the market turns, prices always go down and the interest rates go up, causing my friends to have negative cash flows that they may not be able to support. One negative cash flow property you can support, but what about 5 or 10 properties? It becomes an impossible task, forcing investors to sell some or all, of their properties, in the down market, when there are a limited number of buyers, all of whom have many choices on what to buy. 

Many of these friends sold at a loss or a greatly reduced profit, and if the properties couldn’t be sold then they were just taken by the banks in foreclosure. The worst part of loosing or selling houses at the bottom of the market is not the money that is lost or the pain that suffered but that the investor is out of real estate market completely when the market starts to boom again, which it will. Every boom market brings a new batch of buyers. Very few of the old speculators are around to take a second ride on the real estate rocket. I personally have been in the middle of 3 rocket rides and 2 crashes. I survived all of them despite having several banks planning my funeral over the years.  

Let me try to respond to the following arguments I heard in 1980, 1990 and 2005 which were all just before the market crashed: There is still a housing shortage. The population is supposed to increase 50% in the next 5 years. More people are moving in than out. Inflation will raise the value of housing. The baby boomers are getting older and richer. 

The Housing Shortage

Lets take the issue of shortages, which is why prices have been going up. There have been more buyers then sellers. The buyers are composed of two groups a) Speculator/Investors and b) Homeowners. The newspaper published a statistic that only 16% of the population can afford a house at today’s prices. That translated means that everyone that can afford a house has already bought one, and unless the prices go down the rest are out of luck. There is no housing shortage; it only appears to be so. The truth is that 25% or more of the buyers are the speculators/investors and therefore are not buying a property to live in, but to rent. Did you know that rents went down in Los Angeles 10% in 2004 from 2003? Westside Rental Connections who rents over 60,000 units per year reported this to me in Summer 2004.  

In 1990 (top of market) the vacancy rate was less than 2%. Two years latter the vacancy rate increased to 10%. After the Los Angeles riots in 1994 the vacancy rate increased to 18% in Hollywood. Building owners were loosing there building in foreclosure because they couldn’t get enough rent to pay the mortgage payments. The vacancy increase that took place immediately after the crash was caused by the unemployment that came about by the economic slow down of real estate and business. Single people living alone started to save money by doubling up with friends or moving back home and living with their parents. This vacancy increase happened very rapidly.     

The Population Increase

This argument is true, the population will increase over a number of years, but this is not true in the short time period between last month and next month.  Of course it also depends on the location we are talking about. The Sun Belt and the Western USA are going to continue to grow. The rust belt-North Eastern US still needs to first go through a rebirth, which it probably will in the next 25 years. 

What really drives the market place?

Interest rates have always driven the market place. Rates go up the market dies, Rates go down the market goes up. Real simple. Rates have been going up ¼% every 3 months because that is what the Federal Reserve wants to happen. That alone will slowly drive buyers out of the market and has been, slowly.  

There is one last item which has always destroyed hot real estate markets and it does it overnight. In 1980 the market was unbelievably hot and the Federal Reserve was worried. They notified the lenders to stop making investor loans. If you were buying a house as an investment, you couldn’t get a loan. The builders found overnight they had no buyers and the rest was history. One year later Ronald Regan’s administration wanted to slow down the economy and raised the prime rate to 18% or higher. That further killed a dying market. This week Citibank cancelled an approved loan to me because they didn’t like the comparables used in an appraisal. They were scared about the market. 5 minutes ago I received a phone call from a friend in Clearwater Florida who told me the lenders are tightening up on appraisals. That means they are going to prevent prices from going up. Last night, another friend told me Washington has told the banks to tighten up. The lenders, through their appraisal policy can kill any market overnight. GAME OVER. 

What do you do next?

If you do not own real estate but want to, start your preparations so you can buy in two 2 years. If you own real estate and want to keep it, convert your loans to 10 years or longer fixed rates. If you own more than you can afford to hold for 10 years, you need to contact me and I will be happy to help you work out a plan so that you can survive and even flourish until the market hits the next top in 10 years.