Real Estate: A Lump of Coal for Today’s Investor

And I’m wondering where the lions are…

–Bruce Cockburn

9 July, 2015–Suckers cluster around an auctioneer, cheeks flushed, heartbeats racing, furiously bidding properties up ten, twenty, twenty five percent over appraisal. Emotions are high. Winners think they stole the property. Losers are sick. Won’t be outbid on the next one. A toxic investment environment, this. Seeing the frenzy in full, the wiser man turns and heads home.

The real estate market is once again flashing danger signs. The driver of this mini-mania is memory of prices eight years ago. A compulsion to get in before it’s too late. Market psychology is white heat extreme. Correct action is to get out, not buy. Sell ’em if you own ’em, because, even after the market cools and prices begin to drop, the bottom fishers have to be taken out.

It was a false bottom. Markets move from extreme to extreme. At the next bottom, the true one, there will be no buyers. None. Even experienced operators will approach the offerings with clammy hands. The fear of loss will have replaced the fear of missing out. A Dead Cat Bounce is topping now. It will be years before the right kind of fear will pervade the real estate market again.

Pulte Homes

dead cat bounce, new

If I owned investment real estate I would use the enthusiasm to sell because a long slow collapse into the worst kind of situation for real estate investors is coming on the heels of this speculative bounce. Anyone doubting this expectation would do well to study the history of real estate in the 1930s.

With the onset of a global deflationary depression, the first thing to go will be renters who can be depended on to pay rent in a timely manner. The average renter today has little cash reserves, hasn’t had a meaningful increase in income in many years, and is vulnerable to being laid off from work. At the same time, there is a surge of homes coming on the market as rentals. Rents are high now, but they will come down when the supply of rental properties goes up.

Neighborhoods that were developed originally for middleclass home owners will deteriorate as the mix devolves to increasing numbers of rental homes. Owners of rental properties will be pinched when renters become unreliable. Maintenance will decline, bringing down values. Desperation will set in and the quality of renters will go down.

Good neighborhoods come apart when homeowners are hit with bad economic times. The decline is stealthy at first. By the time home owners see what is happening it’s often too late to get out. During the bear market of the late sixties-early seventies, beautiful neighborhoods in places like the Back Bay area of Boston slipped into disarray, ultimately descending into quagmires of crack houses and prostitution. It would be decades before those neighborhoods would be re-gentrified.

When he was alive, venerable investment letter writer, Richard Russell, would occasionally write about his dad, a real estate salesman in New York. In the thirties, many beautiful brownstone homes in Manhattan had been chopped into multifamily rental properties. During the worst of times, brownstones that were only half rented could be bought for ten thousand dollars and generate two thousand dollars annually in rent. A twenty percent return with the property half empty. There were no buyers. It was very frustrating to Russell’s dad, and it was the ideal time to buy.

Eventually, occupancy went up. Eventually, rents went up along with prices. Eventually, those great brownstone neighborhoods were reconverted into single family homes for wealthy buyers. Today, a home of that type sells for ten million dollars the day it comes on the market. Time to sell again.

Stocks will be bad enough in the period ahead, but they are liquid and can be sold immediately. Real estate will not generate a sell signal to investors until deep into the depression. By then, maintenance, taxes, neighborhood decline, sketchy rental income and a systemic rise in vacancies will add up to an investment nightmare. Not a good prospect.



No one should consider any part of this presentation as a recommendation to buy or sell any securities whatsoever.

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