Another Record for this Housing Market Crash
Many people thought the housing market crash wasn’t coming anytime soon, that prices would continue and continue to rise. I even heard people saying that they had to get in now otherwise they could never afford a house at the going rate. Like any other boom, people forgot to look at the fundamentals.
Well today the fundamentals are right in your face. There’s no escaping them. No Ponzi scheme can save you. CNN has just reported a 6.7% price drop in prices from last year. If you adjust for inflation, that’s closer to 10%! The largest drop recorded since the index began in 1987. It marked the 10th consecutive month of price depreciation and 23 months of decelerating returns. With no end in sight.
I hate to soapbox, but as far back as 2004-2005 I was already suggesting that the market was overpriced. The numbers no longer made sense. It had to stop and prices had to come back down. I even wrote on ways to protect yourself. For example in December 2005 I wrote: The Simplest and Best Way to Protect Yourself from the Real Estate Crash. If you followed that advice you’d be significantly protected from the current housing market crash right now.
Knowing that there was a shakeup coming, I personally prepared. I followed my own advice, I ate my own dog food. For example I locked the mortgage on my personal home at 5.4% for 25 years! Yes that’s a fixed rate of 5.4% for 25 years. I had the option of 4.8% for 10 years, 4.3% for 5 years, or a variable for 3.9% if memory serves me right. Back then when I told people how excited I was to get 5.4% locked for 25 years I was continually shocked by their reaction. They couldn’t believe I was willing to pay that much interest. 4.3% was a lot better. And why not variable, interest rates were low and dropping.
This is when I tried to explain that interest rates can’t keep going down anymore, and definitely can’t stay at those rates. That we were just above inflation. It just can’t stay that way forever. Over time rates have been closer to 8-10%. They would climb back.
I also kept telling people how I didn’t want to be part of the upcoming mortgage refinancing storm. As rates increased people wouldn’t be able to refinance when their mortgages came up for re-financing. Basically the whole house of cards would come tumbling down. This is basically what’s happening now, and why we can expect to see a continuation of this housing crash for at least several more years. At least until the last of the 5 year fixed mortgages that can’t be refinanced dwindle away.
The good news is that unlike what the media portrays, there is an end in sight. It’s just a few years away.
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Is it Possible to Predict When a Market will Crash?
Every once in a while a specific blog comment will elicit a full article rather than a simple blog comment response. Recently Andy Brice from Successful Software (founder of Perfect Table Plan) wrote such a comment on my recent blog entry Manias, Panics, and Crashes: A History of Financial Crisis:
“Interesting. I’m expecting the insane UK housing market to level off or crash any time now. But I’ve been saying that for the last 5 years…”
Andy is a very smart person whose blog I regularly read (and sometimes comment on). Whose opinion I respect. In this case I absolutely agree with him. I’ve been saying the same thing for North America for some time now, as is evident even in my first month of blogging over two years ago here on FollowSteph.com.
The interesting part of his comment is that he (myself included) know just how hard it is to accurately predict a full economic shift from mania to bust. It’s easy enough to see when we’re in a mania; the fundamental economic principles no longer govern asset prices. But what’s hard is to predict when the general public will realize this. It’s just like the Tulip Bulb boom of long ago; as long as there’s a bigger “sucker” willing to pay more for the asset (in that case rare tulip bulbs) the prices are going to keep increasing.
But now comes the reality. Again it’s not possible to exactly predict when a boom or bust will actually happen, it’s easy to predict when we’re in a boom or bust phase. If the economic fundamental no longer justify the prices then we’re in for either a bust (overly priced as is today) or a boom (under priced as often happens when people overcompensate after a depression). The bigger the discrepancy the bigger the boom or bust.
The good news is that although we can’t accurately predict the exact time a bust will happen, we can still accurately predict when it’s a good time to get in and out at a profit. As Benjamin Graham expresses in his book The Intelligent Investor, as long as you’re buying your asset for less than the real value (intrinsic value) and selling it at a higher price than the real value you’re ahead. He doesn’t show you how to maximize your profit, he just helps you identify how much your asset is overpriced or under priced. No one can accurately tell you when an asset has reached its maximum price (over valuation), that’s speculating on you knowing and understanding the publics psyche which no one can do.
To put it in other words, asset (stocks, real estate, etc.) prices will always shift above and below their true economic value (known as intrinsic value). If you buy them for less than their intrinsic value you’re ahead. If you sell them for more than their intrinsic value you’re ahead. The key to investing is not to try to buy assets at their lowest price and then sell them at their highest price, no one can do this. It would be amazing if that were possible, but it’s not.
What does this all lead to? Well over time an asset can only deviate so much above or below its intrinsic (real) value before it has to re-align itself (adjust its price back to a reasonable value). Right now, at least in North America for sure, prices of real estate properties have deviated significantly above their intrinsic value, so much so that they are now correcting themselves and trying to re-adjust to their intrinsic value. And don’t think we’re there yet, they’ve still got a lot of re-adjusting to do. I expect significantly more fallout before it stabilizes. As a very basic general rule of thumb, a real estate investment property should generate you at least a yearly revenue of 10% of the purchase price (including all costs – renovations, closing costs, etc.). Right now we’re not even close to this, many properties are running at negative cash flow values! This isn’t sustainable.
Knowing this however doesn’t mean you can’t profit from the boom and bust cycles. All it means is that if you buy assets in the under priced area of the above graph and sell in the overpriced areas you should be able to consistently make profits and protect yourself. The “margin of safety” is generally considered to be the discrepancy between the actual price and the intrinsic value – that is how much the asset is under priced. The further off you from the intrinsic value you are, the bigger the profit potential and the closer you are to the max and min’s of the boom and bust cycles. Of course you need to be extremely careful the further away you are from the intrinsic value, especially for overpriced assets, because when the adjustment happens it will be faster and more volatile!
It’s possible to consistently achieve respectable profits, all you need to do is look at the intrinsic value to know when to get in and out. Although sometimes it may take years for an assets actual price to at least come back to it’s intrinsic value, it eventually does. But as Andy’s comment suggests, knowing when a market has peaked is hard to predict. He already knew that the intrinsic value was no longer aligned with the actual price of the asset (in this case real estate), but he still couldn’t know when the adjustment would occur. No one can!
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Manias, Panics, and Crashes: A History of Financial Crisis
Are we doomed to repeat history? Unfortunately yes! The book Manias, Panics, and Crashes: A History of Financial Crisis originally written in 1978, now on it’s fifth edition (2005), clearly illustrates just how predictable we are:
“The end of a period of rising prices for assets to distress whenever a significant number of investors have based their purchases of these assets on the anticipation that their prices will continue to increase. Some of these investors may have a ‘negative carry’ in that the interest rates on the funds borrowed to buy the assets exceed the cash income on the assets; these investors anticipated that they would be able to use the increase in value of the asset as collateral for new loans that would proved them with some of the cash that they would need to pay the interest on the outstanding loans. When asset prices stop increasing, these investors are shunted into distress mode since they have no ready way to get the cash they need to pay the interest on their outstanding indebtedness.”
And what about:
“Causes of distress and the symptoms of distress are observed at the same time and include sharply rising interest rates in some or all segments of the capital market, an increase in the interest rates paid by sub-prime borrowers relative to the interest rates paid by prime borrowers, a sharp depreciation of the currency in the foreign exchange market, an increase in bankruptcies, and an end of the price increases in commodities, securities, and real estate. These developments are often related and show that the lenders have become over-extended and are trying to reduce their exposure to risks and especially to large risks.”
Sound familiar to anyone? And to think this was written years ago and it’s repeating itself yet another time. History does repeat itself.
The good news is that if you educate yourself you can come out ahead. And this is why I strongly recommend the book Manias, Panics, and Crashes: A History of Financial Crisis. It’s a pretty intense book written using somewhat verbose and specific economic terms, as you’ve probably already noticed from the quotes above. Therefore if you’re not familiar with economics and business expect it to take a bit longer. But overall the information is excellent and very viable. And although I believe myself to be fairly well versed in economics and business, this book sure brought home some points I hadn’t fully appreciated. A very good read. Well worth your time.
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Interest Rate Poll
School Versus the Real World
Many years ago when the movie Back To School originally came out I remember laughing quite hard when Rodney Dangerfield’s character Thornton got NASA to do his Astronomy homework for him. If memory serves me correct, he also got the a famous author write an essay about his own book for his English class as well. Of course this was funny, how could it not be.
Although funny, according to the academic world this is wrong. This is what’s called cheating! Having someone else do your work for you. It’s a simple black and white case, he didn’t do his own work, someone else did it for him, therefore he cheated on his assignments. This is looked down upon, and it’s easy to see why. If you don’t do the work you’ll never learn the material. Very simple.
Now in real life the opposite is true. You need to do some of the work, but those that get ahead generally have teams do many of their work for them. For example, if you buy real estate, you often get your real estate agent to process the paperwork for purchase of the property, you don’t do it yourself. You get a mortgage broker to prepare the financing for you. You might also get a lawyer to do some of the work. Maybe you also have a property manager to manage your property. In the academic world, this would be considered cheating because someone else is doing the work for you.
In business the same is true, otherwise you’re really a self employed person (or employee)! If you’re employed right now, what are you doing? Someone is paying you to do their work for them. Think about it! Every employee is doing work for someone else. In the academic circle, this would also technically be considered cheating.
The reality is that the academic world teaches us to do everything ourselves, to learn how to do everything ourselves. To balance our check books ourselves, to run our finances ourselves. In the real world, and especially in business world, the opposite is true. In business we’re often thought to get a team to help us. And I can attest that starting a business without an initial team in place is much more difficult. A team can make a big difference. Getting a good accountant, a good lawyer, and so on really does helps. But what’s more, you generally need members on your team that have specific skills that you might be lacking such as a graphics design, sales, marketing, software development, team management, accounting, etc.. Getting a software product like LandlordMax out the door requires more knowledge and skill than any one person can have.
The other week when the movie Back To School played as a rerun on TV, which by the way was the inspiration for this article, it really made me think about this. I realized that since I’ve starting my company LandlordMax over four years ago that my reality has changed. Yes the movie was still good, but what really caught me off guard is that I no longer found this joke as funny. Actually quite the opposite, I think it was a great move by Rodney’s Dangerfield’s character Thornton. It really showed his business acumen! He couldn’t be successful in business without assembling at least one good team, which is why he quickly went ahead and got NASA to do his Astronomy homework.
In some way, it really made me appreciate the difference in realities different people have. Why we don’t all think the same. Successful business people often look at assembling a good team first whereas the average person tries to do everything themselves because this is what they’ve always been thought. There’s nothing wrong with this, but without leveraging other people’s skills and time, you can’t get further ahead than the number of hours you have in the day. It’s a simple reality, a simple difference in the way we perceive our worlds, but it has a large implication in how we’ll go about living our lives.
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Buy or Rent?
Today I came accross a really good analysis of whether it’s better to rent or buy. Of course the results depend on your assumptions and numbers, but what I particularly liked about this one is that they not only showed their numbers, they also described all their assumptions! Please note though that you will need to register with Google to view the spreadsheet with the information, but that’s free. It’s worth the minute it takes to register if you haven’t already done so.
Also, if you’re interested in the blog entry itself, and want to see what others have commented about it, you can view it here.
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What Goes Up Must Come Down!
I just now came accross the most interesting graph I’ve ever seen about the current housing boom! It’s amazing. It’s a graph showing the index of the average home price in the United-States adjusted for inflation.
Looking at it quickly, ignoring the recent run-up, it’s already very interesting. Prices declined during World War 1, the Great Depression, and againg during World War 2. It also clearly shows the 1970’s and 1980’s real estate boom and bust cycles.
However what’s really interesting is the incredibly major spike for the 2000’s!!! All I can say is WOW!!! Assuming those numbers are correct, that’s incredible! It really shows the effects of having 30-50% price increases year over year. It just didn’t make sense. It reminds me a lot of the tulip bulb boom, the first real market boom in recorded history.
All I can say is that’s quite an adjustment we can look forward to. For those who have cash, the real estate market will afford many amazing deals in the near future as the prices correct themselves!
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Update: LandlordMax Traffic Doubles As a Result of the Free Real Estate Analyzer
A few weeks ago we released a free online real estate analyzer on my company’s website (LandlordMax) in the hopes that it would increase the traffic to our website, and hence create more interest in our main product. The idea is that if you offer something of value for free, you will generate significant traffic from it.
We initially doubled the traffic to our website, which was great! Since then, as I promised to update you all, we’ve continued to get at least double our previous traffic each day from before we released it, sometimes much more! This increase in traffic has been maintained, and is actually still growing as its gaining more exposure. At this point, we’re barely promoting it anymore if at all, we’re letting the viral aspect take over, which is great. This might turn out to be our best marketing investment yet!
If you have a website and you want to increase your traffic significantly, offer something of high value for free and people will come.
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LandlordMax Free Online Real Estate Analyzer Continues To Double Traffic!
Just a quick update because I promised I would post an update tp the entrepreneurs following this blog, the traffic (measured in unique visitors) to LandlordMax continues to maintain at least double it’s previous best day before the we launched the new LandlordMax Free Online Real Estate Analyzer. Therefore this service continues to be a success as a traffic and buzz generating campaign!
Once at least a month has passed by I’ll write a detailed entry showing some of our results so that you too can benefit from it. But I’ll quickly mention that there is definitely something to be said about offering something of value to generate traffic and buzz!
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Cities With the Highest Percentage of Millionaires
Phoenix Marketing International just released a study and found that New Mexico’s Los Alamos has the highest concentration of millionaires living in one city. Almost 1 in 10 residents of Los Alamos is a millionaire! Think about that, at any one point in time, almost every store in the local mall probably has a millionaire in it (assuming there is an average of 10 customers in each store).
Here’s are the top 10 cities with the highest percentage of millionaires:
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| City | Millionaires |
|---|---|
| Los Alamos, N.M. | 9.7% |
| Naples/Marco Island, Fla. | 8.6% |
| BridgePort/Stamford/Norwalk, Conn. | 7.2% |
| Vero Beach, Fla. | 7.2% |
| San Jose/Sunnyvale, Calif. | 6.9% |
| Sarasota/Bradenton/Venica, Fla. | 6.7% |
| align=”left”Easton, Md. | 6.7% |
| Hilton Head Island/Beaufort, S.C. | 6.6% |
| San Francisco/Oakland, Calif. | 6.4% |
| Honolulu, Hawaii | 6.4% |
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