The reports of real-estate's 'death' are greatly exaggerated …

The reports of my death are greatly exaggerated

The text of a cable sent by Mark Twain from London to the press in the United States after his obituary had been mistakenly published.

Just like Mark Twain, I think that real-estate has been prematurely ‘written off’. Do you need proof?

Just check this often-cited graph (I think that it’s from Irrational Exuberance by Robert Shiller) floating around the internet:

It purports to cover a period from 1900 to 2005 in a linear fashion … a clear bubble-spike, right?

What could one reasonably conclude from this?

A long downward trend and/or an even longer flattening until house prices catch up with, say, 3% – 4% inflation?

Now, take the period covered by the red line beginning roughly in line with where the ’10’ starts in the phrase on the graph that says “Yields on 10-Year …” – got it?

That’s roughly 1987 until today …

Now, let’s look at an a national index of housing prices covering that same period from a source that I trust – Standard & Poors (the same rating agency that produces the S&P500 stock price index):

This picture tells a slightly different story, doesn’t it?

One reason is that this one, I don’t think, is inflation-adjusted whereas I believe the Schiller one is (or at least ‘adjusted’ for something … any of our readers know what that might be?). In either case, a definite ‘bubble’ can be clearly seen in both charts from, say, 1999 to 2007.

But, have a look what happens when you break this second chart into three sections:

1. We see the tail end of a rise from (we don’t know when, because S&P apparently only started collating this data in 1987) to the end on 1989 … the extent of this rise is pretty important, because we then see …

2. … a ‘flat’ line (or worse) from the end of 1989 to roughly the end of 1998, then …

3. … all hell breaks loose from the beginning of 1999 to somewhere towards the end of 2006 when a clear crash occurs.

So, was the flattening in 2. a correction for 1. OR was the growth in 3. an over-correction of 2.?

I can’t say for sure, but I can say this:

If you draw a compound growth curve between two points: a 20 year period when the market moved from an index of 75 (roughly at the end on 1987) to an index value of 200 (roughly at the end of 2007), we can see that that represents an average compound growth rate of just on 5%

Given that real-estate compounds at 3% to 6.5% annually, depending upon which source you believe (I’m firmly in the 6%+ camp), here’s what all of us as investors have to decide …

Buy now (or soon) while the going is cheap (particularly, if you think that interest rates will also start to go up soon), or wait because you believe that real-estate is still overpriced.

Be warned: if you wait too long (is that 6 months or 6 years?), the ‘real estate discount party’ might be over!

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8 thoughts on “The reports of real-estate's 'death' are greatly exaggerated …

  1. Although buying when interest rates are low means having a lower monthly payment, the rise in interest rates will do little for the potential appreciation of a given property.

    If you take a loan out for 500k at 6% and mortgage interest rates rise to say 7.5% by the time you wish to sell that means a person wishing to buy your house would need to pay an additional 675 dollars per month just to buy your house at the same price you paid for it originally.

    My point is that if your are looking to purchase a house with the intention of selling in the next 5-10 years and making a profit off of home price appreciation then your prospects are much more dismal than it may seem to the naked eye.

  2. @ Drew – Absolutely; which is why 5 – 10 years is a relatively short investing horizon in anybody’s language. On the other hand, interest rates rise => higher costs of home ownership (fewer people can afford to buy) => better rental prospects (more people have to rent). And, even if that is not the case, if you buy cashflow positive, it’s the future rental income stream that you are really looking for … capital appreciation only comes about if you sell.

  3. Your points are correct, but my point was that the crux of your article was the real estate is cheap, by which I assume you mean that there is greater appreciation and cash flow potential for real estate now than there was say a year ago.

    As you agreed in your last comment, due to current and future interest rate environment it is entirely possible that real estate will not appreciate for a decade. Given the current cap rates on real estate across the country you would be better off buying a municipal bond.

    Also your 20 year (1987-2007) time period for the 5% appreciation of real estate wreaks of selection bias, just look at cash shiller from the end of 2007 till now and it is impossible to make the 5% appreciation argument much less 6%. Long term home price appreciation is a function of the growth in household income.

  4. @ Drew – Its obvious that YOU won’t be buying any real-estate any time soon 🙂

    If my selection ‘wreaks {sic} of ‘selection bias’ it’s only because S&P only provides their data commencing in 1987 (as I mentioned in my Point 1.).

    I also disagree with your ‘capital non-appreciation theory’, but my point is that if you purchase for income – and, hold for the very long – term, the intermediate appreciation (or lack of) is moot … over a 20 – 30 year investing horizon bonds will lose out to stocks – and, especially to RE – almost every time.

  5. Quite the contrary, I intend to make multiple real estate investments in the next 6-12 months, however none of those investments will be in single family residential units.

    My contention regarding your selection bias was in regards to the end of the sample not the beginning. In the last 9 months (since the end of your sample) residential real estate prices have fallen 15-20% nationally (of course depending on location) which if calculated in your annual growth equation would make the 5% annual appreciation argument difficult to substantiate.

    I also am not advocating the purchase of municipal bonds but rather using them as a comparable. For example if you purchased a general obligation municipal bond from your state, (which means all income from the bond is tax free) which here in CA have been yielding as high as 6% in recent months and you were in the 35% tax bracket then your after tax equivalent yield would be (6/(1-.35)) = 9.2%. Comparing that to the cash flow + appreciation of a single family residential home investment purchasing a muni seems like a no brainer.

  6. @ Drew – I’m afraid I’m not with you:

    1. You are saying that if we extend the S&P graph (which we can do when they provide their next update) RE will have fall even more?

    2. If so, my point was that people thought RE was overpriced and is still too expensive … I am saying that if the ‘normal’ growth for single family RE is 4% (approx. inflation, as some say) to 6.5% (as other ‘experts’ contend) then the growth in recent memory is well within that ‘curve’ … and, you seem to say RE may even be under-priced now, once we factor in the further drops of the past 12 months?

    I have NO interest in comparing investments on the basis of where MUNI’s sit TODAY v where RE sits TODAY; I am only interested in long term performance: there simply is no MM101 or MM201 argument for MUNI’s or any other bonds.

    I agree that there are better RE choices than single family – or, even other residential – but, only for the larger, more sophisticated RE investor.

  7. @Drew –

    “My contention regarding your selection bias was in regards to the end of the sample not the beginning. In the last 9 months (since the end of your sample) residential real estate prices have fallen 15-20% nationally (of course depending on location) which if calculated in your annual growth equation would make the 5% annual appreciation argument difficult to substantiate.”

    What point are you trying to make? That he intentionally left out information that would have strengthened his argument…

  8. @ Jeff

    He actually made two arguments:

    One (the argument that real estate appreciates on average at a 5% annual rate) which would be hurt by not including the last 9 months of data.


    Two (the argument that real estate is now cheap and thus a good value) which, as you note, would be strengthened by the inclusion of the past 9 months of data.

    I do not think he intentionally left out the data to strengthen his argument, my point was that in the past 9 months we have seen unprecedented changes in the real estate market and with numerous sources of readily available and reliable data it seems that data should be included in any calculation of long term rates of appreciation.

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