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Thoughts on Real Estate

Thoughts on Real Estate

 

 

     Many of our clients are getting caught up in the real estate “thing” again. I think it’s time to take the pulse of this important segment of our economy.

 

Back in 2003

 

     Almost exactly 13 years ago, I stood in front of our clients at our annual dinner with a picture showing the cover of a recent Economist magazine. It was a hot air balloon house attached to Earth (in place of the basket). The title read, “The Houses That Saved the World”. Most articles in that issue talked about the rise of real estate prices and how that sector was keeping the global economy alive and thriving. Indeed – and for almost another three years that was the case.

 

 

 

     The point I was trying to make then was that real estate had entered a bubble phase and the ultimate and inevitable decline in prices would be severe, creating perhaps one on the greatest recessions of our day. That proposition was not well received. In fact, I can remember a few audible Boos! Tough crowd. As it turned out, we were early with that warning but the outcome was nonetheless even more destructive than we proposed. The Great Recession was caused by the popping of a credit bubble/real estate bubbles, which began in late 2006, shredding the financial markets and banking sectors 18 months later. Now let’s bring things forward to today.

 

     Today, real estate prices across the majority of major metropolitan areas of the country have…….not yet recovered from their peaks in 2006 (one decade and counting). Seven of them have pushed out to new highs and we’re proud to say that Denver, CO is leading that charge. Take a look.

 

 

     One can look at this chart from a half full or half empty perspective. The half full view says, there is still upside potential in real estate and many markets are still discounted. The half empty view says, real estate prices in all but a few markets are still in a secular trend that is bearish and unproductive. We did use the term “dead money” with regards to real estate back in 2006 and that label does seem to be accurate in describing all but a few metro areas.

 

     For aggressive, opportunistic investor types, real estate did offer perhaps a generational buying opportunity back around 2012 when it appears most markets finally found a long term low in prices. The good news is that prices continue to rise steadily from that low with strong demand and low supply. If we had to guess, we would suggest that this “recovery” in prices still has further to go, but not a lot further.

 

     Looking forward, we see a rough road for real estate again starting sometime in the next 12-18 months. The basis of that statement is based on three facts. The first is fact that prices will have recovered more by then giving those who bought near the top in 2006 that sense that they can get out at the same price they paid without much damage, other than 12 years of lost opportunity. Another factor will be the cost to borrow money, which we anticipate to be significantly higher by then. Higher borrowing costs are a negative for real estate prices on an exponential basis. And finally, we see property taxes as the last deep well of taxation for our needy and underfunded state and local governments. Income and sale tax rates are already absurdly high and suggestions to raise either will be met with some serious resistance. But property taxes outside of the east coast are still relatively low. We are already hearing and seeing local public schools and state governments planning to float higher mill levies in upcoming November ballots. All in, we have a real estate market that feels expensive (but could go even higher), but is potentially on the verge of a surge in supply (from 2006 buyers), higher borrowing (from higher rates) and carrying costs (higher taxes). While we’re not looking for a real estate wipe out or anything close to the last downturn, this is simply not a good set up and quite the opposite of what we would consider an attractive investment. When prices are low and rates are coming down from a higher level, then you should be ready with your bag of cash to buy.

 

     The group I’m most nervous about is the Millennials. They are just now getting confident enough, solvent enough, gainfully employed enough, to buy their first homes. This is a generation that grew up seeing and feeling household financial disasters all around them. They are gun shy to pull the trigger on any financial commitment. And now, they are buying their first homes in an environment that is less than ideal. I can only hope that the bulk will continue to hold off and rent until we see some real opportunities develop again in real estate. I’ll take a wild guess and say sometime after the year 2020.

 

     Please don’t shoot the messenger. We always call it as we see it and recognize that real estate is always near and dear to everyone as your home and something you love to own. Real estate pricing on the way up is always a local and regional thing, some markets are stronger than others. But when the tide goes out, all ships fall, just like any other asset class. So timing is everything and that includes real estate. We hope this helps in any decisions you might be considering in this important asset class.

 

Cheers

 

Sam Jones