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    Thursday, April 14, 2005


    Real Estate Bubble

    Yet another great real estate bubble article here. James Grant (of Grant's Interest Rate Observer) reiterates the primary value criteria for housing (as an investment rather than as a home).

    "For many years the standard cash return on income-producing real estate was 9%, O'Connor relates. In booms it was less; in busts, more. But 9% was the number to which it regressed. Today it yields 5% to 7% on average--with all signs pointing to even lower yields just ahead."

    There are many stories, reminiscent of the .com bubble, of buyers purchasing a place and flipping it within days. There are also stories of new condo's being flipped multiple times before they are even built.

    In the end, my friends say that real estate over a 10 year time horizon never lose money. In real terms that is probably not true if you buy at the top and 10 years later is a bottom. However a meek return of a percentage point after inflation is probably awaiting most house buyers that buy today. Condo buyers (the valuations of which have been estimated to be nearly 30% overvalued) could see real capital losses for more than 10 years.

    Is anyone going to sell their house and then rent for 2-3 years to take advantage of the overvaluation? Again people I talk to say no. Because they don't feel that it's worth their while, after all moving house is incredibly stressful. So what would a 5% to 10% yield mean in capital losses.

    300K house at 5% yield is 15k rent per year
    Assume rent stays the same (a reasonable assumption of the short term, especially as rents will be capped by the poor economic environment that would go with a big housing slow down) then;
    15k rent as a 9% yield is a 166.7K house. A 44% loss.

    Today no one thinks that they are going to see a 40% loss on their house just as no one thought worldcom or Enron's stock would be worth $0. Well in fact, it is not true to say no one. Value investors that understand the value of an investment is the value of the returns from that investment do believe that some housing will decrease by a significant amount, just like they believed that .com companies with no earnings were worth zero!

    Is it worth moving house and renting for a few years with 150k to lose. It most certainly is. Many people have almost no equity in their houses, are going to default and companies with significant mortgage exposure are going to go broke when their "secured" portfolios lose 20-40%.

    On an unrelated note, I recommend reading this blog and others using an RSS reader. The RSS (Atom) feed for this blog can be found at .
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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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