Source: Whybuywhenucanrent and Seattle Bubble Blog
The point of the post below was to illustrate that residential real estate has precious little inherent value. Rather, it’s a subjective commodity. Land values can escalate wildly, or go to zero. The actual materials a home is constructed from, no matter how irreplaceable, are usually meaningless. People will pay $1 million for a graceless, tasteless, boxy piece of crap on a soulless street because it represents a social goal. Financially, it could be a disaster.
Pitted against this irrationality of real estate is the more ordered, structured, transparent world of financial assets. And while stock markets are just as capable of going to hell as housing markets, investors have liquidity without bidding wars or hormonal young buyers getting in the way.
So, there’s risk everywhere. My argument today is that residential real estate represents far more risk than stocks, bonds and mutual funds. At this moment there is a two-year supply of houses for sale in our major cities, and prices continue to fall while sales collapse. This is not a commodity to own if you happen to need cash. And as all this happens, most people who bought since 2006 with little or nothing down are sliding towards the abyss of negative equity.
Of course, everything gets worse in 2009.
We haven’t even tasted the impact of widespread job losses. Major retailers will disappear in the new year. The car company bailout is nothing but gum in the dike. The federal deficit will balloon hideously, guaranteeing higher taxes four years from now. Oil is going to $30 a barrel. And you’ve seen just the beginning of the real estate meltdown. Wait until all those people who pulled their listings waiting for the Spring market, realize there isn’t one.
It’s entirely possible this economy could tip into a deflationary spiral of the kind we’ve already discussed. Within 60 days, governments in Canada and the US will have thrown everything they’ve got at this mess. If it doesn’t work, stand back. All assets – real and financial – will be blown up.
This is why prudent people are quietly getting ready. Are you?
(BTW, those houses are in Detroit and Vancouver. But you knew that. You’re obsessed.)
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Some people have argued passionately on this blog that the stock market is the definition of risk. They harbour fears the 1930 experience will be played out again, and a second sickening slide will come, ultimately robbing investors of 89% of their invested sum. This seems based on an irrational fear of financial assets, images of Bernie Madoff and an inbred fear that anything you can’t pee on the side of isn’t worth owning.
Fair enough. Stocks have been scary lately. Hell, everything’s scary. But when it comes to stocks, bonds, mutual funds and the like, at least there is a broad, public market in which valuations are determined. Stocks trade relative to each other, and based on the financial health and prospects of the businesses underlying them.
This is where real estate – at least residential real estate – is fundamentally different. My argument, deeply held, is that real estate investors will come out of this mess far worse off than equity holders. Stocks may have lost half their value, while real estate is down about a third, but stocks will recover long before housing does, and it may be 2020 before a house in Edmonton or West Van once again achieves ts 2007 pinnacle.
This is because the real estate market is not really a market. It’s just a just swap meet where people come to bid on things based on emotion, hormones or their own perceptions of supply and demand. Unlike a share in RIM, which is worth the same in New York or Kelowna and tied to corporate profitability, the value of a house swings wildly, uncontrollably and irrationally from market to market. House prices are dictated by the local economy, geography, neighbourhood demographics, surrounding housing stock, local taxes and societal trends, just as much as interest rates, consumer confidence and the availability of credit.
Over the last few years in Canada we have grossly distorted home values. Sellers were greedy. Buyers were fools. Ottawa primed the pump with Canadian subprimes. Realtors were irresponsibile. The media was bought off. We borrowed more mortgage debt than ever before to gobble houses many could not afford at prices which won’t be seen again for years. There’s plenty of blame to go around.
And one lesson is this: When assets get plumped for no good reason, they can get bombed just as easily when the tide turns.
So, look at the houses above.
The one on the left has 2,978 square feet, the one on the right 2,634 square feet. The one on the left was built 80 years ago, the one on the right, 63 years ago. The one on the left sits on a lot 35 by 160, and the one on the right on a lot 50 by 120. The one on the left has 6 bedrooms, and the one on the right has 5 bedrooms.
They are both active listings at the moment within downtown neighbourhoods of two large cities.
The house on the right is listed at $998,000. The house on the left is for sale at $300. (That’s not a typo.)
Can you guess where?
And then tell me why residential real estate is more stable than Research in Motion.
