Earlier today, we looked at several Real Estate related charts.
One particular chart we looked at from Northern Trust showed the percentage of net worth
improvement Households derived from Real Estate. But it lacked historical context, and I mused that I would like to find out exactly how much these numbers
deviate from historical norms.
Amanda Mason of Northern Trust came to the rescue, and informed us of the specifics: The median from 1952 to 2005 has been 19.9%. Compare that to 2005’s 61.2%.
Wow! That is quite revealing as to how dependent Households have become on Real Estate for net increases in worth.
I updated Asha Banglore’s chart with that new info from Amanda:
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Reversion to the mean is cruel bitch, ain’t she?
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UPDATE June 13, 2006 6:41am
Interesting report from National City Mortgage on where the largest overvaluations can be found:
House Prices in America
Updated for the 1st Quarter of 2006
http://www.globalinsight.com/gcpath/1Q2006report.pdf
The short version is in a story by Marketwatch columnist Rex Nutting: More housing markets overvalued
Thanks, Barry. what a powerful and creative chart. It would be interesting to see the pattern over a longer period with more data points to see what else we can learn about its variability over time.
That just means house prices are creating wealth. What matters is how people are changing their behavior as a result. Are people neglecting other means of building wealth because their house seems to be going up? What does the growth in net worth excluding home value and mortgage debt look like? If people were continuing to save just as much outside of housing, it would suggest that house prices dropping later would not be a big problem. Given that the savings rate has been negative for almost a year, it seems likely that people have actually been neglecting other forms of wealth building. This will make falling house prices a far bigger problem for the economy.
I know you hear these types of comments a lot but;
77.6% of 2003 household net worth was ex-RE.
54.2% 2004
38.8% 2005
Looks to me like a whole lot of household asset generation was ex-RE in a period of massive RE appreciation. More a case of massive returns masking really good returns otherwise.
I also don’t see where cases of people “cashing out” of unreasonable RE appreciation and converting to other forms are considered. For every buyer there is a seller. My divestment of everything except personal use real estate over this exact period of time doesn’t show up here as far as I can tell. The money was made in RE but the profits were taken and whomsoever has those assets now are leveraged as compared to my outright former ownership. Short form:
A cash neutral RE rental investment vs. $200k earning as much in conservative investments. To me they are current account equal. Future value entirely based upon home prices with a bias we all acknowledge. THere’s also remodeling going on. The recent run up caused many of us to get overweighted in RE. I don’t now and never wanted 61.2% of my returns from RE. I suspect as we replicate the Naz 2000 in RE 2006 your historical median will reassert itself.
Keep in mind all capital gains, RE and ex-RE are only the reflection of the enormous increase in supply of currency/debt vis a vis the supply of available investments, despite their strong growth, too.
Would you agree that as the availability of carry trade liquidity evaporated all bubble pricing will revert to the mean?
“Would you agree that as the availability of carry trade liquidity evaporated all bubble pricing will revert to the mean?”
Yes. Absolutely.
One thing that isn’t talked about here is that when people realized a return on their RE (ie they sold their house), they generally bought a larger one with more debt. So on the balance sheet their assets have increased but nothing has been realized and won’t be until the house is sold. So yes, Americans got balance sheet richer, but they haven’t realized that income.
The same thing happened during the dot com boom. People got rich on the balance sheet, but it wasn’t realized because nobody sold. And then it evaporated.
all capital gains, RE and ex-RE are only the reflection of the enormous increase in supply of currency/debt
No, not all cap gains are money supply. RE represents realization of idle assets, investments, changes in demographics & geographics & technology, inflation and trade value equivalence and internal money supply. Not just the last three.
I have no idea about “the availability of carry trade liquidity evaporat[ing] bubble pricing [reverting to] the mean.” Inflation will erode dollar denominated assets. Recession will reduce sales prices. Wages will lag pressuring both. Demographics will adjust to all of the above. Markets will reflect everything eventually. Money will be made in the imperfections of all of the above. The only thing I feel is a sure thing is that owning housing as an investment in the next decade is probably a bad idea.
These charts have been great. I lived through the dot come era, being in the heart of silicon valley and having run one myself. (mine did not go bust and 5 years after selling it to a private company it still thrives. Acteva.com)
I however, was not exempt from getting sucked into much of the hype. After it was all over, I worked hard to understand how I could have been taken in. How I ended up buying stocks that intellectually I should have known were bad investments. I realized that a big part of it is that it is human nature. That a bubble is a bubble because of the human psyche and that is the very same force that will eventually deflate that bubble.
That I could talk myself into suspending the basic laws of economics, capitalism and solid core invesment principles was at first a mystery yet, I can not deny that I did it. So, I swore that I would pinch myself on a regular basis from then on and make sure that I stayed rational.
I have been paying very close attention to the housing market for over 2 years now ever since I pinched myself and realized that it had bubble characteristics.
I agree with Ritholz and think that this is about to play out. If so then my pinching has paid off :)
I am also learning how powerful these forces are. I have had discussions now with dozens of friends and peers and am amazed at how much resistance there is to even consider my points. Basic quantifiers are being dismissed with the wave a hand if they do not support the precept that real estate is the last great wealth builder.
Each person I have this discussion with will admit that there is a possibility of a slowdown coming for many parts of the nation but will defend their own locality to the death!
Of course that becomes an adsurdity when these conversations are held with people from over 20 different geographical locations all pointing at each others markets as the weak ones. I think this is more proof of concept for the bubble thoery.
Thanks to this blog for trying to post good solid data on the subject.
The internet, housing, commodities, and emerging market bubbles are all related.
These are commonly seen in the broad context of a deflationary environment, which has been in place since around 1980.
Deflationary periods share certain characteristics, especially the introduction of new labor forces, globalization, and rapid technological innovation. These were present during most of the 19th century, another deflationary period marked by a series asset class bubbles.
And the deflationary 19th century roller coaster led to the gilded age, tariff walls, and the rise of fascism.
Of course, history never repeats …
«Of course, history never repeats …»
Someone famous said that history does not repeat, but it rhymes…
“I lived through the dot come era, being in the heart of silicon valley and having run one myself.”
I wasn’t in the heart of Silicon Valley, but I owned a software company at the time too. It was terrible. All the dot com start ups were picking my staff off, one by one, for about $100K more than I was paying them.
By April of 2000 we were totally gutted.
I didn’t get sucked in at all either. My phone would ring about twice a day and the question was always “Do you have a portal ?” “How many eyeballs does your site get ?” Totally ridiculous.
Time and time I tried to explain to these callers why we didn’t have portal and why dot coms were doomed, but I doubt anyone listened.
I thought about investing in dot coms several times but it never made sense. Some of my friends thought I was nuts. In October of 1999 I had the option of making a big balloon payment ($20K) on a truck and trailer we had bought or buying stocks. I paid off the truck and trailer and we still have them. That is how much I thought of the dot com bubble at the time.
I sometimes wonder if we really learned anything from the dot com bubble. It was over so fast. People complained about losing money, but then not much else was said. The thing I always hear now is “don’t ever buy an Internet stock”, which isn’t quite right. I guess maybe that is why RE is the new dot com bubble.
The most heartbreaking thing I saw was one of my employees being a Northern Telecom fanatic. It was at about $90 at the time. And then it started falling. Him and his father bought in all the way down. They were still buying at $42. I remember he came to work one day almost in tears. I think they sold at about $10. Actually, he had an accounting background. I always wondered how someone that was supposed to understand something about business could have been so blind.
Not that I don’t make mistakes…
«The internet, housing, commodities, and emerging market bubbles are all related.
These are commonly seen in the broad context of a deflationary environment, which has been in place since around 1980.»
Uhmmm, uhmmm, as usual when I see ”inflation” and also ”deflation” mentioned I feel uneasy, and ask ”of what?” because that matters a great deal.
My personal interpretation is that «Easy Al» for mostly political reasons (some of them patriotic) has created an environment where the price of money has gone down a lot for a long time. Too bad that manna from heaven cannot last forever…
If the price of money goes down, the price of some other things in terms of money must go up, and which ones depends on pricing power.
Pricing power has been highest for various asset categories, as they have become relatively scarcer.
Now real estate has been one of those, and it has overshot, simply because of momentum investing.
How will things adjust? Well, the big deal is that the home price/yearly wage ratio has become abnormally large, depressing fundamental demand for homes, and this can result in these outcomes:
* The ratio reverts to the mean (or rather lower) as house prices shrink. This happens if interest rates go up.
* The ratio reverts to the mean (or rather lower) as wages grow. This happens if interest rates stay low.
* First buyers etc. switch to rent, which stays cheap, and then landlords have to put up with rental income being a rather lower percentage of house value than usual. The market seizes up for a long time.
* First buyers etc. switch to rent, and rents revert to the mean by raising by the same amount as house prices, and then disposable income gets hit badly. The market seizes up for a long time.
Usually what happens is that shrinking nominal house prices are a political catastrophe, so the ”inflation party” ensures that wages and other prices are allowed to grow until there is reversion to the mean in the house price/wage ratio.
My suspicion is that the fabulous ”free money” era happened with the purpose of making a majority feel very happy and not worry about distasteful things like foreign wars and ballooning deficits.
If monthly payments shrink or grow slower than the value of the house (‘Money for Nothing”) the average middle class voter is so happy that little else matters…
«I have had discussions now with dozens of friends and peers and am amazed at how much resistance there is to even consider my points. Basic quantifiers are being dismissed with the wave a hand if they do not support the precept that real estate is the last great wealth builder.»
I remember seeing a really nice dotcom era cartoon where this guy does a presentation and the slide says:
“The market for inflated expectations will be worth *trillions*!”
:-)
«The thing I always hear now is “don’t ever buy an Internet stock”, which isn’t quite right. I guess maybe that is why RE is the new dot com bubble.»
Well, yes indeed, because most investors first allocate their investment by asset class, and then within the asset class.
The traditional asset classes are stocks, bonds, houses, commercial property, and commodities.
Private investor normally only invest in stocks, houses or bonds; commercial property and commodities usually are more for professionals.
So the usual cycle is that investors pile into stocks because of huge ”free” capital gains, and get burned, so they next pile into bricks because houses are “safe”, and get burned, so they pile into bonds because at least they have a ”guaranteed” income, and get burned, and the cycle repeats.
The reason why this cycle is resulting in huge bubbles, more than semi-normal peaks, is because there is so much free money sloshing around, after years of 1-2% nominal interest rates. Even now at 5% nominal the real interest rates are nugatory, or arguably negative.
If there is something I had never expected to see in my life was a 1% nominal discount rate in the USA…
The only (semi-good) reason that I can imagine for the Federal Reserve to do this is political, to keep all the voting and investing classes punch drunk happy even with a couple of (poorly run) wars going on and to keep the cost of funding the wars with t-bills as low as possible.
The statistics that Barry has shown and those I have pointed to have these two impressive : in 1994-5 something happens that causes PEs to start exploding, and in 2001-2002 the post boom collapse is halted and PEs stabilize at historically high levels.
If ”Abraham” Bernanke has to offer sacrifice, as Barry seems very resignedly afraid of, bad news.
However my expectation is that instead of driving down inflated asset values via high interest rates, the politics of the situation are that adjustment will happen by driving up most prices until their historical relationships revert to mean.
The key point here is that why low wage earners have no political leverage, and thus have had to take significant compensation cuts over the years, house owners have massive political leverage, and they will not stand for falls in the value of their houses.
Also, all those foreign holders of t-bills have to be given a good cramdown, and deflation is exactly the wrong recipe for that.
«Private investor normally only invest in stocks, houses or bonds; commercial property and commodities usually are more for professionals.»
Well, I should have added: and as a special case, cash is also an ”asset” of some sort that people can invest in.
Another worrying sign is that Warren Buffet and many companies have been investing in cash for years now. Evidently they expect the value of cash to go up (as expressed in other assets) or the value of other assets to go down.
Or perhaps it is just a defensive play: when the wars started, companies cut investment and costs and started accumulating cash, because war is a period of high uncertainty and peril.
Just bear in mind that houses are only worth as much as other people are willing to pay for them. The rapid acceleration of home prices may have appeared to inflate the value of real estate in most local markets. But if aspiring new homeowners can’t afford to pay the new prices then the real estate market can’t be sustained. Banks have supported this boom by offering more and more extravegant loan packages that took greater and greater risks. But now that they are beginning to tighten their criteria again, we may see prices fall solely because the retiring generation cannot find anyone capable of taking over their debt load.
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