|Irrational Exuberance, Part II?
Every where you look these days, experts are spouting that real estate is in a bubble in many
areas across the country. An article in last week's USA Today showed an amazing increase in the
median house price in the United States to over $200,000 for the first time. To me, that is amazing
and quite frankly, a bit sobering.
The real question is what are YOU going to do about this market? Many "experts" are
stating that people should completely stay away from real estate investments at this late stage.
Other "experts" are stating that in many areas of the country, we are no where near bubble
stage so buy everything in sight. To me, both those views are naïve.
If I accomplish nothing else from this web site, maybe I can convince a few people of one
fundamental truth about markets: no "expert" KNOWS what this market, or any other market is
going to do. If you don't believe me, I challenge you to turn on your favorite financial news channel
and listen in to the talking heads for a period of a few days. My guess is that after about a week,
you will find an equal number of "experts" predicting the stock market will go up as opposed
to those "experts" predicting that it will go down.
In fact, this is what keeps a market reasonably balanced. If it became suddenly obvious to
everyone that the market was going up, prices would escalate up in minutes (actually seconds in stocks)
until a new balance is reached. We'll, I hate to be the bearer of bad news but nobody really knows
what this real estate market is going to do either. Long term trends in some places are pretty clear
but what the market will do in the next 12-36 months is pretty dicey.
Frequently the question from new investors (or stock traders) becomes if "experts"
don't know where the market is going, then how do they make money? Very simple...... If they decide to
participate in a market, then they do 4 things:
- They take their best guess where the market is going;
- They limit their risk in case they are wrong;
- They try to make their “wins” much bigger than their losses; and
- They monitor the markets like crazy to provide early signs that they are wrong so they can get
out as fast as possible
In the Mastermind Group, we are now starting to implement something in our forum where we use
all of our eyes and ears to try to do step 4: monitoring of the market. Part of what we have recently
discovered is that there is a move underway by several lenders to really tighten the requirements on
certain investor loans.
In case you are one of the believers that "real estate NEVER goes down and there is no
way to lose money", let me just play out one possible scenario for you that to us, appears as
plausible as any for something that might derail this market and make it go flat or down. Again, I am
not predicting the market will crash since there are too many unknowns to predict that. I am just
saying here is one possible way that the market could go soft and we need to be prepared to limit our
risk in case this happens.
Suppose that Greenspan, and/or congress, and/or our president determined that the housing
market was too overheated and potentially put the country at risk because of too much possible exposure
to a run of foreclosures. After a little bit of study (which they already know now), they decide that
really the investors are the ones driving all of these markets so what they need to do is really put
the brakes on them without turning off the rest of the housing market. Hmmmm, how to do that especially
since raising the short term interest rates lately have had little effect on the long term rates.
Well, maybe one idea is to STRONGLY make a suggestion to the primary players in the secondary
mortgage markets (Fannie Mae and Freddie Mac) that it would be very helpful if they refused to make a
market for investor loans unless they had tighter requirements. Let's say, for example, that they
needed 20% down, and had to be seasoned at least 6 months before they could be sold in the secondary
market. Given that Fannie Mae and Freddie Mac are already in hot water with the Government, they might
just agree to help them out on this little issue.
Well, those 2 little "requirements" could be pretty readily implemented but would
have HUGE impact in the investor home market where people are buying and flipping homes in 2-3 months
(and yes, I am guilty of this as well). If the secondary market was not going to buy the mortgages,
then guess what, the people writing the mortgages are only going to offer those terms which can be
resold; i.e., in this example, investor loans with 20% down and holds of at least 6 months.
My estimate is that those 2 simple requirements would eliminate 80-90% of the flipping and
would probably rapidly flatten, or decline prices in many areas. Yes, deeper pocketed investors will
likely switch to a longer term approach when this occur but it appears that many of the investors that
are driving this market may not be able to do that simple step.
Now suppose you are somebody that has taken out 6 condos but have to close before flipping...
Oops, now you have to hold those for 6 months at least and now many of your potential buyers (who were
going to flip it) went away as well. Were we have to be careful with preconstruction investing is that
our timelines can be long enough that it is hard to change investment styles mid-stream and roll with
the market changes.
Before you say this is ridiculous, I encourage you to read about what happened in the 1986-87
time frame in real estate. Many very successful, over-leveraged investors went bankrupt with one
stroke of the Government pen with a tax law change. I personally know one individual that was worth
well above $100M and with that one pen stroke, suddenly (over a couple of years period) had a net worth
that was several million dollars to the negative….. Oops.
So is this irrational exuberance part II? I would argue that it depends upon you. If you
believe you can buy anything and it will go up and there are no worries,...., then yes you may be guilty
of irrational exuberance. If, however, you are a believer in this market and you are making as smart
as investments as possible, and you understand your risks throughout, and you are trying to manage them,
then I would say no, it probably is not.
There is typically multiple opportunities in almost any market condition if you're willing to
learn and adapt. Where people frequently stumble is they ASSUME what worked yesterday will also work
today. To further compound the issue, they risk too much on that one single assumption. If you are
going to be an investor, simply learn to adapt to changing conditions and always listen to what the
market is trying to tell you.
Chris Anderson, PhD
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