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Real Estate: What does the future hold?

One of my Realtor friends says that not so long ago, he seriously considered declaring bankruptcy to get clear of the three properties he bought at the height of the bubble. He’s dropped the plan, seeing that things are slowly turning around, but he’s skill skeptical about the future.

Meanwhile, some speculators think real estate is set to grow at a fast clip. Yeah: any time now. Yale economics and finance professor Robert J. Schiller reports on surveys of home buyers’ attitudes. In 2009, 311 people responded. Asked how much they expect their property value to change annually over the next decade, their average answer was an increase of 11.2 percent; the median response was 5 percent.  Asked about short-term prospects, respondents answered, on average, that they expected a 2.3 percent rise in their home value over the next 12 months.

He who thinks his single-family residential property value is going to increase 11.2 percent per annum over the next ten years is stuffing his pipe with some mighty potent happy weed.

Over the decade I owned my last house, its value rose about 8 percent a year. But I got a good deal on it when I bought it out of an estate at the tag end of the recession that followed the savings and loan fiasco, and I sold it just as the late, great bubble prices were starting to run up. A four-bedroom house with many designer remodels, it stood on a nice street bordering a prime central neighborhood, within walking distance of an acceptable public school.

My guess is we’ll see a plodding annual increase of about 2.5 percent for the next several years, followed by a rise to 3 percent for a couple years, then settling into to 5 or 6 percent for the duration. More optimistically, I can imagine a 3 percent growth rate for several years that then drifts past 4 percent and 5 percent to arrive and stick at a steady rate of 6 percent per annum.

If you owe, say, $211,000 on a house for which you paid $235,000 and that’s now worth $160,000, what does that mean for you?

Scenario 1. Sale value rises by 2.5 percent for four years, then 3 percent for two  years, then 5 percent for 3 more years:

Value rises to $176,610 after 4 years.
It reaches $187,366 two years later, after a total of 6 years.
And it hits $216,899 3 years later.

You’ve held the property for 9 long years. Interest has picked your pocket thoroughly and you won’t get your down payment back, but if you sell the house, at least you don’t have to bring any greenbacks to the table.

Scenario 2. Value rises at 3 percent for three years, then 4 percent for a year, then 5 percent for a year, then 6%:

In 3 years, it’s worth $174,836.
Another year later, at 4 percent, it reaches $181,830.
The next year, as appreciation shifts upward another percentage point, it’s worth $190,921.
The following year, at 6 percent, it reaches $202,377. Six years have passed. You’re still upside down, but today if you try to sell it you only have to bring $8,623 to the table, far better than the $41,000 you’d have had to come up with if you sold it in a panic at the outset.
With appreciation holding steady, you hang onto it for 3 more years at about 6% p.a. (simply by way of comparing it to the first scenario), and it’s worth $241,034.

Because you’ve had to pour a lot of interest into the thing, when you sell it at the end of year 9 you don’t walk away with anything to make Uncle Scrooge proud. But at least you can unload the place without having to pay cash to the bank to get out from under the loan.

IMHO, that’s about the best we can expect. If that’s so, either of two strategies can help turn this lemon into lemonade:

1. If it’s a decent house in a safe neighborhood, live in it and enjoy it for nine years.
2. If it’s not anything you’re comfortable living in, rent it and use the rental income to turn the house into a gigantic tax deduction. Use the revenue to pay the mortgage bills, defraying some of the losses on the investment. If, as expected, inflation goes into the stratosphere, over time you’ll be able to charge enough rent to cover the payments and have some left-over cash to put in savings. Assuming you have a fixed-rate mortgage.

Let’s suppose a miracle happens and houses start to appreciate at 4 percent. This puts you right-side up in about seven years. Well, what the heck! If a miracle like that can take place, surely an immediate annual appreciation of 6 percent isn’t impossible. That would haul you out of the deep end in a little over five years.

There’s another possibility, of course: massive inflation. In that scenario, the real purchasing value of the money you owe on your monthly payments drops. If you manage to get and hold a job, the payments become more affordable over time. The dollar value of your house rises, but then the dollars are worth a lot less. You reach a point where you can sell the house for the number of dollars you paid for it, but those dollars won’t put a better (maybe not even a comparable) roof over your head.

Back in the days when bankers were bankers, they used to say real estate should always be seen as a long-term investment. Guess those old guys knew what they were talking about! And the only thing they smoked in their pipes was tobacco.

Image: Bungalow in Darien, Connecticut. Public Domain. Wikipedia Commons.

6 thoughts on “Real Estate: What does the future hold?”

  1. If you owe, say, $211,000 on a house for which you paid $235,000 and that’s now worth $160,00, what does that mean for you?

    Hi – I enjoy your blog greatly.

    You need another “0” in $160,000

    Best regards,

    Julie

  2. This whole analysis is completely absurd. It fails to take into account wages and inflation.

    Houses can’t rise faster than wages, because at some point no one can afford houses. Wage inflation over the past 10 years has been basically 0. It’s likely that housing prices will continue to fall until they are back in line with wages and rents.

    We’re in deflation right now, between 3-6% per year, so until that stops, it is unlikely that housing prices will rise at all.

    This analysis cannot be taken seriously unless that is all factored in. When you factor it in, you may find that housing prices may not rise much (if at all) for the next 5, 8, or possibly 10 years, and even then, won’t outpace inflation.

    -Erica

  3. I enjoyed reading your post and I offer no criticism.

    But, I do agree with Erica that real estate values are tied to wages. That’s why they ratchet up and then crash every decade. But, they are never going to go way up and stay there as long as wages aren’t keeping pace. Otherwise, the houses become unaffordable to most buyers.

    I live in a very desirable part of So. Cal. and you can’t find a decent house for less than a half mil. But, my kids probably won’t be able to afford a house in San Clemente. In fact, if I hadn’t bought my house in ’96, during the last crash, I could barely afford it myself. I suspect houses are going to come down even further before this is all over.

    • @ Hope to Prosper (& Erica): it’s very probable that low wages–or no wages–will keep property values from rising for some time. However, it must be remembered that in Arizona, a right-to-work state, wages have always been below par, yet prices blew way up out of proportion to the locals’ earning power. This happened partly because in-migrant Californians, who were accustomed to inflated real estate prices, were willing to pay far more than the market value of properties here, apparently unaware or not minding that they were being ripped off. And, as elsewhere, it also happened because banks were writing loans that they knew very well borrowers couldn’t afford. Even at the height of the bubble, a very few real estate agents kept repeating the old mantra: It’s not what you can qualify for, it’s what you know you can actually pay. But most people had too much stardust in their eyes to read that particular message on the wall.

      Despite the generally low wages, there’s a surprising amount of money here. Large swaths of the Phoenix metropolitan area are very upscale and very expensive, well beyond the reach of what remains of the middle class. The result is that by and large we don’t have a lot of truly middle-class housing. What you see is either upscale or downscale — often in enclaves set side-by-side — with very little that’s in-between. Frankly, I wonder if wages will make much difference. Most people mid-level white-collar workers and people in the trades can’t afford nice housing in good school districts, no matter what. And the people who are wealthy enough to afford better housing likely will stay that way. Them’s that got, gets.

      IMHO, prices may stay static for several years; a 3% increase that keeps up with inflation is not a real rise in value. But I doubt if they’ll drop much further.

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