Tuesday, May 10, 2011

"Why A Real Estate Appraiser Prefers The Stock Market To Real Estate," by Fred Carach

The twin crashes of the stock market and real estate that began in 2007 have devastated the American people as nothing has since the Great Depression. The American people today are far,far poorer than they were prior to these twin crashes. But something very strange has occurred. The stock market bottomed out in March of 2009 and since then has blasted upward in a powerful bull market rally while real estate the favorite investment of the American people and where most of their wealth resides has twisted ever so slowly in the wind.

It is time to ask a most important question. What accounts for this strange divergence? Before we go any further I need to state that in this article I use the narrow, popular definition of real estate. I refer only to condos,townhouses and single family homes. This article ignores apartment buildings and commercial real estate. Those interested in my considerably different views on commercial real estate are invited to read my article on commercial real estate and REITs titled, "How The Small Investor Can Afford To Buy Commercial Real Estate," on my blog.

It is important to point out that until the recent crash real estate had enjoyed one of the greatest sustained booms of all time. You have to go back  to the S&L crisis of the late 80s to find the last time that real estate was not in boom conditions. That crisis ended in 1991 and from 1991 until 2007 real estate did nothing but go up. Everyone was riding a wave that they couldn't lose on. You had to be truly stupid or unlucky to lose money in real estate during this fantastic 16 year period.
For reasons that I have never been able to understand people have enormous difficulty in understanding that in residential real estate it is impossible for real estate to rise faster than people's income for any sustained period of time because people will not be able to qualify for the mortgage.

And this is exactly what happened as the boom progressed. All sorts of strange mortgages were being created to fudge the issue that people could not possibly qualify for the homes that they wanted to buy. Mortgages with weird names such as ARMs, Alt A, negative amortizing mortgages and of course the famous liar loans dotted the landscape.

In 2007 the yawning gap between what people could honestly afford to pay and ever rising real estate prices could no longer be papered over and the whole rotten edifice collapsed. In that year the median priced home sold for $230,000 and the median income household could afford to buy a home in the $150,000-$175,000 price range using honest standards. Incidentally, that is exactly what the median priced home is selling for today. For the first time in many years the median income American family can afford to buy the median priced home.

Why then do I an insider with 30 years in the appraisal industry and a licensed realtor prefer the stock  market to real estate? It is indeed fortunate that real estate is selling for the first time in many years at a price range that is affordable to the American people but the $64,000 question is what will make real estate values rise. The answer I am afraid is that in the next five years there is almost nothing that I can see that will cause a sustained increase in real estate values on the national level.

It is amazing to me that people can not figure out why real estate values are dead in the water and refuse to rise. Contrary to popular belief real estate doesn't increase in value because they are not making any more of it or some other idiotic popular delusion. Real estate increases in value for only one reason and that reason is because buyers engage in bidding contests to purchase properties. In the absence of bidding contests real estate prices cannot and will not rise.

By now it should be obvious to the reader what the problem is. The problem is that the American people have been financially devastated by the twin crashes of the stock market and the real estate market. They are no longer players. They are too broke to engage in bidding contests.

Until the crash there were millions of active real estate players throughout the country who had a net worth of say at least $1 or $2 million on paper if not in reality that they could borrow against. Huge numbers of these players no longer exist. They are done, through, finished, foreclosed upon and have
declared bankruptcy. These now vanished players were the heart of the real estate market and they will not be coming back anytime soon. Indeed many of them will never come back. Their credit ratings have been destroyed and no bank will lend them money. This is a fatal combination in the world of real estate.

The stock market sails serenely on for the best of reasons. You don't need a credit rating of 620 or better to buy stocks and you don't need a bank loan to buy stocks. Stocks are a cash market. In this sea of darkness there is one light. The remarkable rise in real estate of the "cash buyer." For the cash buyer with a 7-10 year time horizon real estate is a market that has real potential.           


Forty Years a Speculator
Fred Carach
Oakland Park, FL 33309
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