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GLOBAL REAL ESTATE MARKETS FORUM
* Realty Reality November 2005

Leigh Budlong, Eric Englund, Ole Bear, Rob Kirby, and Sol Palha

TOPIC#7:

RealEstate IS the stuff dreams are made of! Ain'tit?
The Buck Stops When? or The Maltese Falcon?
� The Stuff Dreams are Made of!

Just how long can the Federal Reserve keepthe Real Estate money-backed FRN [Federal Reserve Note]con game going with debt-backed real estate anddebt-backed paper � funnie monie unbacked by specie?

Truth, Dare, or Consequences?
the story of the red balloon...30 years later
by Leigh Budlong, MAI - CCIM
Beyond Value, Inc.
with Gale Bullock

I remember distinctly a cartoon aimed to teach its youthful audience a valuable lesson. Whether it was the Electric Company or Sesame Street is not clear, but what strikes my memory some 30- years later is the message: you are responsible for your actions.

The cartoon went something like this. A little girl was contemplating popping a red balloon, but before doing it she thought about the consequences on just what might happen.

First, there would be a loud noise.
Then, her baby sister would cry.
Next, her mother would come to see what caused her baby sister to cry leading to punishment.
On top of all that, the red balloon will no longer be inflated.
The little girl would be instructed to clean up the mess�

What does this bright 5-year old decide to do?

She decides not to pop it.

My job is to give a professional assessment, an opinion, of a property�s value. In today's real estate market there are a number of factors tugging on the seams of traditional valuation techniques with motivation being harder and harder to quantify. Motivation, a basic human instinct, is personal with complex layers influencing decisions. While I haven't seen a line item adjustment for �just got to have it�, this should maybe be considered. However, the only way to factually support the adjustment since paired sales don't work, is simply Fed Speak and hot air? But what's really in the balloon?

One thing is clear: buyers aren't playing by the old school rules with much reliance on stand-by economic indicators such as overall cap rates.

Unlike stocks or bonds, real estate is a joint-venture between borrowers and lenders. The lenders� job is to lend money, otherwise their job is pointless. Years of Fed rate reductions have flooded cash though our system, which subsequently flowed into the global market. Lenders have had to get creative, making new products to accommodate more customers.

As perceptions shift, market participants grapple to understand the new rules and valuation experts struggle to reconcile the divergences. Why would investors willingly accept such low premiums (cap rates)? How could rents be depressed but asset prices rising? Isn't the market due for a correction? So, what's in the balloon?

We've been awaiting the downturn, or market correction for years. The Bay Area had a temporary slowdown after the dot-com meltdown, but the real story is the continuing flow of cheap money and loose lending standards shaping the real estate landscape. Adding fuel to the fire, real estate is the darling for many investors wanting an alternative to the stock market and low yielding bond return. Well that is unless you are in the carry trade as an Asian Central Bank loaded with Federal Reserve Notes to invest. Getting to be somewhat of a complex mix of gases in the red balloon isn't it? When we combine that balloon with Charles� Law that heat expands gases, the red balloon starts turning pink as it inflates. We suspect Greenspan and now our new FED Guru Bernanke have been brushing up on their chemistry, and figure that the inflation printing press will work pretty much like Boyle�s Law, that as long as the pressure of the printing press remains the same, the balloon won't get any bigger. Hump. I guess they figure that works for real estate. Yet central bankers rewriting the laws of economic chemistry are playing with a really nasty red balloon. Soooooooo? What's in the balloon?

What are some of the other trends influencing prices aside from motivation? How about: multiple buyers pooling down payment money to make an acquisition, overseas buyers with currency hedges favoring their purchasing power, loan products that allow for multiple owners to have individual loans, creative use of IRA money that permits buying real estate, and of course, the amazing grace � the mortgage interest deduction. Last week, the Wall Street Journal ran a front-page article about the game of chicken being played around the globe as risk is rated lower in pursuit of better returns. The Fed flooded the market with US dollars, and we've managed to spend them creating multiplier effects along the way. That multiplier has gone into real estate in the form of low cap rates, inflated Gross Rent Multipliers, and increasing prices, while rents go soft, and expenses continue to rise, such as utilities, insurance, and property taxes. Build it and it will lease is the mantra in times of cheap money! What a playing field of dreams � real estate, the stuff dreams are made of!

In essence, we are partners with the US government, and their backers who then trade a favor with our government and so the cycle goes�we are all in this together. A little pork, pour vous?

Looking more closely at the trends in the capital markets overall, this much is clear: the market doesn't buy the reported low �2-3%� core inflation story. Knowledgeable players know they need to push the limit (and are willing to pay premium prices) in an attempt to outpace inflation. The problem is going to be when �low inflation� is no longer believed by a wider audience. Then we will see the cost of capital rise and catch up to where they players are already � confirming what they had anticipated. I suspect these investors have no idea what's in the balloon, even if it is cyanide gas, as long as it doesn't pop while they are still in the game.

It will be interesting to see how capital markets react as the government attempts damage control measures once the story-line starts to unravel � the dollar ultimately being replaced as the world's reserve currency. That is what is at stake, and it is not a very pretty balloon giving your choice of colors. With so much riding on this, it is no wonder there is great concern about what steps might be taken, and that is exactly why investors are making such risky moves now while they can in the real estate markets. So, what's in the balloon?

The tax policies in particular have a profound effect on the decision makers in real estate. In 1986, the tax code was changed to modify partnerships and their ability to write off losses. The result: a sudden and negative impact on real estate transactions. But long term, in the end a lot of eggs ended up in one basket� or one pretty red balloon filled with some kind of gas.

The latest buzz is about the November 1st meeting regarding tax reform. Today, there is a clear link between capital markets (Wall Street), Washington D.C. (policy makers), and Main Street (real estate owners - homeowners). New financing products have created a new marketplace available to unsophisticated real estate players. For decades it was not a white glove type of industry and usually reserved for the good old boys� network in various cities with strong ties to community leaders and lenders making it a local based economy sector. No more, for globalization has tied the markets, the policy makers, and the taxpayer together. Let's all hold hands, buy a SUV, and get a pretty red balloon to take home to the kiddies! I love that guy McTeer down in Dallas!

The global effect is best described as the never perfecting imbalance of currencies valuations, value of goods and services changing hands in multi-markets, and the ever-pressing undertones of diplomacy (or lack thereof).

So, the goods from China make the longshoremen in Oakland viable market participants (taxpayers), while the former factories that used to produce a similar good have been converted to housing creating jobs for construction, real estate people, and banks (central banking cartel). The money used to finance the purchases is financed by the Chinese because their payment for that container of goods is paid for by our debt. Their willingness to accept payment of IOUs gives them clout. Make no mistake about that! Sooooooooooooooo? What's in the balloon???

But, it also gives the US a breather. For the taxpayers, they get to enjoy low priced items that may or may not truly need but feel they can afford. For the policy makers, politicians, and other riff raff � they can push their agendas through inside the Beltway, despite the cost merely by allowing the burden to be passed on to future generations. That's why they give you a pretty balloon when you buy a SUV so that you can take that sucker home to the kiddies! The rush of money (really nothing more than the electronic clicks transferring from there to here and back again) is just that�a rush. Whenever there is a drug induced (funny monie and creative financing gimmicks) rush, there is always some form of hangover depending on the drug � evidenced by the Rocky Mountain High in foreclosures in and around Greater Denver. But it cannot be a national real estate bubble according to Greenspan, Bernanke, and Snow-Job, since all real estate markets are local. OK, BOYZ, what's really in the balloon?

With the pressure (remember Boyle�s Law?) to keep those strangers kind enough to take our debt (backed by mere a promise to pay back our debts from our balloon toting kiddies), the Fed has that daunting task to keep their returns high enough to keep them coming back (Charles� Law), but not so high that we don't lose the housing financing windfall. Prior to the jolt to reality that life is costing more � gas, utilities, food prices � compounded by the loss of jobs, lowering wage or merely lowering confidence that we, as a country, have it together on top of the already hefty real estate/housing costs, this formula could work. Now, the lines are blurring and tough decisions with long lasting consequences will be made. We suspect the BOYZ at the FED will be brushing up on their chemistry and nuclear physics creating some new empirical formulae and laws pertinent to smashing atoms and inflating gases under pressure with a printing press. With some of the pithy altruistic obfuscations we have heard from Greenspan, Bernanke, and Snow-Job about real estate, froth, and no market balloons, we now think that these Rascals can re-invent Einstein�s Theory of Relativity, since they move faster than the speed of light. Might Be! So, BOYZ, what is really in the balloon?

Popping the red balloon is going to make more than just noise as experts have projected. Trying to allow for merely a slow escaping of air might be a better approach, but the result will be the same, a deflated asset. When the dust settles, it will become evident what magic tonics the FED used to puff the balloon, a mixture of hydrogen (explosive), helium (laughing gas), cyanide gas (lethal), or just plain old-fashioned hot air crafted and spun by our current economic super wizards Greenspan, Bernanke, and Snow.

© 2005 Leigh Budlong, MAI � CCIM
Beyond Value, Inc.
Sausalito, California
Website | Email
Edited by Gale Bullock, MAI

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When Will America's Housing Bubble Burst?
by Eric Englund
Surety Bond Underwriter

Throughout 2005, my clients�contractors of all trades, fabricators, and suppliers�have watched housing continue on its tear. Housing demand seems insatiable. Residential, commercial, and public works contractors are busy all across the U.S. When housing subdivisions and condominium complexes are built out, commercial and public works projects often follow. Strip malls, supermarkets, restaurants, and department stores are constructed to serve these new population centers�much to the delight of the commercial construction trades. With these new population centers comes the �need� for new public schools and other public infrastructure. Public works contractors get a piece of the action as well. Most of my clients are quite busy and turning nice profits. However, during a recent business trip, a common theme emerged in meeting after meeting. My customers are seeing severe shortages in building materials and quality labor. Many are outright stating that the heady pace of construction is simply unsustainable. In turn, some of the more seasoned contractors are predicting a bust�but they just don't know when; yet I will hazard a guess.

In my meeting notes, I found that contractors were running into shortages of the following (pre and post-Hurricane Katrina):

Of these shortages, the one causing the most frustration pertains to a dearth of quality labor. Contractors, frequently, have little choice but to load their construction budgets with ample overtime pay in order to keep quality (and often shorthanded) crews together for the duration of a project. One client quipped: �This constant battle for labor and materials can't go on forever. Things have to cool down sooner or later. But when?�

As to precisely when the bust will occur, this is not knowable. As to why boom turns into bust, only the Austrian Theory of the Trade Cycle provides the intellectual framework allowing one to understand the boom-bust cycle. What we will find, as explained by Roger Garrison, is that central banking is at the epicenter of the business cycle. Dr. Garrison provides the following explanation in the Mises Institute�s fabulous book The Austrian Theory of the Trade Cycle:

The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.

Undoubtedly, the current American housing boom has not been built upon a foundation of savings�keeping in mind that, presently, America has a negative savings rate. This boom has been fueled by the Federal Reserve�s aggressive creation of money and credit. Correspondingly, the federal funds rate hit a low of 1% in June of 2003�about the same time the housing boom began to accelerate.

Since money and credit can be created out of thin air, yet building materials and other resources cannot, does it not stand to reason that relentless credit creation would lead to resource shortages? Of course, the answer is �yes��and Austrian economists know this. Accordingly, Roger Garrison covers this issue in his excellent book Time and Money: The Macroeconomics of Capital Structure:

In sum, credit expansion sets into motion a process of capital restructuring that is at odds with the unchanged preferences and hence is ill-fated. The relative changes within the capital structure were appropriately termed malinvestment by Mises�The boom is unsustainable; the changes in the intertemporal structure of production are self-defeating. Resource scarcities and a continuing high demand for current consumption eventually turn boom into bust.

It is not often one finds an economic theory that describes reality�and Austrian theory does so magnificently. In fact, from the labor and materials shortages my clients have described, it would seem the bust phase of the business cycle is nearly upon us.

Tom Barrack, widely considered to be among the world's greatest real estate investors, wittingly or not, has an Austrian perspective as to why the United States� real estate/housing boom will soon come to an end. He stated the following, about real estate, in a recent Fortune article: �There's too much money chasing too few good deals, with too much debt and too few brains�.That's why I'm getting out.� Tom Barrack certainly understands the dangers of high-octane credit expansion. Yet, what about the inevitable resource scarcities caused by the Federal Reserve�s accommodative credit policy and how will this affect the housing bubble? In the following excerpt, from this article, Mr. Barrack hits the ball out of the park:

�he sees the bubble deflating soon. Barrack thinks the catalyst will be a trend that few others are talking about, a steep rise in the price of building materials and labor. "Construction costs have spiked 30% in the past nine months," he says. The reasons: shortages of labor and materials like lumber because of the building boom, and increases in the price of oil, needed to produce everything from plastic piping to insulation to shingles.

The slump will show up first in speculative hot spots like Miami and Las Vegas, he says, where condo developers are preselling their projects for what look like big profits. When they actually build the units over the next year or two, he predicts, they will end up spending more than the units are now selling for. At that point, says Barrack, the developers will try to raise prices. "But most of these buyers are speculators," he says. "They will either sue the developers to get the original prices or get their deposits back and walk away." The developers will then put the units back on the market, and the glut of vacant condos will drive prices down. "It's the busted deals caused by construction costs that will cause a turn in the market," he predicts.

To be sure, the severe construction labor and materials shortages, seen throughout the U.S., signify the housing boom is nearing its end. Not surprisingly, Austrian economic theory predicted such shortages would emerge before boom turns to bust.

For good measure, let's throw in the following housing affordability and financial-stress factors into the fray�which also point to the impending demise of the housing bubble:

But what about my promise to hazard a guess as to the timing of the bust? After all, Tom Barrack indicated that he sees enough busted deals materializing, over the next year or two, to bring about a downturn in the real estate market.

In order to make a reasonable prediction, I am going to bring into the mix a September 2005 Federal Reserve discussion paper titled House Prices and Monetary Policy: A Cross-Country Study. Per this discussion paper�s abstract: �This paper examines periods of pronounced rises and falls of real house prices since 1970 in eighteen major industrial countries, with particular focus on the lessons for monetary policy.� Here is what I found to be most interesting: �House price booms are typically preceded by a period of easing monetary policy, with policy rates bottoming out about the same time that house prices take off, about three years before house prices peak.� Considering the fed funds rate did not bottom out, at 1%, until June of 2003 (and remained at 1%, until June of 2004, before being ratcheted upwards) one could reasonably surmise house prices will peak somewhere between June of 2006 and June of 2007�and then, of course, will break downwards (for the reasons mentioned above).

With a plausible timeframe in hand, I am predicting the housing bubble will begin to burst within the next 14 months�perhaps by around December of 2006. Ultimately, we have a housing boom built on credit (and not savings) which has lead to labor and materials shortages and has lead to overleveraged consumers. This is why I see a bust�as indicated by accelerating mortgage defaults and a general decline in housing prices�commencing well before June of 2007. To close, always remember Austrian theory allows us to know there will be a central bank-induced bust. As to timing, I am only providing an educated guess.

© 2005 Eric Englund
Surety Bond Underwriter
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The Maltese FED
by Ole Bear, Editor

The past Monday last, Mr. Bush threw Mr. Ben Bernanke into the Circus Ring for FED HEAD come the Green Man�s retirement in January 2006. I already have it on good sources Mr. Green Jean�s has his memoirs ready to publish within six months of his so-called retirement [Just Kidding!] The White House�s timing was impeccable with Special Prosecutor/Investigator Fitzgerald snooping around a few politicians� shenanigans inside the Beltway. In the same week Bernanke gets the nomination, he goes on record that there is no real estate bubble. Now this week, or after Bernanke takes away all our bubble bath, Treasury Secretary Snow gives us his Snow-Job that there isn't a real estate bubble, either. So now we have the economic Bible according to Bernanke and Snow. What a Revelation� the price of wheelbarrows just went down!

Well, after all, real estate is the stuff dreams are made of, ain�t it? It is the only thing I know of on the planet that is a wasting asset from day one when it is built, and actually physically depreciates, while its market value always seems to go up. This is like having a free ATM card. However, if you know anything about music, I view this as a deceptive cadence. What's a deceptive cadence? Very simple really � you are following a tune or song, Bach or Mozart or Evanescence, perhaps, and enjoying the moment. You as the listener think the music phrase is going to conclude in one place, before the music goes on to the next theme, but the composer catches you naked [as in going long or short the markets with your put and your call] and takes you someplace else to a different ending of the musical phrase. A Picardy Third is a prime example, going from a minor tune, ending the music phrase or statement on a major third. Ta-Dah! The Picardy Third originated in the 1500s by the way.

As I am sitting here penning this essay, I have about two dollars and sum odd coins in change laying there next to the essay file folder as well as a five dollar bill and two one dollar bills. If you understand what a real �bill� is, these are not true monetary bills, but Federal Reserve Notes. None of the coins are specie coins, with exception of about five pennies that are real copper made before some date in 1980-something or early 1990-something [I forget the date now.] Even the pennies are not real. You can even hear the difference in the pennies when you drop �em on the desk and let �em bounce around. The new issue quarters without the eagle on the reverse are a joke. They don't even sound like the old quarters. The new nickels don't even look like nickels. Why is this money? Why? � Because for most of us it is the only money we have ever known, and we are lied to that it is real money. In reality, it is pretty worthless stuff since it does not maintain its value very well over long periods of time. This is because of Mr. Bernanke's printing press. This is stealing by stealth and deception, and it has been happening to the American Public since 1913.

This so called legal tender stuff is perceived by us Silly Americans as the only money we got, although heavy metal, aka gold and silver bullion, is both commodity money and fiduciary money. Snow and Bernanke won't tell us that, however. We perceive our real estate and our real estate markets to be the only real estate we got. The Realtor motto is: Under all is the land. The Realtor sales motto is: Location! Location! Location! Pretty good stuff for dreams to be made of, ain�t it? Both our money and mortgaged real estate are debt backed by selling Treasury Bonds to print money to Asians and their central banks, and other foreigners who send daily God only knows how much paper money our way each day to keep this financial house of wax together. The Maltese FED has a really good gig going here, and it has since it was set up as a deceptive cadence to our Constitutional Money system of 371.25 grains of fine silver for a US Dollar, backed by true bills redeemable in Silver as the Dollar Monetary Unit.

I built my adobe hut in 1991, and moved in on December 7th � Pearl Harbor Day. My hard cost was about $180,000+- and loose change, and I spent about $40,000+- more than I had budgeted for, since the market was going up. Nope, I can't build this adobe hut today for that money!

Gee, Whiz! This thing is like the House of Usher! It keeps needing this and that! I have to maintain the exterior, mow the dang yard, prune too many shrubs, and I have repainted a couple of rooms. Now the Bride wants the whole interior painted. We also had some workmen [they were plumbers and HVAC guys] who ruined a � bath we had to redo on the first floor. The HVAC guy installed an incorrectly sized humidifier filter, causing water to drain from the 2nd floor into my kitchen sink below, ruining the kitchen ceiling. Oh, yeah the ceiling has been repaired, but the kitchen/hearth room ceiling still needs to be repainted since I can't just paint the repaired area. Well, since I am a realty valuation guru, this thing with all of it's deferred maintenance and depreciation based on its typical 60 year life is now probably worth close to $300,000+- and loose change. That is unreal! But, I am not moving anytime soon�

Why?

I have a pretty nice loan under 6%. I haven't refinanced with a Snow Job to the banking cartel extracting all this supposed equity out of the property, like every brother and their dog, Spot, have done. An interest only loan in my view is taking a surgical knife, self-extracting a pound of flesh from your body, and giving it to the central banking and mortgage cartel, which is a rigged casino to begin with. Coming back to The Maltese FED, this is the stuff dreams are made of� sucking folks in to put debt on their depreciating real estate [but appreciating by the inflation caused by The Maltese FED, itself!] It is a smoke and mirror, Folks! One must understand the men behind the curtain in the Land of Oz pulling the switches and levers, for that great Pivot Point that real estate is the stuff that the debt of dreams and our money system are made of. Inflating real estate through the ABS and MBS markets back our legal tender money system in my view based on promises to pay the debt on the real estate.

One of my most favorite books is Fiat Money Inflation France, How It Came, What it Brought, How it Ended? by Andrew Dickson White penned in about 1876. The currency at issue was the French assignat at the time of the French Revolution. The powers that were, printed money like crazy. They even tried using land to back up the currency, which was being printed 24/7/365. This fiat money inflation helped to destroy the socio-economic structure of France, and devastated all social classes. A black market developed for trading goods and services in specie. Trading in specie [real gold and silver] was made a crime punishable by Madame Guillotine! � if you got caught. The lands they tried to use at that time to back their version of the �Continental� and the Mr. Lincoln�s �Greenback� were mainly church owned lands, since the Catholic Church in France during the period was a major landowner. White�s book is a real great read and is free at the link noted above.

I view real estate as debt and a big Ponzi Shell Crap Game. Everybody has to live someplace, granted and for sure! One man�s Palace, can be mused as another man�s Adobe Hut. As long as the Palace and the Adobe Hut have a mortgage�.

Neither man is free from The Maltese FED. The Crap Game will go on as long as we believe The Maltese FED.

Ole Bear, Editor

© 2005 Gale Bullock
Editor for Realty Reality
Columbia, Missouri
Editorial Archive

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The Illusion of Wealth
What's Backing the Bull in Real Estate?
by Rob Kirby
Kirby Analytics

Three guesses to anyone as to what really is behind the great bull-run we've seen over the past several years in real estate prices over the past several years. If your guesses happen to be location, location and location � well � perhaps you're in the wrong place!

Now, if you happen to be thinking easy credit, leverage and liquidity [with a little bit of smoke and mirrors thrown in for good measure] � all provided by the good folks at the Federal Reserve � then you are now talking my language.

Easy Credit Charade

Yes Matilda, nominal interest rates are indeed going up! However, credit continues to be extended at an unprecedented pace. In U.K. financial historian Edward Chancellor�s Crunch Time For Credit?, the author concludes,

�US and UK economies 'badly corrupted' by massive growth in debt��

and

"The growth of credit has created an illusory prosperity while producing profound imbalances in the British and American economies...When credit ceases to grow, the weakened state of these economies will become apparent."

In an exhaustive study, Chancellor points out that the credit boom along with its accompanying asset inflation has produced fattened bottom lines [profits] for companies and individuals alike but at the cost of what he terms �inappropriate balance sheets�.

In the case of your typical American home buyers [aka Jane and Joe Sixpack], this inappropriateness has taken the form of extracting equity from the inflated value of an already leveraged asset � like their home � but it doesn't stop there!

To prolong the this easy credit charade � beyond its natural life cycle which ordinarily would have concluded when rates began rising � lenders are toting new and exotic mortgages with loss leaders [cheap or off market introductory rates now that rates are rising] to entice �hooked� or willing participants. You see where I sit, it's all about greed or getting the next fix,

�The mortgage industry not only grasps this refinancing game, it aggressively markets new loans to these borrowers, raking in additional profits from fees and other charges. And lenders continue to devise more creative loans that reduce payments further and extend purchasing power in pricey markets such as California.�

So, consumers � enticed with sweet financing terms - have increasingly been going further and further into debt. The Fed has, for the record, �observed� all of this unfolding.

Why?

With consumer spending accounting for somewhere in the neighborhood of 70% of GDP, it does not take much head scratching to figure out what might or could happen if real estate prices ever head south. The prospect of such an event has at least crossed the mind of Alan Greenspan,

Federal Reserve Chairman Alan Greenspan warned last month that "exotic" loans could subject borrowers and lenders to "significant losses" if home prices fell.

Take note: the Fed Chairman cited risks to both borrowers and lenders. My take on this quite simple: A drop in real estate prices could have a highly detrimental effect on the U.S. banking system. A deleterious event in the U.S. banking system or the GSE�s [i.e. the Government Sponsored Entities - Fannie Mae or Freddie Mac] could easily serve to undermine the U.S. dollar should holders of their debt securities be �spooked� into a selling stampede.

A Picture That's Worth A Thousand Words

So while the Federal Reserve has been removing excess accommodation �at a measured pace� [since June of 04] � it's no small wonder that 10 year bond rates have in fact fallen!


chart compliments of Jesse

What the chart above also shows is the degree of �liquidity� that the Fed is pumping in to the financial system at the same time they �claim to be tightening� rates. With the unprecedented borrowing needs and current account deficit the U.S. is currently facing � the Fed is �walking a fine line� between appeasing foreign lenders [with rate increases] and keeping the financial system �juiced� with enough liquidity to prevent a consumer induced �contraction seizure� in this highly leveraged economy [through falling � highly leveraged - asset prices].

While the Fed and their highly placed Keynesian cronies in academia will continue to spout assurances that �all is well� in financial land, imbalances continue to mount and there never seems to be adequate [believable] explanations to such fundamental questions like why one income was more than adequate to feed and house a middle class family a generation ago and today it's a tough balancing act to do the same on dual incomes?

To this extent, money and what backs it has come a long way. It used to be that the dollar was backed by specie [gold]. Now - it seems the dollar and its fate is backed by already highly leveraged real estate � so long as real estate values continue to increase.

© 2005 Rob Kirby
Kirby Analytics
Toronto, Ontario, Canada
Website | Editorial Archive | Email

Real Estate Dream or Nightmare?
by Sol Palha
Tactical Investor

I'll do my dreaming with my eyes wide open,
and I'll do my looking back with my eyes closed.
Tony Arata American Song Writer

Once upon a time not so long ago real estate was a good investment, it was something that would appreciate slowly and it was something that almost everyone who saved had a chance of owning; that is no longer the case. Artificially low interest rates, the heavy promotion of the totally bogus concept that owning a house at any price is an American Dream, the huge amount of money pouring into pumping the false claim that anyone can make a fortune owning real estate, mass stupidity in believing that they should get on board before the train leaves the station etc have all contributed to create a monstrous bubble. We have spoken of this situation in 3 prior essays listed below.

Unfortunately real estate is no longer the stuff dreams are made off; instead it is the main ingredient of nightmares. Prices have shot to such levels that most people who go out and buy a house right now with all these creative financing options should seriously consider checking themselves into ward 12. Some of these creative financing programs are extremely risky and carry almost the same risk if not more then playing with options or futures. We have interest only loans (after a certain period has lapsed the individual has to usually make a balloon payment to play catch up), we have teaser introductory interest rate mortgages as low as 1% (some even have the audacity to state that borrowing a million dollars is no longer such a big deal); they forget to mention how things could suddenly change when those rates revert to market rates, the biggest scam of all is that anyone with a pulse can get a loan to buy a house ( the lending standards are so atrocious in fact one could say there are no standards anymore) and the list goes on. All these programs have suddenly enabled a huge group of individuals that should have never bought a house in the first place to go out and buy; as is the case with anything when demand suddenly overwhelms supply prices spike. When prices start to spike another phenomenon kicks in mass stupidity; suddenly everyone thinks they have found the Holy Grail to making a quick million. All of a sudden everyone is a real estate expert and now its time to buy the second and maybe third house; with logic out the window and with madness and greed in the driving seat prices can only but go up ( at least in the short term). These actions are eerily similar to those that occurred before the Internet bubble exploded; prior to the explosion everyone and his grandma had become experts in buying net stocks.

Many individuals jumped into real estate because it appeared to be the only way to protect themselves against inflation (since they know little about hard money such as Gold, Silver, etc) that was and is still being created by the Feds; the Feds are 100% responsible for creating this bubble. However the masses have not noticed a few simple facts:
  1. Interest rates have been rising, which means the cost of buying a house has gone up significantly in the last 6 months or so.
  2. The US dollar has been getting stronger, which means that technically speaking the cost of buying a house for foreigners is also going up; a lot of foreigners were buying property in the US because it appeared to be cheap when compared to prices in countries with stronger currencies.

We are running one the biggest budget deficits in history, more and more high-end jobs are being lost and are replaced with lower paying jobs, consumers are loaded to their gills with debt etc. To make matters worse a lot of individuals are taking out home equity loans and spending these real estate gains without a thought as to what they will do should this market crash. In addition many are using these new found gains to maintain old lifestyle habits that can no longer be supported with their current incomes. Add in all the factors above and buying a house right now is the one of the most insane things an individual can do. This is especially true for those who have a hard time coming up with the down payment and for those that do not have at least 10 months of mortgage payments tucked away for a rainy day.

The current situation in housing has all the ingredients to suggest that a top has already been put in and a nice long fall awaits this sector for the next 2-3 years. Housing prices have been dropping for several months ( real estate prices have been falling for approx 1 year in Britain and Australia and the markets in Beijing pulled back last month), inventories are building up and its taking a lot longer to sell higher end real estate; these are all subtle signs that a top is in the works.

If we take a look at the housing index, we can get an idea of what's going on right now.

(We spoke of this in our last essay Housing Problems)

As you clearly see, the long-term up trend in the one-chart has been broken and this does not bode well for the housing sector.

It looks like it is going to test the 525 zone again then carry on correcting.

This is a more telling picture.

The long-term up trend line in the 3-year chart has been violated. It looks like we could eventually trade all the way down to 200-250 ranges in the next 2-3 years.

Toll Brothers has been smashed. In less then 5 months it has lost over 36% from its high in June to its low in November. This is precursor of things to come for the rest of the housing stocks. Once the stocks in the housing index sector start to break down like TOL brothers ,it's not so hard to envision this Index testing the 200-250 ranges.

Conclusion

Mass psychology clearly indicated that it was time to bail out of this sector many months ago; signs were appearing all over the place stating how easy it was to become a realtor, seminars pumping the million dollar dream concept and everyone in the neighbourhood turning into a real estate expert overnight were all indications that it was time to flee. In terms of fundamentals everything stopped making sense a long time ago and in terms of TA the long term up trend in both the 1 and 3 year charts have been violated. So basically all three areas are clearly stating that real estate is a rather dangerous investment and we think it would be wise to listen to them. While the Crowd was busy admiring the Emperors new clothes it took a child to point out that he was actually naked; the same applies here most of the adults are asleep on the wheel and only those with clear minds will be in a position to spot the cliff that is just around the corner. Is real estate a dream no the dream has ended and the nightmare has just begun.

Initially I wanted to be Muhammad Ali. But then I got into a fight
and I got my butt kicked, so I figured I could choose something else.
Babyface 1959-, American Musician, Producer, Songwriter

© 2005 Sol Palha
Tactical Investor
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