“Bulletproof” Real Estate Starting to Slide

As usual, I am starting the day with Drudgebart.com.tv. I’ve finally learned my lesson about clicking the blind video links. I used to find myself inadvertently watching one disappointing video after another, before realizing what I was doing. Now when I see “breitbart.tv” in the link, I avoid clicking.

One interesting story: Miami luxury homes are finally dropping in value. A LOT. The story has to be horrifying for speculators. Among the examples: a property that sold for $2.75 million in 2005, selling for $500,000 at auction. I knew the prices of ordinary homes had dropped something like 20 percent. But 80%? Wow. The story says the deal still has to be approved by the seller. I think I’d hold on and try to squeeze more out of it, before I’d eat a $2.25 million loss.

I know a realtor who got caught up in the tulip-bulb frenzy when it started, and for a while he made good money. Unfortunately, instead of merely selling real estate, he bought a bunch of spec properties he couldn’t afford. If I recall correctly, one of his loans has an interest rate of 18%. Why? Because “experts” were saying the interest rates didn’t matter. If you make a 50% return in six months, what do you care about an annual rate of 18%?

Now he’s trying to unload his own house, to save his credit. He may have to quit real estate. He hasn’t made a payment in months, and the only reason he hasn’t been thrown out on the street is that his lender is even more scared than he is. Better to have a nonpaying owner living in a house and taking care of it than to let the house go unoccupied and fall apart.

This neighborhood is looking more and more like a ghost town. There are several “for sale” signs on every block. There are vacant lots all over the place. When you drive down the street, you see one empty house after another. Houses that should have gone up two and three years ago aren’t going up at all, or they’re finally starting, after terrible delays. I would hate to buy one of these places. They’re being built to sell, in a county where construction is illegal-immigrant-built junk even in the best of times.

And people are RENTING here. That’s unusual. Anything to get the houses filled, I guess. If the economy gets a lot worse, this neighborhood could easily become a collection of unoccupied homes subject to vandalism, squatting, and arson.

Here’s what I wonder. Where did everyone go? Many, many houses are empty. They had to go somewhere. Maybe they did what I want to do. Maybe they moved north.

According to the story, things are going to get a hell of a lot worse here. A huge number of apartments have been built, and they’re going to get their certificates of occupancy soon. When that happens…WHEEEEE, you’ll be able to rent a nice place for three hundred bucks a month. For owners, that means no more positive cash flow. You won’t be able to charge 2x in rent and pay x on your mortgage and expenses. And that will drive selling prices down even farther.

It’s amazing how bad people are at math. Professional investors seriously believed home prices could increase 25% for year, for eternity. Someone do the math for me. What would a hundred-thousand-dollar house be worth in twenty years? Fifty million dollars? Some ridiculous number. I’m too lazy to figure it out. Wait, I found an online calculator. Looks like it would be worth roughly nine million dollars. Yeah, that’ll happen. With income increasing maybe one-fifth as fast. Assuming a five percent annual increase in income, which we’re not really getting, your income would increase by a factor of 2.65. So your house’s price increases by a factor of nearly 90, and your income goes up by a factor of less than three. Maybe in Bizarro World.

I know almost nothing about economics, but for at least two years I’ve been pointing out that we were headed for a cliff. The free market didn’t cease to function simply because a lot of misinformed people got into house-flipping. Sooner or later, the money to pay for a house has to be earned. And if it can’t be earned, the price has to drop.

Does this mean we’re headed for a buyer’s market? I dunno. The prices will be low, but a low price doesn’t make a good investment. We have a lot of other problems hurting us. Oil prices, food price increases caused by the ethanol scam, increased competition from India and China. Real estate may drop to a plateau where people feel safe buying and then it may plummet even farther. I guess the only good reason to buy a home these days is to have a place to live.

My instincts tell me the credit crisis has to hurt real estate badly. Not just because it will reduce the number of loans, but because it will make buying more unpleasant. If people have to pay more for homes up front, they’ll feel the pain much more directly. Credit is like insurance. It takes the suffering out of high prices, driving prices up. I would venture to guess that the more money people have to put down, the more prices will drop. Here in Miami, small, ordinary homes have been selling for four hundred thousand dollars. It’s one thing to put fifty grand down and pay a thousand a month. It’s another to come up with a hundred thousand or even the whole cost of the home. Those little houses are going to stop looking like bargains soon.

Ironically, Miami has been blessed by the dollar’s slide. Foreigners love it here, and the dramatically increased buying power of their currencies lured them to buy homes. That’s all over now. With Sotheby’s withdrawing home after home, without a bid, the flow of foreign cash is going to dry up fast.

I’ll tell you one thing I’ve learned. You never try to surf a wave all the way to the beach. When I was in law school, I traded stocks, and I paid a big chunk of my tuition that way. When the techs started looking bad, I quit. And I kept my capital. A lot of people lost their retirement money, because they seriously believed the NASDAQ could double in value every year until Judgment Day. Sometimes you should be satisfied with a really, really good return. Otherwise, you’re like a gambler who stays at the table until he craps out. I’m sure there are people who got rich flipping properties. They’re the ones who got out two years ago.

I know I’m no expert, but the experts are losing their homes, going broke, and jumping out of windows. And I’m not. If anyone asked for my advice, I’d say the same thing I said two years ago. Stay out of this mess.