Connecting the Dots

Déjà Vu All Over Again: Real Estate Bubble 2.0

July 12, 2016

Like many farmers, my father was land rich but cash poor, so he never saved any money for his retirement.

“This is my retirement,” he’d say while spreading his arms over our 26-acre farm in western Washington.

He was right because his farmland did increase in value, but he sold his land in the 1980s and didn’t capture the big run-up in real estate prices. My father died in 2009 at age 93, and in his last years his jaw would drop at the prices homes in the Seattle-Tacoma area were going for.

The Seattle-Tacoma area isn’t the only part of the country where real estate prices have gone nuts. As you can see in the charts above, in many cities, home prices are at the same levels (or even higher) as they were prior to the Financial Crisis.

However, economic conditions are very different today.

Before the 2008-09 Financial Crisis, home prices were skyrocketing thanks to easy credit financed via exotic mortgages (no documentation, no down payment), record-high workforce numbers, a 4% unemployment rate, and rising wages.

That is certainly not how things are today, and that’s why I’m starting to see a growing number of real estate warning signs.

West Coast Bubble? Perhaps no part of the country has benefited from the private-equity, IPO, tech boom more than San Francisco, but appreciation has stalled.

In April and May, the median price of a San Francisco home increased by 2% to $1.38 million on a year-over-year basis. While 2% is still positive, it is a far cry from the 23% increase of 2015.

The high end of the market is dead. A record 95 homes for $2.5 million and above are on the market—up 42% from the prior year—and a record 75 luxury condos (defined as $2+ million) are for sale; a 44% increase. Overall, luxury home sales declined in the first five months of 2016, the first time since 2010.

East Coast Bubble? A penthouse near Central Park in Manhattan is for sale for $250 million; the highest listing price ever for a residential property.

On top of that nosebleed purchase price, condo fees are $520,000 a year and the property tax bill is $675,000!

Far East Bubble? I don’t want to leave out our international friends, so take a look at what is happening to the price of raw land in China. The average price in the 100 largest Chinese cities has jumped to a record 3,100 yuan (US$463) per square meter.

That is an unbelievable 50% increase in the last 12 months!

Even more amazing is that the price of raw land in many parts of China is now higher than the price for completed houses nearby.

One challenge for investors is that real estate isn’t very liquid. It takes time and money to sell a piece of real estate, so many hard-asset fans have invested in REITs and property funds instead.

However, even those seemingly liquid real estate investments are turning out to be less liquid than originally thought. Since the Brexit vote, four UK property funds with $23 billion of investors’ money have suspended redemption as their share prices have plummeted.

And that is against the backdrop of the super-accommodative central bankers and record-low interest rates.

Are real estate prices headed lower? I think so, but as always, timing is everything.

When real estate does drop, one of the best ways to profit is by buying shares of ProShares Short Real Estate (REK), an ETF designed to deliver the inverse performance of the Dow Jones US Real Estate Index. Check out my Rational Bear premium alert service for more bearish ideas.

By the way, our beautiful family farm, as well as our neighbors’ farm land, is now covered with parking lots and industrial warehouses.

Tony Sagami
Tony Sagami

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