WHAT REAL ESTATE RECOVERY?

Here is an excellent article from Franklin Sanders a.ka. The Money-Changer about the real estate recovery.

WHAT REAL ESTATE RECOVERY?

"Data through May 2010, released today by Standard & Poor's for its S&P/Case-Shiller Home Price Indices . . . show that the annual growth rates... improved in May compared to those reported for April 2010."

27 July 2010 press release from S&P Indiceswww.standardandpoors.com.

Glance from time to time at the S&P/Case Shiller Home Price Index. You can Google that name and find it, as the URL is too long to burden you with here.

They show two charts, one of the rate of change, and one for the raw index. As of their 27 July 2010 press release, the rate of change, having bottomed in 2009 at negative 20%, has now risen to positive 4.6%. This figures stop at June 2010.

RATE OF CHANGE

Rate of change shows the current direction of a market versus one year ago. Thus a higher rate of change does not mean that the market is rising in significant absolute terms. It might mean that it is only falling more slowly. Viewed through the lens of the real estate bubble's collapse beginning in 2006, the fall of prices certainly should have slowed down.

Do not, however, confuses a slowing fall or brief recovery with a bottom.

RAW VALUE

A glance at the chart for the raw index makes clear my meaning. From 1987 to roughly 1998, the index went sideways at about 75. It broke 100 in early 2000, then climbed straight up into a 2006 peak to 225. It paints a classic example of a market blowing off in a hyperbolic rise. No question the bull market in real estate topped then.

Since 2006 the index has fallen to 150, and has wiggled a tiny bounce, but remains about 150, the fall 2003 level.

The bottom has not yet arrived.

BEAR MARKET EXPECTATIONS

When markets experience a bull movement, a primary up trend lasting 15 - 20 years, they enter a bear market or primary down trend that lasts roughly as long. From peak to trough a correcting market will lose roughly 50% to 95% of its peak value or the preceding gain. Now you can fight with that fact all you want, but in the end that's what markets do. Fight it and you will look as silly as King Canute commanding the tide.

I know, because I have done it. Having been blessed by the silver & gold bull markets of the 1970s, I could not believe they had turned and so rode my faith down in flames for a decade.

But in the end,

• Silver dropped from $50.35 on 21 January 1980 to $3.563 in on 22 February 1993, a 93% loss. A new bull market began in November 2001, nearly 21 years later.

• Gold dropped from $850 in 1980 to $252 in 1999, a 70% loss. A new bull market began in February 2001, about 20 years later.

• Dow dropped from 995.15 in 9 February 1966 to 577.60 on 6 December of 1974, eight years later, a loss of 42%. The Dow did not begin a new bull market until August 1982, sixteen and a half years after its peak.

• From its low beginning on 12 August 1982 at 776.92, the Dow rose to 11,722.98 on 14 January 2000, or, if you prefer, to 14,164.53 on 9 October 2007. Either way, a rough approximation of the Dow's bottom is 6,250 or 7,471 (calculating a loss of 50% of the preceding gain). Since we've already seen the Dow fall to 6,450, and not twelve years after the top but one and a half years, we can guess with fair certainty that the Dow has much further to fall, both in time and price.

[I take the January 2000 Dow high as the bull market high for two reasons. Adjusted for inflation, the October 2007 high was about the same as the January 2000 high. More importantly, I measure the stock bull market in gold, and that peaked in August 1999 at G$925.42 (44.767 oz). The October 2007 top in gold terms came at G$397.08 (19.209 oz), 57% below the 1999 peak. Not even a government statistician could mistake that October 2007 price as any kind of new high.]

BACK TO REAL ESTATE

Now I know all the clichés: nobody ever lost money buying a house, houses have gone up since the end of World War II, house prices never drop, and handling toads will give you warts. But ask folks in California or Florida, Las Vegas or Detroit, if those clichés still hold water.

Let's apply those Bear Market rules of thumb to real estate. The Case-Shiller Index rose from 75 to 225, a gain of 150 points. It has dropped now to roughly 150, and jiggled to nearly 160. Is that the end of it?

A drop to 150 represents only a 50% correction of the previous gain.

A correction of 95% would carry the index to 82.54, roughly the level of 1998.

To believe that the fall in residential real estate prices has ended, you must believe (a) the bottom came only three years after the peak, and (b) the correction will be the mildest possible at 50%.

Challenges to that faith arise first out of the expected span of bull markets to bottom. Three years comes awfully fast after the peak. Also, a correction usually reacts in proportion to the bubble before. The greater the bubble, the greater the correction. The US housing bubble was, we can brag as a matter of national pride, one of the most overblown of all history, nearly toppling the entire world financial system. From that standpoint, does a 50% correction seem sufficient?

Ooooo, and I left something else out that may prove significant. Banks have not yet cleared their bad mortgages out of their portfolios. An unknown but likely-bigger-than-the-Milky-Way-Galaxy number of those mortgages are not performing and have not yet been charged off the balance sheet or foreclosed. What will thousands of foreclosed houses for sale at any price do to the housing market? My guess is, they won't raise prices.

IMPLICATIONS

Now the Case-Schiller index is probably about as accurate for measuring real estate prices as measuring hog-girth in light years. Why? Real estate markets across the nation are not uniform, and demand changes both with location and surrounding economy. A $200,000 house in Middle Tennessee might cost $2 million in California, but when prices begin falling it won't suffer as badly. Still, the index gives us some rough picture of what is happening with real estate.

For investors trying to manage their money, the problem arises in their indoctrination. They've had dinned into their skulls that a house is an "investment." It isn't. It's a consumption item, and if after you've used it you can sell it for more than you paid for it, bravo, but it is still a consumption item. Most everybody (especially now) could probably rent for far, far less than it costs to own and keep up a home, and you wouldn't have to cut grass. Still, though, money aside, if you treasure a home and in your mind it's worth the higher price you have to pay, stay there.

Otherwise, you'd better think about selling residential real estate now, before it drops further, and buying back in a few years after the bear market has wreaked its vengeance. -- F. Sanders

If you like what you read here, I highly recommend you subscribe to his monthly MoneyChanger newsletter.

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