and finally this evening: The layman's theory of real estate

[lektrode]

http://www.sfgate.com

The layman's theory of real estate goes something like this: The Pilgrims arrived. They started using land. More Europeans came. The demand for land was so high that Native Americans were pushed out to make room for the newly arriving settlers. More land can't be built, so demand and prices will always rise, making real estate a great investment. Unfortunately, the formula isn't quite that simple. Here we take a look at real estate prices, and the long-held theory that they will rise indefinitely. TUTORIAL: Exploring Real Estate Investments
Historical Real Estate Prices, Bubbles and Beyond
Prior to the well-publicized burst of the housing bubble and the resulting real estate crash that began in earnest in 2007, historical housing price data from the National Association of Realtors (NAR) seemed to support the theory of endlessly rising prices. The chart below tracks median home prices from 1968 to 2004 and shows an average yearly increase of 6.4%, without a single decline during the 36-year period.

Figure 1: Medium home prices from 1968 to 2004

Source: National Association of Realtors

What the Data Doesn't Show
Unfortunately for homeowners, 2004 was the last year of healthy growth numbers before the market flattened. By 2006, NAR data showed just a 1% increase. After that, the markets experienced an unprecedented decline. Nationally, prices fell in 2007. They fell again in 2008 and yet again in 2009. By mid-2010, housing prices had fallen back to 2004 levels in a stagnant market. What had for decades seemed like a one-way ticket to growing profits had fallen by more than 30% in just a few years, according to Standard and Poor's data.
Even before the numbers began to go the wrong way, the sales price trends data provided an incomplete picture. The National Association of Home Builders reports that the average home size in America was 983 square feet in 1950, 1,500 square feet in 1970, and 2,349 square feet in 2004. This trend continued in the first half of the 2000s, after which it began to decline somewhat.
With the size of homes getting bigger and inflation adding to the cost of building materials, it is only logical that home prices would rise. But what happens if inflation is factored out of the picture? The result is something completely unexpected. Even before the real estate crash of the late 2000s, home prices fell frequently and significantly.
In Fact, World War I, the Great Depression, World War II, the 1970s and the 1980s, all saw periods of significant price decline. Lesser declines have occurred on a regular basis at other points as well. (To see a great illustration of this, check out this graph produced by the New York Times in 2006.)

National Numbers, Regional Trends and Your Neighborhood
Even the national trend numbers tell only part of the picture. Housing price trends can vary widely from geographic region to geographic region. A boom in California can mask a bust in Detroit. Even within the same city, numbers can vary widely. Areas that are experiencing new growth or gentrification can show significant price appreciation while areas across town can be in decline.
When looking at the national and regional statistics, be sure to account for the reality of the market in your local area. Rising prices at the national level may not help you if your city, state or neighborhood is in decline.
Reality
Another important point to consider when looking at real estate as an investment is that your "investment" won't ever pay off unless you sell it. So even if your primary residence has doubled in value since you bought it, from a practical standpoint, it probably just means that your real estate taxes have gone up. All of the gain that you have experienced is merely a gain on paper until you sell the property.

[rshimada]

Re: and finally this evening: The layman's theory of real estate

The Real Estate market in the US goes through regular bust and boom cycles, which Homer Hoyt noticed in the 1930s for the Chicago area. A good web page with an article by Fred Foldvary describing this is at http://commonground-usa.net/foldvary_0607.htm

[flintlock]

Re: and finally this evening: The layman's theory of real estate

The Real Estate market in the US goes through regular bust and boom cycles, which Homer Hoyt noticed in the 1930s for the Chicago area

I can vouch for this as the son of a home builder from the 60s on. Growing up we were never that aware of what was going on in the economy, only that some years we had to wear jeans with holes in the knees, and other years we didn't. And I remember taking month long vacations out West. We had no idea it was because Dad had nothing to do.

[housingcrashsurvivor]

Re: and finally this evening: The layman's theory of real estate

Similarly, I think boom & bust cycles helped instill in me the sense to save (though I also hate shopping, so that helps too), especially remembering my parents keeping as many people employed as they could, even running the business off their savings, while they drew no salary from their engineering firm back in the 80s.

Stupidly, however, I never associated construction cycles with home prices and so was unaware of bubbles. I did buy my previous home at the previous low, just by chance, so at least I had that cushion when relocating myself during this depression to a lower cost area without too much additional harm to hopefully better position myself into the future. Now to see what screws up with that.

Another important point to consider when looking at real estate as an investment is that your "investment" won't ever pay off unless you sell it. So even if your primary residence has doubled in value since you bought it, from a practical standpoint, it probably just means that your real estate taxes have gone up. All of the gain that you have experienced is merely a gain on paper until you sell the property.

Three of my pet peeves in one paragraph?

Saying "your "investment" won't ever pay off unless you sell it" is not at all true when you can rent out a room for income or when you can do a later in life reverse mortgage, even if it goes up in value like any other investment can, even if it never goes up in value like any other investment might, even if it loses value, again, just like is possible with any other investment, all the while providing yourself the shelter you have to pay for anyway, which no other investment provides.

Secondly, saying "So even if your primary residence has doubled in value since you bought it, from a practical standpoint, it probably just means that your real estate taxes have gone up" is only, at best, regionally true, because places like here in Florida our "save our home" amendment effectively caps homesteaded property tax rate increases at 3%. Even without that protection, if taxes did double while values double (as if I'd ever see that again--not planning for it), aren't the smaller tax numbers overshadowed by the much larger capital gains of that scenerio.

Thirdly, saying "All of the gain that you have experienced is merely a gain on paper until you sell the property" is no more true for real estate than it is for stocks which can go up and down before you sell them, for gold which can go up or down before you "cash in" or even for cash in the bank which can go up or down with inflation until you actually buy or buy into something else with it.

If, back in the day, I was only experiencing paper gains, can I please at least have back the non-paper? cash I paid on the taxation of those paper gains? Or will I just have to be satisfied with no longer having all those paper gains but just these carryover paper tax write-offs which only seem to be of any value once a year. Or could I just trade those in for what's behind curtain #3 or for what's in the box, Monty Monty Monty.

Hey, that's not inflation. Those are just paper losses.