Will real estate return to earth in 2004?
(or "The Loss of Gain" principle)
Cliff DrokeLike many people, I became bearish on real estate a couple of years ago (prematurely). This was at a time when the equities markets were still in a bear market and right around the time of the World Trade Center bombing. At that time, the soaring real estate market -- which even then had reached frothy proportions -- seemed near a major top and the then-precarious state of the financial realm threatened the pop the "bubble."
But in the aftermath of 9/11 the financial markets regained their footing and RMS bounced back to make new highs in early 2002. Year 2003 was a banner year for real estate (and real estate equities) as new home construction hit multi-year highs and the Morgan Stanley REIT Index (RMS) also made a series of higher all-time highs. As we enter the second month of 2004, real estate and homebuilding activity continues apace and the RMS index is even now making new highs. But for how long can the unfettered
uptrend be sustained? Will real estate hit any foreseeable major roadblocks in the next 12 months? These are the questions I am continuously asked, and now is the time to try to come up with some answers.
Let's look ahead a little into 2004. Aside from a good start to the year (which probably ensures that real estate and REITs will have a positive overall finish -- based on the January Barometer for RMS), can we expect a strong pullback -- perhaps even a mini-crash -- this year in real estate? I'll answer that question later in this article. But first I thought I'd comment on some recent feedback from a reader, who recently commented to me on the white hot real estate market in Southern California.
The letter begins, "Let me say, that as a Caliofornian, I am astounded and amazed, almost spellbound, by the real estate prices here in Southern California (we live in Chino). I have been intrigued by this market. I know what Greenspan says about the market (there is not a bubble) yet, when I go to a new home sales office and have to camp out to get on a waiting list of 1,000 (and did I mention that the units at hand are already SOLD) these are just hopeful standbys! To think we were actually considering a 1.50 hr
commute to buy a 3800 sq ft 400k house! Luckily I came down to earth.
"I have been through two stock market crashes. The last bubble was surrounded by people swearing this was different. Ahhh, let me see, oh yes, A NEW PARADIGM. That was the catch phrase. Yes, we saw what a new paradigm was...thousands upon thousands of folks that lost their portfolio believing that they HAD to get in now or lose out forever. In fact, many mortgaged their homes to do just that. Perhaps it was that deje vu from the stock market (the hype of having to get in quick before the stock went to the moon) and the early 90's when the California real estate market died for 8 yrs!
"I find it intriguing that people will NOT buy real estate or stocks when they are down and a good value. The psychology behind it is fascinating, at best. Anyhow, when I went to see new homes this past weekend and there were hundreds on a waiting list and people clamoring...I said to myself "this can't end good." I was confirmed of this when I came home and my young neighbors, who just received an inheritance from their grandfather, uttered the words that whisper TOP: "We have to get in now or be out forever...we have to buy NOW or we will never ever be able to buy." So, I am going against the herd (I always learned in the stock market and in real estate that the HERD is always always WRONG) and I am saying that this market cannot sustain itself for long.
"Where will these people get the money for these 5 and 600k and above houses? How will they EVER be able to sustain these payments? I love how the cities are not allowing builders to build only in limits (driving the prices higher because demand is outstripping the amount of building). What will happen then? How can Greenspan and other economist possibly say this is NOT a problem? Can you help me out here? All I know is that I believe otherwise.
"I would love to see you report on this and lend your advice. It seems as though no one in the country really sees what is going on here in California, but let me tell you, it rivals the tulip craze of many years ago and definitely the stock market frenzy. Anytime people fear the loss of gain -- it never ever ends well. WHY doesn't anyone see this?"
The term coined in the above paragraph, "the loss of gain," sums up everything behind the real estate bull market. This is the lynchpin, the rationale (if you can call it rational) behind it all. In my years of observing human behavior in the financial markets I've found that most investors can withstand losses, even heavy losses. But missed opportunities few can bear! The average investor would rather have his arm torn off than miss out on a roaring bull market! This is how manias and financial bubbles are sustained.
The sole reason for buying becomes, not so much outright greed, as it does the absolute fear of being left behind.
Back to the present situation in real estate equities. How much further can RMS climb before it meets with resistance and pulls back hard? I believe we will witness at least one steep correction, perhaps rivaling a "mini-crash," in 2004, probably at some point this summer. This could easily take on the appearance of a 1987-style, straight-down correction that quickly finds support and eventually retraces its losses heading into year-end (more on that in a future article). In other words, I don't expect we'll see the
end of the bull market in real estate this year, although I do believe we'll see the first major correction in real estate since 9/11.
You will note the steep upward slope in the monthly chart of RMS above. RMS has pulled more than 30% away from its 30-month moving average, which means we can definitely expect a steep correction at some point this year. I believe it's safe to assume it will accompany the 10-year cycle low, which is due to bottom later this summer. Even though this probably won't mark the absolute end of the long-term bull market in real estate, it will provide a microcosm of the major ending to this bull market that will
happen later this decade. As the reader indicated earlier in this article there is a tremendous amount of "froth" in the market that needs to be accounted for. There is way too much "irrational exuberance" in real estate, coupled with mindless building of every kind of construction, that has to be corrected before the next (and final?) big upswing of the real estate bull market commences.
February 5, 2004
Clif Droke is the editor of the Durban Deep/XAU Report, a daily forecast and analysis of DROOY, GLG, KGC, XAU, HUI, and GOX written especially for day traders. He is also the author of numerous books on finance and investing, including the top-selling "Moving Averages Simplified." Visit his web site for free samples of his analysis at www.clifdroke.com
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