Sunday, February 12, 2012

The Real Estate Crash

The real estate crash was a giant bubble that began many years ago. It wasn't a business cycle.

Real Estate can't "recover."

I could never understand why in the late 1800's clear up until the 1970's, working people usually bought no more than one three bedroom home that was around 1000 to 1200 square feet, then all of a sudden they started buying what would be the same as an 1890's Victorian mansion.

The Apartment House today from Google Street View.
Dorothy and I  grew up in Eureka, California, an area with most of the houses as small or smaller than those I mentioned. Downtown there were many Victorian mansions, but most of them had been built in the 1890's and converted to apartment houses. We actually owned one of them. We called it, with originality: "The Apartment House," which is what I will call it throughout this blog.

It is no bigger than some of  the single family homes built  now in large tracts throughout California, built from 1990 to 2006, yet few people in Eureka could afford to live in a home the size of the Apartment House in earlier times.

How did all those relatively modest income folks from 1990 to 2006 get to live in mansions and get on the road to owning them?

Tom, on the same porch above in the 1960's.
Dorothy and I have been buying, renting, and sometimes selling real estate since 1959, when we bought our first home. Over the years we have owned a total of forty-two rental and owner occupied units. In Eureka, California we owned ten, in Sacramento, 12, in Clarksburg, 10 and in the area we live in now ten. We have sold all but those ten we have right now, but I have been studying the real estate market from the inside, and it is clear that making money in real estate traditionally is not about buying and selling it, and it never was.

The whole world believed that you could buy a piece of real estate, work  on it a little  and then "flip" it for a good profit. This was dreaming while awake, and it worked for awhile because so many people began to believe it. So many people world-wide confused speculation with real investment.

Speculation builds bubbles. And bubbles always pop.

In 2004 we bought a little two bedroom house for $64,000. I thought that the price was too high, but it was still  close to the price that could make money by renting it, if one had the patience to only make one's money on the equity and slowly wait for inflation to bring the rent higher, but the entire real estate market was expanding itself rapidly inside that bubble, not caring if rents would make money.

The Apartment House about 1973. We were painting it.
A bubble is speculation gone wild. It is not real. It could not continue because even that little two bedroom house was too expensive for most of the people who live in its neighborhood. I had to rent the house for a little less than the payment. By the time the taxes were paid and the maintenance done it cost us about $100 per month to be the landlords.

That means that every month $100 goes into a hole and is hard to get back out. If I raised the rent to try to get that $100 back, no one would rent it. And this was happening when real estate was almost at it's peak, in 2005 and 2006.

"How?" I thought, "How can these people be buying these houses when they don't make enough to pay the rent?" They don't even think about the maintenance, or the taxes, or the insurance, so how can they imagine they can pay for these houses?

I drove through near-by neighborhoods where rows and rows  of giant 18th century mansions were being built (they looked the same to me), and those mansions were apparently being sold.

It just didn't make any sense to me.

News pundits, even now,  keep talking about when real estate is going to recover. How can it recover when it never got really sick? It isn't sick. It was high. It was the same as a junkie who spent twenty years on cocaine and finally realizes that he has to get off of it. He goes into a depression. Those highs weren't real. Real estate never should have gotten as high as it was. So it's not going to recover. People are just going to finally realize that you can't make money in real estate in two years, and your home is a place to live in, not a way to make a lot of easy money. Real estate is a long term commitment.

Me. Fixing a ceiling in the 1970's.
I decided I had to sell that little house. And I had to do it quickly, because it was becoming scary for me to keep it. The price of everything was going up, but rents were not, especially for 100  year old little tiny houses. My tenants were struggling to pay their $500 rent each month.

So I listed the house with what looked like a prosperous real estate broker. She was pretty, with high heels, glamorous make-up, big eyelashes, low cut blouse,  and a large friendly smile.

"I think somewhere around $100,000 would be a reasonable  listing price," I said. "It's only been two years since I bought it and that would make something around a $35,000 profit." I thought this was a high price.

"What!," she retorted. "We'll list it for $170,000. We can add all of the costs, repairs and everything to the cost, and it will be covered in the loan."

"We can what?" I said, "How can we add anything to the price?" I said.

"The bank will cover $105% of the selling price," she said.

"That seems illegal," I thought, but I signed the listing papers, unconsciously counting my profit.. It was November 28, 2005.

About two days later, she called.

"We've got an offer for $154,000, and I have a deposit." I still thought it was only worth about $100,000, if that. Really it wasn't worth more than I paid for it because I could only rent it for $500 per month.

I scrambled down to the real estate office and signed the offer, and the property was put into escrow. By December 27, 2005, all the documents were filed and it looked like it was sold.
We waited for the buyer's loan to clear. It was January, 2006. Then the buyer wanted her deposit back, because she couldn't get the loan. The real estate agent said we should give her back her deposit.

I said, "No! Why have a deposit if you just give it back?"

"That's the custom," she said.

"I don't like the customs now." I said, and I thought,  "Something is all out of whack."

I insisted, so we kept the deposit, but my tenants moved out because I had told them the property was sold. Now instead of just loosing $100 per month, we were losing $600, and we couldn't re-rent the property, because no one wanted to move in and then just be told to move back out.