Reading through many realtor blogs this week, it would seem that the real estate market has hit bottom. Consumer spending improved dramatically and the DOW climbed up 78% from its low point in March 2009. The self-serving claim by the real estate community is that it’s time to purchase a home. Lets look at why they maybe wrong.
The Federal Debt Ceiling set limits on deficit spending for the Federal Government and some estimate that the US will reach its deficit spending limits by Spring 2011. The Obama administration argues that the Congress needs to raise the debt ceiling or risk defaulting on government loans. The Republicans state that they want to cut government spending at a time when economic recovery need fiscal stimulus.
Any default on government loans would shake world confidence in US Treasury bonds and the US Dollar and the result would be 12 to 17% interest rates similar to the 1970s. The easier but more insidious route would be to expand the M3 money supply. In 1980, M3 ranged around $1.8 trillion US. In 2010, the M3 expanded to $14 trillion US or a 700% plus increase in our money supply.
We’ll hear mixed messages from economists. Some worry about deflation as occurred during the Great Depression. In our fractional reserve system, banks magically create money when they create loan ledgers. When you deposit $1000 into Wells Fargo at 3%, your bank can turn around and loan $10,000 (10 times the cash reserve holding requirements) at 24% in the form of a credit card loan. When debtors start defaulting on promises to pay, it can snowball into credit compression and cause deflation. With the collapse of our credit markets, we see huge deflationary pressures. Ben Bernanke, renown for his speech about dropping money from helicopters to stop deflation, believes that we need to print our way out of deflation.
As a result of current FED monetary policy to combat deflation by expanding the M3 money supply, I believe we’ll see rampart inflation similar or worse than the 1970s. During inflation, the depreciation of the value our money gives the price of real estate, commodities, oil, gold, silver and other hard assets the appearance of skyrocketing valuations. Inflation benefits debtors and harms creditors.
THE PROS AND CONS OF BUYING REAL ESTATE IN 2011
CONS
1. The market has not bottomed. In Washington State, capitalization rate trends show that the income from rents point to an overvaluation of real estate prices. I believe the market will bottom out around 2014 or 2015.
2. If market values continue to fall, it would be a risky time to invest in capital gains strategies such as flipping houses, fixing up houses, or other short term strategies.
PROS
1. Interest rates will never be this low in a very, very long time. If either we default on our government loans, if the US dollar value collapses or the if US keeps expanding our Federal Debt Ceiling, the results of these scenarios all point to 12 to 17% interest rates during this decade.
2. It’s a great time to purchase cash flow properties because inflation will cause home values and rents to increase in the next 7 to 9 years AND decreases the real cost of borrowed money. Because the banks now have strict income requirement verifications, you’ll need very high incomes or cash flow to get a 20% down payment loan on a cash flow property. You will have to search very hard for a good cash flow property because homes are still overvalued.
3. Land values have bottomed out. It’s now possible to purchase a lot of land for $50,000. This is a rock bottom price because it costs around $40,000 to build the entitlements (permits, zoning, utilities, land usage, etc.) for the land. With capitalization rates around 6% in the Greater Seattle Area, you’ll earn a higher return on investment now by purchasing land and building an apartment building than buying an existing apartment.
If you believe my 2011 Inflation Analysis above, holding dollars or investing in mutual funds/stock would be the worse investment you could ever make. For smaller investors, you may want to consider purchasing some silver bullion or purchase commodities such as oil. For cash rich investors, the best investment now is purchasing land at rock-bottom prices and building in two years for high capitalization rates and cash-on-cash returns.
For a no-nonsense Realtor who will give really help you with your real estate investments, please contact me at 206.832.9590.
