A Little Game of Old Maid, Part V

By Robert Ringer

(The content of this series of articles has been taken from my 1982 book “Civilization.” In the previous excerpt from that book, I examined several alternatives for getting your capital out of paper money, including stocks [which I referred to as "Capital Crapshoots"] and two slightly less risky “Capital Question Marks”: collectibles and commodities. A third and very different kind of Capital Question Mark is real estate-and following is what I had to say about it back then.)

Real Estate
Now that everyone has once again been reminded that real estate does not always go up, and now that gullible, arrogant speculators and thousands of uninformed real estate brokers are back to tending bar and waiting tables, we can settle down to analyzing real estate on a rational basis.

I first began to sense that the real estate bubble was about to burst when I heard a famous real estate counselor speak at a financial seminar in the summer of 1980. In response to his own rhetorical question about when the real estate bust was going to occur, he replied, with a self assured air of finality, “Ladies and gentlemen, there’s no bust. There is no bust. We have a temporary lull in the market.”

Those who were naive enough to listen to this kind of nonsense, and base their investment decisions upon it, may now be wondering why I don’t just classify real estate as a Capital Black Hole. You certainly couldn’t prove otherwise by their results.

But the fact is that real estate is neither a Capital Black Hole nor a Capital Crapshoot. It is a hard asset, an asset with an obvious utility value. This, coupled with the fact that, in most cases, it is not restricted to a fixed, long term rate of return, causes real estate prices to move generally upward in line with price inflation. If that were all there was to it, it wouldn’t even be a Capital Question Mark. Unfortunately, however, it’s not that simple.

The real estate boom of the past forty some odd years has been built primarily on a debt pyramid of low rate, long term mortgage money. (Whenever I refer to low rate, long term mortgage money, you may assume I am talking only about fixed rate mortgages.)

Now that the lending institutions have awakened – very late in the game, as usual ─ this kind of mortgage money has become an extinct animal. The writing was on the wall when the hotshots began touting “creative financing” – i.e., second mortgages, “wraparound mortgages,” purchase money mortgages, and other schemes used by both buyers and sellers to shield themselves from the realities of the marketplace. “Creative financing” is but a euphemism for selling one’s property at a decreased price without admitting it to oneself.

As we have continually witnessed during the collapse of Western Civilization, human beings will go to ingenious lengths to prolong the day of judgment. They will do almost anything to keep their illusions alive. Unfortunately, the day of judgment is now coming due for those who foolishly signed short term balloon notes to purchase real estate; as a result, foreclosures are rising and prices are falling.

I was once so negative on real estate that I was not even willing to consider it as a possible vehicle for escaping paper money. But the early stages of the collapse in real estate prices have rekindled my interest. It now definitely rates the status of a Capital Question Mark.

Fortunes will not only be lost during the coming economic collapse, but made as well. In between the falling bricks and mortar, there will be pockets of opportunity that would not exist during “normal” times. But there are so many uncertainties involved in real estate – much more so than in any other hard money asset ─ that one must proceed with extreme caution and patience.

Basically, there are two titanic forces pulling the real estate market in opposite directions. On the one hand, chronic debauching of paper money continues to increase the demand for real estate, just as it does for all hard assets. On the other hand, the engine of the market ─ inexpensive, long term mortgage money ─ has ceased to exist, which decreases demand.

It should be pointed out, however, that this lack of mortgage money also means drastically reduced new construction, which further raises the demand for existing real estate. But not all types of real estate. For example, does the demand for single family homes really increase when construction decreases?

Here, once again, the media have misled the public. They talk incessantly about an aberration called “pent up demand,” which seems to imply that just because someone wants something, that fact alone increases the demand for it.

The media have not yet figured out that sellers do not particularly care whether or not a person wants a house, a car, or a television set. What they really want to know is: Does he have the means to pay for it? (Desire + means = demand.)

And, not surprisingly, deteriorating economic conditions are leaving more and more people with the means to pay for fewer and fewer things ─ especially things as big as houses. Thus, pent up demand is nothing more than an invention of the media.

Nonetheless, there is the uncertainty of government intervention in the housing market. On second thought, I should refer to it as an uncertain certainty. That the government will intervene is not subject to dispute. The only question is when, where, and how?

You can be sure that the cries of the voting class will cause white knight congressmen to come forth with freshly printed paper money to make single family homes more affordable. They may not blatantly just hand out paper money to the masses, but the effects will be the same. Leave it to politicians to devise a variety of clumsy schemes to accomplish their aim of pacifying voters.

But don’t base your real estate investment decisions on the hoped for actions of politicians. The problem is that when Uncle Sam starts passing paper money around, he may not be interested in supporting the particular type of real estate that you have invested in.

Commercial real estate, for example, may not get subsidized. Any increase in the value of commercial real estate will probably have to come from a combination of two factors: a de crease in construction and an increase in the number of people wanting to trade in their paper dollars for this kind of asset. And keep in mind that, as the economic collapse increases in intensity, there will be less and less tenant demand for office and retail space, which could decrease investor demand (i.e., decrease prices) along with it.

If you are interested in converting paper dollars into commercial property, patience will prove to be a virtue. Opportunities should increase dramatically as things worsen, and ultimately you should be able to buy properties at well below their replacement costs.

But regardless of how attractive the bargain, never obligate yourself to a short term note on the assumption that you will either be able to refinance the property or resell it at a higher price before the note comes due. Both alternatives are highly doubtful, to say the least.

More on real estate in Part VI.

______________________________

Today’s Reflections:

I must admit that it was a pretty easy call when I said: “That the government will intervene is not subject to dispute. The only question is when, where, and how?” Blustering Barney had just arrived on the scene as a freshman Congressman from Massachusetts a year earlier, so I had no idea who he was – let alone that he would make a prophet out of me.

But, as things turned out, he was the driving force that made my words come true: “They may not blatantly just hand out paper money to the masses, but the effects will be the same. Leave it to politicians to devise a variety of clumsy schemes to accomplish their aim of pacifying voters.”

However, humility forces me to admit that anyone who takes the trouble to be even a casual student of history soon learns that governments are addicted to repeating the worn-out mistakes of the past. And in a democracy or democratic republic, those mistakes will almost always be in the direction of appeasing the masses (a.k.a., vote-buying).