January 1981
Vol 3 No 4
There is currently a book on the best seller list titled “Crisis Investing”. (I would have given two inches of height to have thought of that title.) The author, Douglas Casey, is, to say the least, negative about real estate investments in the United States. Many authors and investment advisors are proclaiming that real estate values will plunge dramatically in the next five years. Mr. Casey has apparently studied them all and has condensed all of their fears into one chapter. This is not meant to be an attack on Mr. Casey personally, but on the real estate prophets of doom as a group.
Many of these authorities, at the same time that they are telling you to sell your real estate before it’s too late, are trying to sell you their product which is by their definition fail safe. (Remember, never take advice from a person trying to sell you something!). I don’t sell real estate – I buy it! It’s actually against my best interest to have you buying in competition with me and driving up the prices, but I am going to tell you to keep buying. In the next few paragraphs, I will debate the points which Mr. Casey and many others are contending will be the downfall of the current real estate market.
Although Mr. Casey later makes some distinctions, he, like so many critics, considers “Real Estate” as one market which encompasses all property everywhere. To group land with houses, is like grouping stocks with bonds and condemning them as an investment in securities. One factor that gives the informed investor such an advantage is the individuality of each parcel of real estate. Land, for many reasons, is not a good investment for the layman. It has neither the income nor tax shelter available in improved property, and more importantly, it only has value in the event that the Government will let you build on it.
For five years we have traveled the country, praising the merits of the single family house as an investment. Houses give the investor cash flow, tax shelter, and a hedge against inflation unequaled in the last decade. Because you leverage your investment in a house safely, an investment of five thousand dollars in a fifty thousand dollar house in 1970 would have grown to over one hundred thousand dollars today in nearly every city in the country. That would be a profit before taxes of ninety-five thousand dollars on a five thousand dollar investment, without accounting for the tax shelter and cash flow you would have received during the holding period.
Next, Mr. Casey reasons that real estate prices will come crashing down because of the following factors:
1) Because people are able to purchase property with high leverage they will abandon their properties to the banks anytime things get tough.
2) Real estate, with the possible exception of collectibles, is the most illiquid possible investment.
3) Real estate taxes will soon increase to levels which will make the ownership of property undesirable.
4) Today’s market psychology is that ninety percent of the people think that real estate is a good investment, and when that many people agree on anything, they must be wrong.
Casey feels that house prices in particular will decrease and many houses may be abandoned. “(Houses) are wealth, but don’t produce wealth. Houses are consumer goods and notwithstanding what the real estate salesman says, they are not investments”.
Mr. Casey’s views are typical of those who have read about the real estate market, but have never worked and invested in it. Many of his suppositions have merit at first blush, but have some flaws that are apparent to an owner/manager of several properties. I will defend only houses as an investment, as I have a hard time along with Mr. Casey in seeing the merits of most of the rest of the so-called investment property.
On leverage; it is true that many buyers use all the leverage available to them when purchasing a house, especially when it is their first one. It is also true that these same buyers would be the most susceptible to a downturn economy, and may even be unable to make their payments. However, consider the fact that according to the last census, over 36% of all single family houses are owned free and clear! In addition, only a small percentage of the remaining houses which are purchased each year are acquired at the maximum leverage by first time buyers. When these buyers slip behind on their payments, there are usually several willing and able investors in line to help them with their payments in return for part of the profits.
In the event that the day ever comes when we have wholesale foreclosures due to a massive period of unemployment, the banks and other lending institutions will have no choice but to let the owners remain in their houses until they can again make the payments. The banks are in the money business, not the house business, and would soon be out of business altogether in the event they foreclosed on everyone in a serious depression.
In a depression, by definition, twenty-five percent or more of the work force is unemployed. That, optimistically translated means about seventy-five percent of the people are still at work and paying rent. Our challenge is to acquire those properties which can be rented profitably to those who will still be at work.
Stockbrokers for years have been bragging that their product was superior to real estate, because it was liquid. Many investors in stocks and bonds today will tell you the price they pay for that liquidity is the inability to sell them for what they paid for them. The point that many miss is that everything is liquid, at a price. Every parcel of real estate could be sold today, for cash, at some price. This often happens at auctions, and properties will usually bring market prices and many times more than market prices, depending on the skills of the auctioneer.
Mr. Casey’s contention that Real Estate taxes will increase due to the increasing needs of our city and state governments is a valid one. The recent trends in California and Massachusetts, to reduce the burden on property owners are a refreshing one, and will hopefully catch on in other areas. We have always recommended staying away from the liberal strongholds of the Northeast, and the big cities. The do-gooders are so strongly entrenched there that property rights have taken a backseat for the past two generations.
Invest instead in healthy metropolitan areas, where unemployment is low and so are the welfare rolls. The alternative is to stay away from the large cities altogether. Buy property in the smaller towns, where people can still enjoy all the amenities of the larger cities, but without the burden to support the poor which are attracted to the bright lights and glitter.
As for everyone thinking that real estate is a good investment, I am sure the same people would think that Polaroid was a good buy at fifty cents a share. The significant point to make is that few people took the chance on Polaroid, and even today, few people will put forth the effort it takes to become successful investing in Real Estate. It takes more than hard work, it takes a person who is willing to learn about the investment he wants to make and then has the confidence to bet on himself and his or her knowledge and ability.
Finally, as for Mr. Casey’s charge that houses are not an investment, let’s compare a twenty-thousand dollar investment in a house to the same dollar investment in T-Bills and gold over the last 12 months.
$60,000-House $20,000 in $20,000
20,000-Invested T-Bills in Gold
40,000-Existing 10% cents 14%
Before Tax
Cash Flow $ 4,800* $ 2,800 – 0 –
Less Loan
Payments 4,212 – 0 – – 0 –
Taxable Income (1,690) – 0 – – 0 –
Tax @ 50% ( 845) 1,400 – 0 –
After Tax
Cash Flow 1,433 1,400 – 0 –
Appreciation
Past 12 Months 7,200 (12%) – 0 – 10,850 (52.9%)
(Source, Money
Magazine) ____________ ____________ ______________
Totals $ 8,633** (43%) $ 1,400 (7%) $10,850** (53%)
*$4,800 is the net after deducting for taxes, insurance and maintenance.
**Does not take into account any taxes due on the sale of the asset.
Although last year, with moderate appreciation, the lowly house trailed behind gold, the glamor investment of the 70’s; its return was in the same league. The future appreciation of either investment is speculation. The cash flow and tax benefits are more certain and will comfort the long term investor as he patiently watches his capital grow.
The big news as I write this letter is the interest rates. Prime has just passed through twenty percent and seems to be on the run. Some months ago I predicted that the interest rates would peak around the end of the year and have based my strategies on that premise. By the time you receive this letter, Christmas will be over. The winter will be in full force, Christmas bills will be delivered, and interest rates will be at all time highs. What a great combination of events for those interested in buying real estate.
Those people who have to sell a house due to a job transfer; unforeseen financial reversals, etc. will be faced with a very unreceptive market. They will be forced to accept last year’s price, or accept an offer with a little cash today and wait for their profit until you resell or make a profit on their house.
This may be the last great buying opportunity at reasonable prices in the single family market. When the new administration implements their economic strategy to lower inflation and interest rates, everybody who ever thought about buying a house for personal use or investment will run to the banks to take advantage of the lower (probably 13%) interest rates. This will eventually drive interest rates higher again, but will have a more dramatic effect on the prices of the houses. Buy now while you have the opportunity, or join the masses who will be ravaged by inflation. No matter who is in power, we are certain to have enough inflation to make the holders of leveraged real estate wealthy, while ruining those who are in “paper investments”.
At the National Committee of Monetary Reform Conference held last month in New Orleans most of the speakers were still recommending investments in gold and silver, with silver being touted as the better of the two for the next five years. In addition, several speakers spoke in favor of real estate. Eliot Janeway, consultant, author, and political economist, stated that real estate will be the number one asset gainer in the eighties.
I am still totally bullish on houses. The key to an investment strategy in the eighties will be flexibility. Although I always invest in houses with the intention of holding indefinitely, I know I could liquidate one or two at fair prices on short notice. This allows me to take advantage of other opportunities as they will present themselves in the fast paced coming years.
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