Are you priced out, by the Wealth Transfer?
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The more asset inflation goes on, the more wealth will be destroyed when reality check knocks on the door as stretched homeowners realize that they have little if any equity and a jumbo liability. The main reasons of such an assertion are quite straightforward:
1) Real estate is a non-basic sector, not a driving force of the economy. Many theories of regional development divide a regional economy in basic (export creating or wealth creating) and non-basic (derived or wealth diversion) sectors. Real estate, like retail, is thus derived from the wealth generated from the basic sectors of the economy. It would be an healthy sign to see real estate values appreciate when a regional economy goes well as hard earned profits are accumulated in a stable asset and as homeowners transpose a part their growing wealth in the quality of their homes (renovations, furniture, landscaping, etc.). However, it is a sign of decadence and misallocation when real estate assets inflates in a situation where wages remain unchanged.
2) Real estate has little marginal utility. The economic function of a house is to provide shelter. Rent is thus the price someone is willing to pay to satisfy this basic need at a specific location. It becomes an allocated portion of an income. Housing size tends to be a direct function of a family size. Once basic requirements such as protecting against outside weather conditions and amenities such as running water, electricity and sewage are provided, the utility of housing is satisfied. Any additional assets, such as more rooms and marble countertops, are conveniences (or social status statements) that do not add to the utility of a house. The productivity of an individual remains the same even if the size of the house he inhabits quadruples and is equipped with all the conceivable amenities. Thus, any inflation to the value of existing real estate assets does not add to the productivity of an economy, but contributes to the misallocation of wealth towards real estate.
3) Real estate involves a transfer, not a creation of wealth. Each transaction involves a transfer of wealth from one individual (the purchaser) to another (the owner). A growth in sale prices thus involves a greater transfer of wealth that must either come from additional savings and/or additional debt. This money, which is now fixed in an asset, cannot be used for current savings, investment or consumption and also comes at the expense of future consumption. If debt is used to finance a housing purchase, then future consumption is even more reduced and can only be redeemed by additional debt.
4) Real estate is not a form of savings, but the amortization of a liability. The equity in a house can be extracted when it is sold (pending market conditions which could be radically different from the time when the house was purchased) or through debt using equity as collateral (aka home equity loans). So, the buildup of real estate equity is done at the price of capital plus interest, implying that this equity comes at a price superior than its initial purchase price if debt is contracted (which is most of time these days). Even if the equity of that real estate appreciates, it can only be extracted using debt as an instrument.
At this point the only possible outcome of the housing bubble is additional disruptions and misallocations of capital, a guaranteed source of future economic hardship as paper wealth gets destroyed, especially if it has been used for debt collateral. Thus, real estate is not an industry; it does not create wealth, it siphons it away. Here are some contrarian strategies for such a context:
1) Rent instead of paying a mortgage (plus taxes, maintenance, insurance, utilities and the infinite number of related expenses) and save a lot of money (thousands of dollars per year can be saved compared with ownership of a similar unit; especially in hot markets).
2) Consume as little as possible and put yourself in a saving and/or debt repudiation mode. If you have the cash reserves and the discipline, you can play the 0% interest credit card game to your advantage. Build a cash reserve as much as you can.
3) Stay clear of stocks and bonds, especially those related to housing. Treasuries and money market have lame returns but will not likely lose their value on the medium term. You may consider gold mines, commodities and energy stocks, but be prepared to handle volatility.
4) Buy some gold, in bullion and electronic form (e.g. Goldmoney) as well as some foreign currencies. The only direction the fiat US dollar will take is depreciation (as it did for the last 90 years), both nationally and in regard to other currencies. You have to protect yourself against the systematic debasement of money by the Federal Reserve and the Federal Government as well as the confiscation of your savings through inflation.
5) When the real estate market starts to be distressed (I wish I knew when), wait 6 months to a year to see it become very distressed, if not in a panic mode. Once deflation is firmly established, come in guns blazing with cash and ruthlessly negotiate a lower price by praying on a desperate speculator or a foreclosure; take your time, you will have a lot of choices. Secure, if you have to, a 30 year mortgage even if interest rates are higher (7 to 9% range in all likelihood), and see the Fed in the following years initiate a wave of hyperinflation by printing money like there is no tomorrow. Have the pleasure to pay back your fixed mortgage in depreciating dollars and see the value of your housing asset follow whatever level of (hyper)inflation.
Dr. Rodrigue's research interests mainly cover the fields of economic, transport and urban geography. Area interests involve East and Southeast Asia (particularly China) and North America, notably concerning transportation, distribution and trade issues. Specific topics cover transport systems and logistics, global supply chains and production networks, gateways and transport corridors, urban regions, economic integration, international trade and regional development.
http://people.hofstra.edu/jean-paul_rodrigue/jpr_blogs.html
