Residential Real Estate Prices
A few months ago, I was flipping television channels and stumbled across a show about flipping homes. Flipping involves buying a home with the expectation that you will be able to sell the home at a substantially higher price after making some improvements. Needless to say this is a very speculative strategy and is almost the equivalent of adding leverage to a leveraged transaction.
While I was watching this show, I could not help but think about the recent technology bubble and how it burst. During the high-flying tech rally, even Wall Street analysts and strategists would justify why stocks could sell at price to earnings ratios of about 200. The investment bankers and brokerage houses made boatloads of money from tech deals and transactions, but many investors lost substantial amounts of money.
The recent weakness in residential real estate has not reached panic levels yet, but I would not be surprised if we see dramatic declines in home prices. Prior to the recent weakness in real estate, homes in some markets were appreciating 25% per year versus historical home price gains of about 5% per annum. If you believe in reversion to the mean theory, home prices should decline substantially over the next couple of years.
But there is a silver lining to the scenario of sharply declining home prices. Just as money flowed from the stock market to the real estate market when the tech bubble burst and stock prices tumbled, similar amounts of money could head back into the stock market. All else equal increased demand for stocks could result in higher stock prices. I would gladly exchange depreciation in my home for appreciation in my portfolio. If stock prices become excessive again, I could always rebalance my portfolio into less expensive securities. On the other hand, it is very difficult to rebalance your house.