Is Real Estate Headed Down?

A Down Cycle?

Where I live in California, housing prices are completely whacked! That is a technical term for out of control too high. But we are not the only ones, across the country many mid sized and large cities have seen prices escalate over the last 7 years. Well, the last 7 years have been quite a ride! Many forget that housing and real estate does not always go up. In fact, there is a pretty consistent boom and bust pattern in California and other markets. Some places in the country kind of plod along with steady yet small growth that might track inflation. This is a big reason that Robert Schiller, the Yale economist, does not believe housing or real estate is a “good investment.” He specifically likes to dispel the myth that our primary homes are “investments.” In other words, think of your primary home as a consumable place to live and a liability. A home has certain psychological benefits and is still remarkably a bedrock of the “American Dream”.  Of course, over the long run, it probably is financially advantageous to have a paid off house and live mortgage free. This situation can dramatically reduce your monthly living expenses in order to fund retirement. SEE RELATED: Real Estate – Your Primary Home Keep in mind real estate markets are always a local phenomenon, therefore we speak broadly here. Also, different types of properties fluctuate in price and sales volume depending on economic conditions. We also apply the current market conditions to the effect on someone’s financial independence goals.

Historical Perspective

Housing price fluctuations and sales are typically cyclical. Therefore, we appear to be at the end of a 7 year up cycle. Housing prices have been going up in value and sales have been steadily growing over the last 7+ years. After this historically there is a 3-4 year down cycle period. Since the 1940s this 7 year up and 3-4 down cycle has repeated itself.

A correction in the cards?

From a sales perspective, for the first time in 7 years, year over year sales have dropped. I have always believed housing prices are mainly effected by employment stability, wage growth, median income and interest rates. As these various levers are pulled different things happen in the market. For example, as wages stagnate or interest rates go up, homes become less affordable and less people buy. One thing I believe is that the prices are tied to people’s salaries in many ways. If prices continue to go up at this point, there will be very few buyers.

Silver lining

I think the good news here is that if there is a correction (meaning prices decrease a bit), this could actually benefit sellers and buyers. Sellers that have had property for many years can take advantage of some healthy gains in equity if they are at a place to sell. Buyers can perhaps negotiate a little harder to get prices down a bit. I notice that the bidding wars seemed to have subsided and houses are staying on the market longer. Given the tricky situation, it is important to keep several things in mind. If you lived through the great recession you know that housing can crash. No one knows what the market will do next, but there appears to be mounting evidence of a slowdown and perhaps downturn in prices. Experts do not anticipate the carnage of the Great Recession which was triggered by a housing meltdown, but they do forecast a slow down and some price softening.

FI Dreams

I am jealous of anyone that is selling in an expensive market and moving to a nice mid sized more affordable town. This could be a major boost to financial independence goals. If someone can sell a home in California, take out $300k or $400k in equity, they could pretty much eliminate the need for a mortgage in many wonderful mid-sized towns.

Housing basics

In my opinion there are a few rules of thumb when it comes to housing and wealth building. Here are some thoughts:
  • Buy in a great neighborhood. This does not mean a “fancy” high end 90210 neighborhood, this means a good solid middle class neighborhood with good schools and a high quality of life. Houses can be cosmetically changed and added onto, but you cannot move the property. Buying a good neighborhood seems to pay off in the long run.
  • Don’t buy too much house. I am a big believer and downsizing the whole McMansion thing. We do not need that much space and it just leads to more areas to furnish, decorate, clean, air condition, etc. I strive to find that sweet spot of just enough house.
  • If you have kids, keep green space in mind. Children especially need outdoor play space, I am a big believer of this. Kids locked up in houses in front of computer screens all day are less healthy with more social and mental problems through life. We all need some nature. It does not need to be anything fancy, but ensure some connection to the Earth either by being close to a park or having a nice backyard.
  • Do not go home improvement crazy. The home improvement shows are meant to convince you that your life is not complete unless you have the latest XYZ remodel job. This will do well for your Lowes and Home Depot stock, but not so well for your wallet. Try to be content with a nice, clean, well maintained home.


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