5.02.2006

Flippers, Bubbles and Boomers

Real Estate is one of the prime economic indicators for the national economy; and not surprisingly, 46% of U.S. millionaires own investment real estate-- a statistic that "No Money Down" house-flipping infomercials or seminars would be happy to cite. (The survey does not actually state that real estate investment was the means of aquiring the millions, however, just simply that millionaire assets include investment real estate.)

An MSN Real Estate article asserts that "Flipping houses is harder than it looks." Key quotes:
  • "There is a boatload of competition out there, which means that the obvious deals are gone in a heartbeat. The pros will tell you that they make their money on the front end by buying properties for at least 30% below market value. Finding those houses takes time and once you find them, you'll need to move fast. And no matter what the late-night gurus say about doing this with no money down, it hardly ever works that way. That means you'll need access to cash to do the deal, not to mention the rehab."
  • "The masses believe in the dream that's been promised to them, that they'll be making a fortune in the next six months . . . They don't have the basic know-how. If it were as easy as they make it seem, 286 million people would be flipping real estate."
  • "Right now, you have people jumping in on frenzy and it will bankrupt a lot of Joes and Susies who have no business doing this"
  • Access to large amounts of cash is the hardest part -- and one of the biggest misconceptions -- of the business. . . "If you don't close in 30 days, they keep your money . . . Then you need more cash to carry the house, the insurance, the utilities and the maintenance. You won't get a contractor to renovate a house for no money. People go to trade shows and buy these books and tapes on how to buy a house with no money down. I've never seen someone actually do that."
  • Another reason that access to cash is so important is that you'll probably need to hold on to the house for at least three months because of Federal Housing Administration (FHA) anti-flipping regulations. Houses sold less than 90 days after they were purchased aren't eligible for FHA mortgage insurance; those sold between 91 and 180 days are OK but require an additional, independent appraisal to make sure the sales price is justified.
    What that means for you as the owner is additional carrying costs. Every day you own the house costs you money in interest, utilities, taxes and insurance.

Another MSN Real Estate article that might interest house flippers and ordinary Americans alike: "Housing bubble: Top 30 cities to watch"

It lists 10 U.S. cities where housing appreciation is likely to grow, 10 cities where the housing market is topping off, and 10 cities where the market is likely to decline.

What was interesting to me about this article is not which cities were doing what, but rather how short-term the study was... in analyzing the growth record only the last few years were compared, and in projections, only the next 2-3 years were considered. This is understandable, given the variable nature of the real estate market.

What seems more concerning to me are economic trends like climbing rates of mortgage defaults. Do a Google News search for "foreclosure rates"... scary.

The Housing Bubble Blog is an interesting resource on this topic.

What about a little bit more long-term view? Follow my sidebar link to Harry S. Dent's site and spend some time getting a grasp on his "Key Concepts" section for a nice eye-opener. Keep in mind that he's accurately projected major economic trends for more than 15 years using the methods in his Key Concepts.

I'll try to summarize: Mr. Dent's economic theories rest on one major factor: Demographics. (Technology plays a significant role as well, which I'll come back to.)

In our time, the most significant demographic force is the Baby Boomer generation. Simply put, they have made up the largest economic force in American history, and have exploded every market that they have moved into.

But what goes up must come down. Another first in American history: The Boomers are the first generation who will not be followed by a rising generation larger than itself. Historically, Americans reach their peak spending years at age 46.5, in the height of real estate, automobile and education expenses for a family, as well as invesments towards retirement. This is the spending that drives the economy. (We've been seeing that boom since it started to manifest in the early to mid 1980's.)

But then comes the empty nest, and the clamping down of spending at the onset of retirement.

Let's do a little math. The baby boom started at the end of World War II in 1945 when people made babies in record numbers. Let's add 65 years to that to see when the largest economic force in American history clamps down on the purse strings: 1945 + 65 = 2010.

Four years from now.

Let's do some basic supply-and-demand economics: What happens to a market when there are more buyers than sellers? Price goes up. What happens to a market when there are more sellers than buyers? Price goes down.

Now what happens when the largest economic force in American history suddenly cease to be buyers in virtually every market (except maybe Healthcare) and in many cases (investments and non-retirement real estate) suddenly become sellers?

Depression. That's not my term, that's Harry Dent's projection: a "Deflationary Shakeout, a depression era like the 1930s that will begin between late 2008 and 2010. In the last 80-year cycle, this occurred from 1930 to 1942, says Dent:

"Stock prices fell dramatically, losing 90% of their value, from late 1929 and into 1932. Consumer prices fell equally dramatically from 1930 into 1933. Real estate values plummeted . . . During the Deflationary Shakeout, we see a disinvestment of production facilities and labor that were built up in the race for leadership during the Growth Boom. It is the worst time for employees and most investors." (emphasis mine)

The bright side? In the movie Cinderella Man, there's a scene where the main character, in the middle of the Great Depression, is going to beg for a chance to get money to feed his kids, when he passes a Rolls Royce limousine. It begs the question: when so many were scraping to simply eat, who could afford a Rolls Royce limousine? Those who invested in the Power Wave of their generation, before the Deflationary Shakeout kicked in.

Dent:

"The Power Wave peaks when these innovators enter their 50s and 60s. As they
assume positions of corporate power en masse, they stimulate a revolution in business practices that truly exploits the advantages of the new technologies.
For example, what the assembly line production revolution was to the Henry Ford generation, the Internet marketing revolution is to the baby boom generation today
." (emphasis mine)

Rhetorical question: Gee, how ever would the average person be able to take advantage of this "Internet marketing revolution"?

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