Plum Crazy

Shades of the dot.com bubble in the real estate market:

"South Florida," he said, "is working off of a totally new economic model than any of us have ever experienced in the past."

It is? What's changed? Housing prices are no longer correlated with interest rates and wages? Housing demand suddenly exists in a vacuum?

Of course not. You can lose money in real estate in the short-term. Alan Greenspan is already making noises about the housing market being over-priced. The Fed is considering adding housing prices to the CPI. Do you know what this would do to the rate of inflation? It wouldn't be so low any more. Typically the Fed hasn't seen asset value as its business, but given the current state of the housing market, they are beginning to think it's their business. If they see inflationary pressures as a result, interest rates go up by more than a quarter point. They can raise rates enough to cool off the housing market. Although mortgage rates are driven by the market, not the Fed Funds rate, there is still a high degree of correlation between the two rates.

An environment of rising interest rates will also have an impact on the labor market. As businesses find their ability to borrow at attractive rates constrained, they will invest less. As they invest less, they will hire less. They may even fire workers. Workers will have less power to negotiate pay increases. Nominal wages may stagnate. Real wages may fall.

Mortgages rates go up, making monthly housing payments more expensive. Wages stagnate or go down. Less people may be working. This equals less demand for house purchases. If you only own the house you live in, you're more likely just to stay where you are (assuming you can still afford to with your other, adjustable rate debt, such as credit cards). If you invested in real estate that you're planning on renting or flipping, you're in a worse position. Real estate investors generally don't go for long-term fixed-rate mortgages, like those who live in the houses they buy do. They either go for short-term ARMs with balloons or short-term interest-only mortgages, where payments increase after a few years. Monthly payments on ARMs will go up, while those in the interest-only mortgages will also eventually face increased monthly payments. Rental prices are already stagnant, and most real estate investors aren't making a profit through rental income. Therefore, they can't cover the increase in their monthly payments by raising the rent. The market won't bear that.

What you wind up with in this scenario is a housing market where most people will stay where they are, but some people will be forced to sell since they can't afford the monthly payments. In other words, there's more supply than demand. What happens when supply is greater than demand? Prices go down. The only question is by how much, the answer to which would vary by region. In previous housing busts, average declines have been in the 15-20% range. Given that a fair amount of the current housing market is spurred by speculators, leading to greater than average price increases, there is a real possibility that we would see greater than average price decreases in a housing market downturn.

Let's end with a cautionary tale.

At the Nexus party in Brooklyn, Steve Nguyen, Ms. Romano's fiancé, said he was heeding Mr. Trump's [ed. real estate] advice. "He says buy, buy, buy," Dr. Nguyen said.

Donald Trump's casinos have declared bankruptcy twice, and he only staved off a personal bankruptcy because the banks were willing to subsidize him. Chances are the banks wouldn't be as patient and forgiving with you, Dr. Nguyen. You don't owe them enough money.