That is exactly the problem, people view their home as an investment and people are generally ignorant about inflation. Like you said, if your home is averaging a modest 5% increase in value on paper each year, after inflation you’re only making a percent or two.

But, take an example where someone buys a home for $200,000, and at 5% and 15 years later, they sell it for over $400,000. The homeowners are ecstatic because they are amazed at how easy it was to double their money, what a great investment! Wrong, that was not an investment, and after all said and done, you probably lost money. After all said and done, you may have realized a true gain after inflation of $80,000. Even then, when you factor in the interest you’ve paid and the relatively small amount of principal paid off during that time, your gain on that investment isn’t such a pretty picture.

People simply don’t factor in inflation, and they don’t even consider interest or equity over time. What most people see is the fact that they can double their money in 15 years, and when you’re talking a few hundred thousand, it makes people think they are making good money on their home.

It all comes down to a shift in the way people think about their homes. For the longest time it has been the American dream to own a home and everyone wanted a piece of it. When people were making quick money in short amounts of time with real estate, more people wanted a piece of the action without taking the time to understand what they were doing. Sure, owning a home is great, and it can increase in value and result in making money, but it just isn’t as simple as most people are led to believe.

I’m also interested to see how immigration plays out. Land is a precious resource, and like you said, when you have to keep building houses or apartments, you need to buy more land, and that should spell increasing prices.

I purchased my first home in 1994. Our agent had been selling homes for 20 years in our market and he said, “After closing costs, don’t expect to break even for five years.” That held until 1998 when our maket exploded. It made very little sense to me then and it makes very little sense to me now. I talked to an agent at the beginning of the boom and he said, “Buy now, you can’t go wrong, you can sell in three months and make 5-10%.” No one hemmed or hawed, they just kept paying too much expecting that the price could only go up. Historically residential real estate is a poor investment scoring about 1-2% adjusted for inflation. There are exceptions, but generally your house is an expense, not an investment.

I feel bad for the people getting burned right now, but I am also happy for the young people just starting out who will find housing more affordable. Just like the dot com bubble things got really stupid at the end.

The big unknown here is immigration. the US adds about 2 million people to the population each year. Someone wrote that if it continues, that means we will create the equivilent of 12 cities the size of Los Angeles by 2050. In that environment, I don’t see how residential prices can’t increase dramatically. There will be massive demand for space.

Look at all of the people who were late to the party and began throwing money into tech stocks in 1999. Oops! It is seven years later and some may still have not recovered completely. But for a decade their friends and family were already in the market making money hand over fist, but by the time the majority of people had the courage to get in, it was too late.

It has been the same effect with the housing market, just a longer bullish trend. For years it was almost common knowledge that if you bought a house or property, it would increase in value without a doubt. Unfortunately the trends can never last forever, and as people over the last few years began to get greedy and try to make even more money in real estate, they are finding out that they may get burned.

This whole ordeal is just another reminder of how important it is to keep your wealth distributed across various asset classes. If it isn’t smart to have 100% of your money in a single stock, it isn’t smart to bet your retirement on the value of your house. By having an appropriate mix of everything from equities, bonds, cash, and real estate, you are far more likely to weather the storm regardless of what bubble bursts.

Finally, one of the benefits of major downturns such as this one in real estate is that it opens up new opportunities. While it can be an ugly situation for those in trouble, the markets are efficient and while money is moving out of one type of asset, it will begin to move into others. Not only that, but the housing problem presents an opportunity for new business ideas to evolve in an attempt to solve the problem. It is this constant ebb and flow of the economy that drives innovation and provides opportunity.

And from the article: “Whenever the price people will pay today depends on the belief that other people will pay even more tomorrow, you’ve got a bubble.”

It’s just a shame so many are hanging their financial lives on these prospects! Use to be real estate was something you could count on, now you’ve got to ask yourself is there really anything out there??

Food for thought. Thanks!