You Know It Is a Real Estate Bubble When...

By Tom Hendrickson | October 03, 2005 AAA

The other day this link was forwarded around the Investopedia Advisor office. If you visit the page you will see that it is an article about how Playboy's (PLA) May playmate, Jamie Westenhiser, wants to ditch her career as a model and pursue a career in real estate.

Now – and please bear with me as I attempt to write this in the most sensitive way I know possible – Jamie should stay in modeling.

The jokes started to fly and emails with the subject line, "You know it is a real estate bubble when ..." littered inboxes.

Now, perhaps this young lady is set to embark on a successful career in real estate and in all seriousness we have no idea about her talents, abilities or intelligence, she may very well be the next Donald Trump (TRMP). But the article does raise the question – how can everybody make money in real estate?

Answer - They can't.

Our fear is this – there are thousands (perhaps tens of thousands or even hundreds of thousands) of individual investors out there without the skill or experience to invest in real estate setting themselves up to get burned when the recent craze cools or even worse the 'bubble' bursts entirely. (Much like the investors holding large stakes in Nortel (NT), Cisco (CSCO), and JDS Uniphase (JDSU) in the early 2000's when these company's stock prices crashed.)

We all know that the stock market (as measure by the S&P 500) has been in a rather unfriendly place when looking at the returns over the last five years. Right? Right. We also know that over the past five years American real estate has been one of the most profitable places to be.

But over the longer term real estate is not a proven wealth building mechanism, especially when compared to the stock market.

If you take a look at the graphic below you will see that the last five years is not indicative of long term results in real estate. Also, please not that there are nominal gains and do not adjust for inflation.

StockMarketvsHouseMarket_1.gif

This all leads back to some of our core beliefs here at the Investopedia Advisor. The best way for individuals to build wealth is through smart and deliberate exposure to equity securities.

This is what we believe because this is what we know.

The House Price Index (HPI) is a measure of single home prices in the U.S. Over the last five years the index has climbed from 231.6 to 361.03 - a 56% increase. This is well above the -18% return (yes, that is a negative sign) the S&P 500 has achieved for investors over the same period.

The National Association of Realtors® recently released a report (March 2005) which showed that over one third of all real estate purchases in 2004 were tied to "investment" (at this point in the market's cycle read "speculation"). This includes purchases made for strict investment which comprised of 23% of the market and vacation homes at 13%, both segments saw double digit growth over 2003 levels.

Despite the recent run up and outperformance of equities we do not believe that investors can successfully build wealth by trying to convince a "greater fool" to buy a piece of property from them at an inflated price.

Anyways, you've all heard the stories and those calling the real estate bubble's burst. We are not about to do that, in fact we would even go as far as saying the likelihood is probably just as great that the real estate market will stay hot for the next two to three years as it will burst tomorrow or the next day...but it will inevitably cool.

All we ask is you don't say we didn't warn you when you and your wife plan for your retirement vis-à-vis a great long term return on your second and third house....

P.S If you are interested in becoming a member to the Investopedia Advisor and seeing what stocks we are currently recommending click here to join the service risk-free.

P.P.S Please don't misinterpret this piece, we are not shunning the virtues of real estate all together, in fact we believe real estate has many very attractive attributes (including the ability to be highly leveraged and relatively well protected from downside risk). We are simply saying that right now, the type of investor and the motivations (to make a quick buck) for them entering the market, in many cases, are questionable.

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