Real Estate Booms and Busts

Real Estate Booms & Busts

Recently, I was on my way back from working with Lou Brown as a coach to his students. On the plane ride home, a fellow coach and I were discussing real estate; of all things! - Can you imagine? ? All of a sudden the man in the seat next to me said "I don't think now is the time to invest in real estate" - blasphemy! - went the little voice in my head. Almost simultaneously my fellow coach and I said, "Actually, this is the best time to invest in real estate." (Jinx) We started talking about the real estate cycles and how this down market is the best opportunity we have seen in years to buy real estate. By the end of the conversation the man seated next to us was asking us for any investments we might have that he could take advantage of in his local area.

This got me thinking about real estate markets and how they work. After all, things do not happen haphazardly; moreover, history often repeats itself. I was also interested in the psychology behind the real estate markets given my background; are you surprised?

There was a lot of talk 2-years ago about the "real estate bubble". U.S. Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market). The Economist magazine, writing at the same time, went further, saying "the worldwide rise in house prices is the biggest bubble in history". So what exactly caused the bubble to break, if there ever was a bubble? The answer may not be quite what you think.

I once heard a great analogy for how the real estate market flows. It was likened to a leaf in a stream; sometimes it is flowing fast, some times it goes slow and maybe it meets a waterfall or gets stuck in an eddy. Over the past 100 years there have been many ups and downs in the market place. Sudden changes in the market are rare, although they do change abruptly. Most certainly there is a psychological component that plays into all of these turns. Analysis of past booms seems to indicate that investors often do not understand the supply response to price increases. Actually, there seems to be a tendency for investors to overestimate how unique an investment is, that they favor, failing to take into account the principles of supply and rising prices. Investors can't possibly imagine how many competitors there really are; hence why so many investors bought into pre-construction in areas that were already saturated with pre-construction units. The end of booms seems to be associated with the increase in supply of the investment and its negative affect on price. Hence people getting stuck with an "investment" they cannot sell and then feeling duped.

Looking back at the history of the past real estate market, we can see many booms and busts. In the 1880's there was a boom in southern California Real Estate and what is amazing are the similarities that it has to the recent real estate boom of the 2000's. Much like other booms, investors in the 1880's failed to consider the supply of new homes built and the psychological market reaction. In December of 1887, the Los Angeles Times ran an ad that read: "Phenomenal Success! Sales unprecedented in real estate records, this price will positively be advanced". How may of you saw ads for real estate in Arizona, Florida or Las Vegas in the last couple of years that proclaimed a similar sentiment? Long before the peak of the California real state boom in 1887, the newspapers began to change their tune and run articles proclaiming the "foolishness of real estate investors". Much like the articles I read about 2 years ago referring to the "Real Estate Bubble". By 1888 and 1889, the newspapers were reporting the end of the California boom and the psychological fall out had occurred as people felt embarrassed to have been caught up in the emotion of the boom.

The next real estate boom was the Florida land boom of the 1920's; remember the saying: "...If you believe that, I've got some swamp land in Florida for sale you can buy". Where do you think that saying came from? Stories of appreciating houses in Florida began in 1921 and there began to immerge stories of people striking it rich in Florida real estate. The boom steamed on until 1926 when the boom came to an end supposedly because of a hurricane and a recession. However, what seems truer, by account, was that the over supply of new homes and the change in the psychology of the investor ended the boom. Once again the newspapers that had once reported gold in Florida now reported "schemes" and "doubting prices" in early 1925; in fact the Chicago Tribune wrote an article that read: "On the other hand, there are developments along the Dixie Highway that will never be developed - sheer fraud. City gateways and a lot of street posts stuck up along the pines, ten miles for anywhere, maybe in the heart of a turpentine grove with nothing in sight to warrant they've ever being developed. The lots, however, have been sold, for the professional can always land the sucker."

This reminded me of an article I read a while back about vast developments in Arizona and Las Vegas where no one seemed to live because all the houses had all been bought by investors. One thing is for sure: the over development of real estate units as the boom progresses and psychological reaction of the investors to media touted scams was what brought the boom to an end in the 1920's.

Let's look at the real estate boom of the 1980's and see if there are some similarities. It started on the east coast of the U.S. in the early 1980's and peaked around 1985, while on the west coast of the U.S., it peaked around 1988. The boom ended in early 1991. The sharpest period of declining home prices can be seen around the time of the Gulf War. It appeared that the psychology of the war produced a sharp decline in traffic of prospective home buyers.

The social psychology of the processes that produces a boom and ends a boom are still unclear, but play an integral role. One thing is for sure; the real estate boom of 2000's was much bigger than any other boom that preceded it. I believe the media played a big role in the changing psychology of all these booms and busts. Over the last 100 years of history the media has touted stories of striking it rich with real estate and then after a few years, turns and tout the "scams" and "foolishness" of investing. This seems to be the common element in all booms. A sense of excitement and enthusiasm followed by a sense of betrayal and embarrassment for having taken part in the boom; this change in psychology must have an impact on prices and sales.

As of now, there is a mixed reaction as to where we are in this boom. Some would say it is over and real estate will stay down for another 18 months, yet others feel it is already turning around. I hear reports of 100% mortgages coming back and that the Traffic of Prospective Buyers Index is showing improvement. Moreover, the number of US housing permits given to builders increased earlier this year. Will we see a revival of the market? If it is to happen, then there will need to be a shift in the current psychology of home buyers.

Local markets are microcosms of the larger market as a whole. Here in Chicago, we have had our own booms and busts over the years. One example was the real estate boom after the great Chicago fire of 1871 and the psychology of the people of the town. After the fire, The New Orleans Bulletin reported that "Chicago had had its day and would not be rebuilt". For Chicagoans, this was absurd and rebuilding started feverishly. The rebuilding of Chicago is legendary among recoveries and booms. One article in the Chicago Tribune reported that in October 1871, the ground that had been burnt, if it not be rebuilt, would be worth 1/4 of its former value after the fire. Another article reported that once it was rebuilt, the ground would be worth as much as it was prior to the fire. In 1872, a man by the name of Otto Young moved to Chicago and bought as much real estate as he could despite being told not to by those around him. Otto Young become one of the largest holders of real estate in Chicago. Today that real estate is commonly known as "The Loop". At the time of his death in 1906 he was said to be worth 17 million dollars. No doubt Otto saw an opportunity and jumped on it.

By 1883 a recession had hit much of the US. Many investors came to Chicago to buy real estate expecting to buy for 30 cents on the dollar. Investors found that this was not the case and in fact Chicago, because of its strong economic foundation, had continued to flourish. As the market continues to flourish, in the span of 9 - 19 years after the fire, the price of land in Chicago was nearly astronomical for the era. In 1880 a quarter acre was valued at $130,000 and in 1890 at $900,000. Even though the fire was one of the largest U.S. disasters of the 19th century, the rebuilding that began almost immediately spurred Chicago's development into one of the most populous and economically important cities today. Even today, despite the change in the real estate market and the booms and busts over the years, Chicago remains one of the best places to invest in real estate because of its strong economic foundation. My belief is that as an investor, opportunity is knocking for those who know what to do within real estate. I believe the next 2 years will produce more millionaires in real estate than ever before, especially for those who learn how to buy right and hold the investment for the next boom in 10 - 20 years. Why do I think this? Look back at history; it repeats itself.