Published December 21, 2010
As wealth managers, we’re not in the business of making short term forecasts or bets on the economy or the financial markets. Instead, we work with clients to help them make more rational and informed decisions about their money by serving as their “personal chief financial officer.”
Sometimes, this requires us to remind our clients of the old adage: What goes up must come down.
Over the past decade, in our role as personal CFO, we’ve sounded public warnings of the dangers of the country’s rapidly inflating real estate bubble and the negative impact the bubble was having on the average American’s personal net worth statement. In the November 2005 issue of Investment Advisor, we wrote, “Similar to the tech crash in 2000, someone will be left holding the bag. We are seeing a period of unsustainable growth that could wreak havoc on the speculative real estate investor.”
Again, in the April 2006 issue of Boomer Market Advisor, we warned of the negative effect an overheated domestic real estate market was having on consumer attitudes toward savings and investment when we wrote, “This so-called housing boom has created a mythical wealth effect. It convinced consumers they could use their home equity, which they believed would increase indefinitely, to fuel their consumer-driven lifestyles.”
In the harsh light of today’s post-bubble real estate market, these words have an eerily prophetic ring. The economists now tell us that housing prices peaked in early 2005, started to decline in 2006 and 2007, and may not yet have hit bottom as of 2010. The current foreclosure crisis which began within the “subprime” mortgage market in 2008 now appears to have spread to homeowners with “good credit” as sudden unemployment or a prolonged period of underemployment has led many homeowners whose budgets were already stretched thin to consider the previously unthinkable foreclosure option.
The foreclosure crisis has even spawned a new breed of real estate entrepreneur specializing in acquiring foreclosed properties, rehabbing them as they are often stripped bare of all furnishings, and then renting them out with the hope of eventually reselling at a higher price once the housing market recovers. Despite the federal government’s efforts to reinvigorate the real estate market through two rounds of homebuyer tax credits, there does not appear to be sufficient strength in the market to sustain the level of sales activity after the expiration of the tax credits.
In fact, year to date 2010, short sales and foreclosures have accounted for about one-third of home sales, with an average price discount of 26%, according to RealtyTrac. Nationwide, there are almost 2.2 million properties in foreclosure. Everyone agrees that more such sales are on the way, but estimates vary widely as to the amount and duration.
Robert Shiller, the Yale economist and co-creator of the S&P/Case-Shiller Home Price Index, which tracks the real estate market, and who correctly called the real estate “bubble” in 2006 just before housing prices fell through the floor. In recent public comments he expressed concern about the possibility of an even longer-term decline in home prices that would eclipse the current foreclosure crisis when he says, “If home prices drop further, homeowners will fall further underwater and lending institutions’ balance sheets will become more distressed. That could bring on another phase of the crisis that might need another (government) bailout”, he stated.
Amidst all the negative news in the domestic real estate market, Shiller does see some signs of hope. His firm recently surveyed professional real estate market forecasters and found that on average, they’re now predicting a cumulative home-price increase of about 8% from today out to 2014, or about 2% a year which would suggest a modest recovery in home prices. If their forecasts turns out to be right, that might be enough to propel the real estate market out of the extreme doldrums and pave the way for further growth. Only time will tell if this optimism is warranted however.
Ultimately, the current real estate crisis serves to reinforce the old adage “what goes up must come down.” We believe that the current crisis will ultimately pass, only to be replaced by another “crisis de jour” just as history has shown us inevitably will happen. It also is a harsh reminder that Americans need “get back to basics” when making decisions affecting their long term financial well being. This means developing and adhering to a financial plan which incorporates time-tested principles such as asset diversification, patience and savings, instead of speculation, as the means of achieving their financial life goals.
David J. Huber, CFP® is Chief Executive Officer of Huber Financial Group, Ltd., a fee-only registered investment advisory firm located in Buffalo Grove, Illinois specializing in financial planning and investment management for high-net work clients. He can be reached at (847) 541-6888 or at www.huberfinancial.com.
J. Peter Doyle, CPA/PFS, CFP ®is a Wealth Manager with Huber Financial.