There’s always something to howl about

Until there is a brokerage counter at Wal-Mart, there is no real estate bubble

Ever wonder about the relationship between gold and real estate?

Jim Klein got me to thinking about a “store of wealth”, when I postulated that there is no gold bubble:

I think people can get snookered into thinking it’s a great “investment.” It’s protection, it’s barter; it’s a store of wealth. To me, that’s not what “investment” means, which is usually about income. I believe that in actual inflation periods, gold tends to appreciate on the low side, particularly when compared with many other assets. It does much better /anticipating/ inflation, as now.

I remembered hearing that term before, over on Seeking Alpha:

Gold and Real Estate have historically been the two ways to store real value as they are as real assets as you get. So what happens when the value of one real asset is artificially manipulated? We all know by now what caused the bubble in real estate, but, at the height of the bubble it was unknown to the market that it was a bubble on the verge of bursting

Real estate does have income-producing value though, as Sean Purcell pointed out to us years ago.  Also, the median-priced home is larger today than it was 40 years ago, because of change in retail demand.  Still, for fun, let’s compare the median price of a single-family home, in August, 1971 ($25,300) to the price of a single-family home, in February, 2011 ($202,100), in ounces of gold:

On August 1, 1971, the price of gold was pegged at $35/oz so it would have taken 722 ounces of gold to purchase a median-priced, single-family home.  Two weeks later, The United States terminated its participation in The Bretton Woods Agreement, creating a fiat currency.

At the end of February, 2011, you might have paid $1,400/oz for gold.  You could purchase a median-priced, single family home then for 144 ounces of gold, about one-fifth the cost (in gold), from 1971.

What I’m missing here is the net operating income you would have derived from that single-family home, over the 40-year period.  I’d have to know what the rents were for each year, the property taxes and costs for fire insurance, maintenance, etc..  I suppose we could assume 1% of the value of the home for monthly rents, adjust it each year to the median-price, and deduct 25% of that income for taxes, maintenance, and expenses.

One of the great reasons to purchase real estate is that you can leverage it.  If we could assume that you purchased that home, in 1971, with just 20% down payment, financed the rest, and the rents covered the financing costs and expenses, and amortized the loan for you, we could say that you only paid 144 ounces of gold then, for 144 ounces of gold today but…

…you could live in that house today. Real estate then might be a real bargain today and, until they have a home brokerage counter in Wal-Mart, there is no bubble in real estate.



34 Comments so far

  1. Greg Swann April 19th, 2011 4:14 pm

    WestUSA or one of those bobblehead brokerages has offices in WalMarts in metro Phoenix. Meanwhile, I can easily get you to 15% cash-on-cash on a newer suburban tract home. Can you get a reliable 15% per annum on any other self-amortizing investment? Phoenix is the home of the unbubble, right now.

  2. Brian Brady April 19th, 2011 4:38 pm

    The only chink in that armor is the word “reliable”; that’s the great unknown right now. Could rents actually decrease?

  3. Greg Swann April 19th, 2011 4:53 pm

    > Could rents actually decrease?

    In neighborhoods I don’t go to, they could. 😉

    The most amazing thing to me about the National Association of Vampires is how little understanding they have of the role of expertise in selling real estate. My houses are leasing with days-on-market in the single digits. Things can change, but, for now at least, change is all for the better.

  4. Brian Brady April 19th, 2011 5:07 pm

    This post is a broad-brush but I wanted to throw some paint on the wall. I figured the trim will be done in the comments section

  5. James Malanowski April 19th, 2011 5:10 pm

    OK, so it’s not residential real estate, but if they ever decide to do it, they’re ready.

  6. Jim Klein April 19th, 2011 9:28 pm

    > Could rents actually decrease?

    Wow…can you come up with any scenario where they would? More ex-homeowners, cheaper dollars, near halt in new production for years and maybe the most convincing of all…we’ve paid for the banks to hold huge inventory. Personally I can’t imagine any scenario where rents go down.

    The one exception is total breakdown, which is suddenly not completely farfetched. But in that event, having a place to stay will involve a lot more than money.

  7. Cheryl Johnson April 20th, 2011 4:21 am

    > Could rents actually decrease?

    Here in Los Angeles, rents have indeed decreased. And not just in seedier neighborhoods. I can point to one home in Mount Washington we leased a week ago for $1,850. In 2005-2006, it was leased for $2,450. That home is not an anomaly.

  8. IPIN Live April 20th, 2011 4:28 am

    An interesting post, but a few points to consider.
    The cost of the storage of the gold if you had taken physical delivery (not cheap over 40 years!).

    Gold can be purchased in paper form on leverage – not recommended on the long term because of the cost, but it can be done.

    Gold can also suffer massive losses in the market place much quicker than gold – largely because it can be shorted – property for all intents and purposes cannot.

    I have an extensive article on the comparisons of gold over the UK property market for the last 10 years – comments/views are of course welcome.

  9. Jim Klein April 20th, 2011 7:01 am

    You’re right Cheryl, but I was addressing going forward when prices and rates finally bottom. I still can’t imagine a scenario with continued decreasing rents, but I’m open to ideas.

    I like your essay, Peter, especially from an “investment” angle. The thing is, as a store of wealth, there hasn’t been a recent period when major currencies (like the US dollar) went entirely into the tank and so became worthless as such a store. And worse…it doesn’t really matter who wakes up now; the horse is long out of the barn. That doesn’t make gold a lock to soar, but it does leave increasingly few alternatives.

    Too bad food eventually rots. Property takes much longer, though, so I agree with your premise. Personally, I can’t see any asset class these days that comes close to real property that has any productive value at all. I’m pretty sure—that’s why the banks are keeping so much of it!

  10. Brian Brady April 20th, 2011 9:32 am

    Peter, I think we both missed the rents angle in our comparisons. The first chart on your article compared price performance only. Of course, we can’t “compound” the rental income because reinvestment in real estate require much more cash.

    If we took Greg’s example (15% cash-on-cash), and deducted operating expenses (let’s say the NOI was 12% or an 8.5 cap rate), we could buy another property every 7-10 years (without employing leverage).

    What I’m learning here in the comments is that, over the past 40 years, gold had to increase 40 times over to keep pace with a real estate investment which increased 8 times over. Which is more likely in 2050…$56,000/oz gold or a median price property of $1.6 million? I don’t know but that’s what makes these exercises so much fun

  11. Greg Swann April 20th, 2011 10:49 am

    Cash-on cash is net of all expenses except income and capital gains taxes. I’m ignoring appreciation, also. I can hit 20-25% cash-on-cash without too much trouble. I think I can beat just about any passive investment.

  12. Sean Purcell April 20th, 2011 12:34 pm

    The one exception is total breakdown, which is suddenly not completely farfetched.

    This occupies a lot more of my thinking lately than I ever expected. In the worst case scenario, gold is not nearly as valuable as property… Gold is a repository of value during crisis, but is of little actual value during the crisis. On the other hand, I can barter shelter in my home for: food, drink, sex, arms, ammo… even gold.

  13. Jim Klein April 20th, 2011 2:15 pm

    > On the other hand, I can barter shelter in my home for: food, drink, sex, arms, ammo… even gold.

    Right, as long as it stays your home. That may not be up to you and even if it is, you may not want it to be.

    After this, I’ll try to keep it to short quips here and put the essays elsewhere. But right now is the time for thinking outside of the box. The markets are telling us, in no uncertain terms, that the next half year or so is etched in stone. What they’re not sharing, because they haven’t an inkling of an idea, is what happens after that. IMO today was one of the biggest days ever because it fairly shrieked, “Okay, we’re going to settle in for this ride and see what happens on the other end.” IOW it was an affirmative declaration of what I’ve been saying all along is the guiding principle…”Maybe logic doesn’t hold.”

    The HUGE problem is that logic does hold and ignoring what’s going on, just ain’t gonna work. I don’t care what detail is picked—worldwide currency destruction, insane sovereign debt loads, housing in the hands of the banks, socialist policies never even dreamed of by the wildest communists, or the really fundamental one of all, individual production being hammered down, with the absence of it being rewarded and presence of it being punished. This is why all production has been moving steadily toward the largest outfits, and will continue that trend for the foreseeable future.

    These matters are boiling in the pot and the lid will blow off, whether we look at the stove or not.

    The serious underlying problem is that virtually ALL sides are coming up with the wrong answers. Greg can explain the details of that much better than I, but the important point is that it’s a virtual guarantee that the wrong answers will emerge. That’s why it’s absolutely essential to think outside of the box, because we KNOW that whatever happens, it’s not going to be in this box. The good news is that this can be a huge investment advantage when all the other participants are (foolishly) committed to staying in the box.

    The bad news is that’s it’s an awfully big territory, outside of the box! Or maybe that’s good news, too.

  14. Sean Purcell April 20th, 2011 2:38 pm

    My comment was limited to the very small window (3 days? 3 weeks?) of active collapse.

    Outside that window, I agree with you Jim that logic tells us what has already been set into motion and going forward, independent thought will be paramount. For one, those who are losing power will try everything they can to maintain it. But maybe more impactful (and certainly more easy to understand), is a saying we had on the trading floor: “the market moves to hurt the most people.” That is the essence of contrarian trading and it’s based on the idea that most people choose herd mentality over individual thought.

    So the problem isn’t just finding plausible answers outside the box, but whether or not enough people awaken to individual thought and choose to step outside the box!

  15. Jim Klein April 20th, 2011 3:57 pm

    Yep, Sean. I figure you start with the one you always live with, make that the best you can, and then add from there. Carefully.

    There never was a problem, except the hoodlums.

  16. Al Lorenz April 21st, 2011 10:48 am

    Brian, you’ll never get a job with the NAR until you learn the line, “it’s a great time to buy.” Maybe the twist is, it’s a great time to buy, if you’re smart enough to buy the right things.

  17. Jim Klein April 21st, 2011 12:34 pm

    > Brian, you’ll never get a job with the NAR until you learn the line, “it’s a great time to buy.”

    Oh, that was them? So with help like that, why is everyone griping about the increases? “Must be a bunch of ingrates…”

  18. Brian Brady April 21st, 2011 2:50 pm

    “Brian, you’ll never get a job with the NAR until you learn the line, “it’s a great time to buy.””

    Think about it. I just gave them some fuel for the next jingle, in this post; “Real Estate: better than silver or gold”

  19. Al Lorenz April 21st, 2011 2:53 pm

    That’s funny!

  20. Michael Cook April 21st, 2011 4:33 pm

    Sad I missed all the fun here. A few more points:

    You cant talk about volatility of gold and then talk about the lack of volatility of leveraged real estate. How many people are living in a home with zero equity??? Seems like real estates not the safest leveraged space to be in either.

    Additionally, leveraging a gold investment is not a herculian task. Margin can certainly be a man’s best friend or worst enemy, but its readily available. Even modest leverage proves that gold is either tremendously overvalued as compared to real estate or vice versa.

    Taking delivery of gold??? Thats just silly. I know plenty of traders that havent taken delivery in 40 years. Storage costs dont make sense since the market is extremely liquid. Perhaps some transaction costs make sense.

    Median housing prices is also a challenge, seeing as how I live in New York, Greg in Phoneix and Brian in San Diego. Where is that darn medium house I need to be investing in. Yet, we can all invest in gold at the same price. Doesnt add any math to the analysis, but does make it a bit tricker.

    Timing also matters. Choosing a down real estate market and an up gold market at any one point in time is one thing, but do they even correlate in the long run. I think a chart would be more interesting and I think looking at it by region would as well. Just a few thoughts. Very interesting though.

    By the way, you guys all assumed that the medium house could be leveraged and rented out for more than the mortgage. That is not the case in New York and I suspect the median house would be harded pressed to make much more than the mortgage payments as well.

  21. Greg Swann April 21st, 2011 5:42 pm

    Just to absolve myself, I never talk about any real estate market except Phoenix, and even then I focus on particular towns and particular subdivisions within those towns. I know I know a lot about a little. I don’t believe anyone knows anything at all about more than a few real estate markets. Big picture pronouncements, even if just about Phoenix as a whole, leave me cold.

  22. Brian Brady April 21st, 2011 6:52 pm
  23. Michael Cook April 22nd, 2011 6:53 am


    There will always be that problem, but the markets at the moment are sufficently liquid enough to trade out to a user at any time. There are enough computer makers, jewelers, etc. that use the end product to avoid me having to take delivery of five gold bricks.

  24. Jim Klein April 22nd, 2011 7:15 am

    Michael, did you know that every person in history, caught on the wrong side of a bubble or a crash, thought exactly like that the day before?

    Really, you’re confirming my reading of the signals—“Okay, we’re going to settle in for this ride and see what happens on the other end.” Just don’t forget there’s the other end!

  25. Joe April 22nd, 2011 7:31 am

    There is nothing inherently unique about the value of gold that has made its price skyrocket the way it has over the past couple of years. Global supply and demand levels have remained steady, the only thing pushing the price up is panic buying egged on by billionaire hedge-fund managers like John Paulson (who, incidentally, earned 5 billion Dollars in 2010 betting on gold price increases).

    Current gold prices, in my view, are absolutely a bubble – everybody knows this except for the poor saps rushing to get in on the action. The price will continue skyrocketing for a bit and then come crashing down and investors will be left hurt and confused like they always are at the end of these things. It’s not so much betting on the inherent value of gold as it is betting on the predictable reactions of human beings.

    With house prices the way they are right now real estate is by far the better investment option.

  26. Sean Purcell April 22nd, 2011 7:10 pm

    Joe, why are gold prices a bubble? Because they’re going up? That’s no rationale. As a matter of fact, that’s not even accurate. Here’s a graph of inflation adjusted gold prices. In 1981 gold hit $2251/ounce in 2010 dollars. What do you think of 1981 vs 2011? Would you rather be facing the issues we faced then or the issues we face now? (Personally, 1981 is starting to feel quaint by comparison.)

    I agree there’s a bubble right now: it’s bubble-headed thinking. Jim described it best as “the irrational belief that logic doesn’t hold.”

    I’m thinking gold looks pretty damn good to at least $2000/ounce. Then it might be time to take a breath, look around, and see if you hold… or buy more.

  27. Jim Klein April 22nd, 2011 7:20 pm

    It hasn’t skyrocketed because of its value, Joe; it’s the destruction of the currencies in which it’s denominated. Even extreme tightening won’t do much at this point. IMO 1325 is an absolute bottom, and the dollar strengthening that much is very, very unlikely. Investment-wise, though, I agree with you.

  28. Brian Brady April 23rd, 2011 1:57 pm

    “Michael, did you know that every person in history, caught on the wrong side of a bubble or a crash, thought exactly like that the day before?”

    …like, those CDO traders who leveraged up 30 to 1.

    “but the markets at the moment are sufficiently liquid enough to trade out to a user at any time”

    MC, I’d have bought the liquidity argument 4-5 years ago but after hearing the welfare queens, from the banks and insurance companies, threaten economic collapse, I started believing them.

  29. Sean Carr April 23rd, 2011 4:28 pm

    More interesting comparisons for weekend entertainment.

    In 1964, a gallon of regular gas cost $.30.

    A 1964 quarter is now worth $7.30, or almost two gallons of gas.

    So, as measured in silver , a more stable commodity than dollars, the price of gas has declined.

    I am by no means weighing in on Peak Oil. But, the price of gas is increasing in dollars, not in other commodities (i.e metals).

  30. Jim Klein April 24th, 2011 7:16 am

    There are lots of factors and the story could always change, but it’s even more remarkable than you imply, Brian. In 1964, it took 20-25% of an ounce to buy a gallon of gas; now it takes about 10%. That’s a doubling in relative value, and it’s not like we stopped using oil. Indeed, when you throw in the large amounts of silver used then for photography, it’s even more interesting.

  31. Greg Swann April 26th, 2011 10:19 am

    Two words: Compramos oro. You see those words everywhere. Every granny has a silver tea set she never uses, and every lithographer has a negatives library that is more obsolete every day. Hoarding metals presumes an inelastic supply. Might make sense to ask the Hunt brothers if the trading supply of precious metals is really inelastic.

    Worth two copper-free cents, total.

  32. Jim Klein April 26th, 2011 7:22 pm

    It remains to be seen if this is a bubble. I’m inclined to think not, since big leverage seems to be missing. In any case, it’s the exact opposite of the Hunt brothers–that was narrow and this is wide, as far as the demand source is concerned.

    Hoarding presumes inelasticity, but opting for a means of barter and wealth storage does not. I’m inclined to look at the silver boom the way you look at the Tea Party—hopeful, but far from a done deal. The Tea Party has the Dems working for it, and silver’s got the Fed!

  33. Greg Swann April 26th, 2011 7:38 pm

    I agree with all of that, too. I owe you two more worthless pennies.

    To the extent we are willing to entertain the subjunctive in a rational way, we tend to be reactive with the brake pedal, rather than looking for ways to hit the gas. All of the things we talk about come down to loss-avoidance, loss-prevention, loss-mitigation. Of the two numbers that matter to the human mind — infinity and zero — most of us can see only the number zero most of the time.

  34. Jim Klein April 27th, 2011 4:56 am

    I sure agree with the sentiment, Greg, but still can’t see the way. To me, it’s like saying you should drive smooth laps around the Dodge ‘Em Car ring. Nice goal, but ain’t gonna happen.

    I think slavery is an abomination, but can’t quite figure a world
    where people actually want to be slaves. It can be tough persuading such minds that Splendor makes more sense than Suffering, that Life is better than Death.