If the stock bubble bursts, the exit strategy is probably not going to be real estate.
When stock and real-estate bubbles collide
By Dan S. Barnabic
As a series of articles on this website suggest, we’re not headed toward a bubble — we’re in one. But how is this bubble different from past bubbles and what will happen when it ultimately bursts?
MarketWatch recently interviewed former Federal Reserve Chairman Alan Greenspan who said that,“when bubbles emerge, they take on a life on their own. It is very difficult to stop them, short of a debilitating crunch in the marketplace.” That quotation alone is enough to send a fear to any investor in the market place. It applies to any sector of the economy, be it stock markets or real estate.
Judging by the recently voiced increased concern of some very reputable economists, we are presently living in an economic bubble that has a real potential of bursting.
To what degree will bursting the bubble affect the investors and the ordinary folk on the street, is anybody’s guess but the consequences of it may be severe. We’re living in an equity bubble and a highly advanced one. On the most historically reliable measures, it’s easily beyond 1972 and 1987, beyond 1929 and 2007 and is now within 15% of the 2000 extreme.
We may be in the third biggest stock bubble in U.S. history. U.S. stocks are now about 80% overvalued on certain key long-term measures, according to research by financial consultant, Andrew Smithers, the Chairman of Smithers & Co., and one of the few to warn of the bubble of the late 1990s at the time. The history shows that the bubbles form from time to time, and affect some, or in some instances, all segments of the economy. A major high-tech bubble occurred in 1990s, but back then, many investors reinvested their money in the real estate sector, which started to improve by 1997, following its disastrous collapse of 1989/2000.
This time may be different though. If the stock bubble bursts, the exit strategy is most probably not going to be reinvesting in real estate. By monitoring the housing starts in the U.S., a sad realization surfaces. They’re disappointing. The real-estate market isn’t recovering at the pace expected. Many of the millennial generation, burdened by their heavy student debts, cannot even afford renting apartments on their own, let alone invest in the still overheated real estate. Most retirees face the same problem, because of their limited incomes.
In my estimate, real estate is overvalued by at least 35% and maybe up to 50% in some congested urban areas. If real estate was to crash simultaneously with the stock market, the future doesn’t bode well for the North American economy. Such possibility may be especially painful to seniors whose livelihood depends on dividends invested in their stocks. When it comes to real estate, which I’m much closer to, I always warn people that it all comes down to housing affordability.
If one is able to either purchase or rent any kind of real estate by being able to pay for carrying costs of such investment with one-third of their annual income, they could be well off, notwithstanding the oscillations in the economy. In other words, if you buy the real estate with a fixed mortgage interest rate for 30 years, and carrying of such mortgage doesn’t exceed one-third of your annual income, you will be able to preserve the quality of your life. On the other hand, if you have to spend half or more of your annual earnings to carry the mortgage payments, as is the case right now with many American homeowners, then your quality of life may become bound for disaster with the possibility of losing the equity in your home by the time another market crash occurs.
The Feds announced that the quantitative easing which kept the economy breathing on artificial lungs for quite some time now, may come to an end by the end of this year. This means no more printing bonds to keep the economy going and much worse, introduction of higher interest rates to combat possible inflation. Inflation is one the most feared economic conditions which drives consumer confidence down and historically speaking, brings housing appreciation to zero.
This time around, the stars seem to be aligned for the bubble to burst within almost all sectors of the economy. This may spell a serious hardship for an average American in times to come. Whether it’s going to happen later on this year, or in the next three years, isn’t anymore a question. The question is, how severe will it be and are Americans going to have enough resources to sustain it and recover from it?
It’s been reported that over 30% of real-estate buyers are foreigners. That’s another worrisome sign, as it points out that an average American experiences financial difficulties in buying real estate. In these times of uncertainty, “cash is king.” It may now be time to sell your stock and real estate and hold on to your cash. Later on, you can buy the stocks and real estate cheaper once the bubble bursts and devaluation takes place.
It may also be wise to sell your overpriced condominiums and stay away from them altogether as they’re extremely volatile to any economic slowdowns. Most condominium complexes are composed by unit owners of various financial strengths. The weak financial unit owners will be the first ones to go when the market tanks, causing vacancies in the condo complexes and putting the strain of maintaining the whole complex on the remaining unit holders, by way of higher maintenance fees and special assessments.
Remember these brand new condo complexes that were mostly vacant during the last crash, between 2006 and 2010? History has a funny way of repeating itself.