A REAL-LIFE REAL ESTATE
BUBBLE
by Dr. Steve Sjuggerud
"The Florida boom was the first indication of the mood of the
Twenties that God intended the American middle class to be rich."
- John Kenneth Galbraith
The Great Crash
In 1914, George Merrick switched from selling fruit to
selling Miami land. Florida would never be the same again.
In 1910, only 5,471 people lived in Miami. By the time Merrick was through
in 1925, he had installed some 3,000 real estate
salesmen alone in the city. Merrick's fleet of 76 busses was constantly
bringing down prospective buyers who all had the same mission: to get rich
on Florida real estate.
But George Merrick is only a small part of the story. In all, by 1925,
there were 25,000 real estate agents working in 2,000 offices in Miami. As
the population grew to 75,000 - remember, it was 5,000 just 15 years
earlier - an astonishing one in three Miami residents sold real estate
there.
Why was everybody hustling to buy in Florida? Author John Kenneth
Galbraith explained it well in his 1954 classic, The Great Crash: "This is
a world inhabited not by people who have to be persuaded to believe, but
by people who want an excuse to believe. In the case of Florida, they
wanted to
believe that the whole peninsula would be populated by the holiday-makers
and the sun-worshippers of a new and remarkably indolent era. So great
would be the crush that beaches, bogs, swamps and common scrubland would
all have value."
Stories of overnight fortunes were headlines across the country. "One man
picked up ocean frontage for a quarter ($0.25) an acre and sold it for a
million," writes Maury Klein in his book on the subject, Rainbow's End. "Another
reluctantly took 1,200 worthless acres on a debt and couldn't
sell it at $10 an acre, until the boom delivered him a whopping $1.2
million. A returning soldier traded his overcoat for 10 worthless acres
near the beach and soon found it worth more than $25,000. A poor woman who
had bought a Miami lot back in 1896 for $25 sold it during the boom for
$150,000."
"Getting rich is easy," everyone came to think during the boom. Just buy
land in Florida and you'll be rich in a few weeks. The illusion seemed
true. In fact, the assessed value of property in
Miami went from $63.8 million to $421 million in just four years
(1922-1926). Money was growing on trees
(palm trees, right?). Did it matter if there was any value to the
underlying asset? Nobody cared. And as the boom was reaching its peak,
following a trend that would have made Tech and Telecom investors of the
late '90s proud, nobody even bothered to do any research anymore...they
just bought with the expectation of getting rich straight away.
"An enterprising Bostonian," says Galbraith, "a man by the name of Mr.
Charles Ponzi, developed a subdivision 'near Jacksonville.' It was
approximately 65 MILES west of the city. (In other respects, Ponzi
believed in good, compact neighborhoods; he sold 23 lots to the acre.) In
instances where the subdivision was close to town, as in the case of
Manhattan Estates, which were 'not more than three fourths of a mile from
the prosperous and fast-growing city of Nettie,' the city, as was so of
Nettie, did not exist."
Then, as quickly as it began, the bubble burst. And it was painful. In
1925, bank clearings in Miami were in excess of a billion dollars. In
1928, they were $100 million - one-tenth of what they were just three
years before. The boom was over. And like the Nasdaq, speculators with
hopes of easy riches were crushed.
My friends, this was a real estate bubble.
I can see many similarities between Florida real estate in the 1920s and
the Nasdaq bubble of 1998-2000. But I really don't see much similarity in
real estate today, do you?
First of all...we don't have any 'cities of Nettie,' though we do have
people speculating on pre-construction developments. We don't have people
buying sight-unseen like Florida land circa 1925.
And most importantly, we don't have the "euphoria" that we had then - a
defining characteristic of speculative bubbles. While some people think
that real estate "always goes up," some are still very afraid that "it's
too expensive and is about to fall." I don't know how many people fall
into each
camp. But for a speculative bubble to develop, EVERYONE has to believe
that this is the sure path to riches - just like people believed about
stocks in 1998-2000.
We're not there yet.
I would define a bubble as "when prices become un-tethered from
fundamentals." Right now, real estate fundamentals, as measured by the
amount of rent you can collect on a property versus its value, are fine.
You can earn 6%+ in net rent on a rental property. Maybe more (even much
more) if you're lucky or good. Where else can you get paid that kind of
income? Nowhere...
No, I don't think we're in a real estate bubble. If prices double from
here, and the word on the street is that "the easy way to get rich is to
buy real estate"...then we'll be in a bubble. That will be the time to get
worried.
We're just not there yet.
So for most investors, the best advice is simply not to worry about your
real estate, in particular your rental properties. We are still a long way
from the bubble stage.
Prices may slow their rise, or as indicated in the New York and California
markets, they may even contract some. Then again, they may continue to
rise. How's that for an accurate forecast? Truth is, nobody can foretell
what will happen. But since there is underlying fundamental value, it
seems
smartest to ride it out - particularly if you don't have too much debt.
Could real estate fall 10% in value? 20%? Even 50%? Sure, it's possible.
Anything is possible. But, in my opinion, we're not in a real estate
bubble. People don't expect to get rich next month in real estate...by
buying this month. Nor would they if they tried.
Regards,
Steve Sjuggerud,
for The Daily Reckoning
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