Global Sound – (PRWEB) July 25, 2004
The first and most important factor that can cause a real estate market crash is when people realize that their investment are pure speculation with unreasonable fundamentals. What this means is that the reason the dot com market climbed so high and so fast was because of speculation, speculation that a company was going to be worth a lot more later because it would earn a lot more later, rather than what it was earning today. Eventually when reality set in and the businesses did not meet the incredibly high expected earnings, the value of the speculation was removed which crashed the market because the price of a stock was based almost purely on the speculation of it’s future earnings, not it’s real current value. No company can maintain a consistently high growth rate of 50% for decades at a time, it’s just simply impossible.
With the real estate market as it is today, if you buy an average rental property you will be faced with negative cash flow on the mortgage expenses alone (assuming $ 0 down), not to mention expenses, property taxes, vacancy rates, etc. Therefore, as in the dot com boom, the prices today are not based on sound financial fundamentals, rather they are mainly based on the speculation of the future prices of real estate. For rental properties to make financial sense in today’s market their prices would have to drop significantly, low enough so that after all expenses (including mortgage) the rental income would be somewhat higher, where the cash flow becomes positive. This cannot happen anytime soon, or even within a few years, rents simply cannot increase at that pace. Therefore the prices of real estate has entered in a severe price speculation mode, just like the dot com stocks of the boom era.
Assuming a correction is made to adjust the prices to bring it back to positive cash flow, we still haven’t dealt with the fact that interest rates are at an extremely low rate, so low that it has greatly affected the prices. For arguments sake, let’s assume interest rates increase to the historical average of 8%, how will this affect mortgages? For a 30 year mortgage at 5% of $ 250,000, the monthly payments are $ 1342.05. However if you increase that to 8%, the new montly payments are $ 1834.41, an increase of approximately 37% (as a general rule of thumb, increasing the interest rate by 1% increases you monthly expenses by about 10%). This means that you’ll be losing and additional $ 500 a month! That’s a huge financial burden considering that a rental property should be increasing cash flow not decreasing.
Therefore it is the prediction of this writer that housing prices will fall, and that they will fall drastically, as much as 30-50+% as soon as either interest rates climb a little or as soon as the housing prices fall just a little (there is nothing like a little fall in prices to destroy a speculative market, you’re basically removing the fuel feeding the speculative fire). As with any other speculative boom market, when prices fall, people generally tend to overreact, which causes even more price drops. After all is said and done and the smoke has cleared, and the real estate market re-stabilizes, housing prices will have decreased drastically, making them once again inviting investment opportunities for the avid investor.
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