Whether you're investing in stocks, bonds, gold coins or real estate, you are rewarded primarily for your exposure to one thing - risk.
In the summer of 2005, I warned readers that if they were speculating in real estate, the time had come to cash in their chips and get out of the game. I listed a number of reasons, but the biggest one was that ordinarily sensible people were talking and acting as if highly-leveraged home purchases were risk-free transactions. After all, they kept telling me, "real estate always goes up."
It doesn't, of course. And now everybody knows it.
According to the S&P/Case-Shiller Home Price Index, which measures home values in 20 major U.S. cities, home prices have fallen an average of 7 per cent since peaking in June 2006.
I would love to tell you that the worst is over. (After all, I own a couple homes myself.) But the reality is we're only in the second inning. Real estate has much further to fall and you should govern yourself accordingly. Here's why...
A decade of declining prices ahead? Last year was the most painful in decades for residential real estate. Home prices fell, home ownership dropped, foreclosures soared, and housing emerged as perhaps the weakest part of the entire U.S. economy.
But housing prices are set to slide considerably further, as anyone with two eyes and a modicum of objectivity should see. Banks and mortgage lenders are raising their lending standards. That means credit will remain tight, boxing out many potential buyers. Interest rates on many mortgages are about to reset, ratcheting up the pain on many borrowers and triggering more defaults. Home inventory is still growing and must be worked off before the market gains some kind of equilibrium.
And now a new study by one former and two current Federal Reserve economists gives us another major reason to be pessimistic about home prices: the price-to-rent ratio.
Most human beings are rational animals. If home prices get too high, many will choose to rent. If rents get too high, many will choose to buy. Economists feel the price-to-rent ratio is perhaps the most accurate gauge of fair home value.
Unfortunately, the new study by Federal Reserve economists concludes that U.S. home prices "likely would have to fall considerably" to return to a normal relationship with