Wondering what will happen to real estate prices? An interesting relationship between stocks, interest rates and real estate
Tarun Sikhdar
May 30, 2005

EXHIBIT B

EXHIBIT C
Are you scared looking at the skyrocketing price of your home? Are you concerned about your real-estate investments?

According to many experts, there may be some local bubbles but not a national bubble in US. In certain parts of California, NY City and Florida prices have tripled in five years. That is bubbly. But national prices of single-family homes, condos and tow homes have not really gone up like a bursting bubble.

Then what is really going on? Exhibit C clearly shows that real estate prices can keep going up even if the interest rates rise. That is exactly what happened between 1974 and 1982. The real estate demand and prices were undaunted even during 1981-82 recessions.

But there was a decline in real-estate prices between 1988 and 1990. It again repeated between 1997 and 1999. During both these periods interest rates dropped and economies actually were strong – very strong.

This just shows higher interest rates and slower economy do not mean lower real estate price. Then what really makes real estate prices go down?

In early and mid eighties as well as between 2000-2005 the skyrocketing real estate prices were the result of not just home buying by single family home buyers who really bought those homes to live in them. But the actual jump in prices came from real estate home investors. These investors are not really sophisticated. They are normal homeowners who try to buy more homes looking at the price escalation of the home where they live. These are small real estate investors.

The decline in real estate prices also results from change in this small home investor sentiment, as they tend to withdraw the money from the real estate market. This actually results from a scare trigger or a super performing stock market.

In 1988, the tax law changes caused the investors to withdraw from the real estate markets.

There is a strange relationship between stock market and small real estate investor sentiments. If for some time, stock market under performs and these small investors get burnt, they tend to jump into leveraged real estate thinking of the myth “real estate never goes down”. That is exactly what happened in early and mid eighties. The small investors got frustrated in stocks during seventies and early eighties as the stock market went no where. They jumped into real estate and pushed it up. Many bought three or four high priced homes and tried to rent them out.

This again repeated during 2000-2005. As small investors got wiped out in the crashing bear market in stocks, they jumped into real estate especially residential ones lured by the escalating prices of their own homes.

In 1988, a federal tax law restricted mortgage interest deductions beyond the home someone lives in. More than two homes were not available for mortgage interest tax deductions. It triggered some kind of an exodus. Also the super performing stock market created a sense of missing the boat in stocks. This resulted in real estate decline between 1988-90.

During 1997 and 1999 the same small investors left the real estate market to join the super charging stock market. They formed stock investment clubs and bought tech stocks at the peak hoping Nasdaq index to go from 5000 to 100,000. Instead the Nasdaq index dropped like a falling apple from a tree to 1000. The same investors now have formed enormous number of real estate investment clubs bidding home prices up.

So what will happen to real estate prices?

Till these small investors get scared and leave the real estate market or get lured by super accelerating stock market, real estate can keep going up. The scare trigger for these small investors can come from Federal Reserve or the Federal Government if they feel that a bubble is forming.

The only way the real estate prices can decline precipitously is a strong – very strong stock market. It can also happen by another tax law overhaul to reduce the budget deficit and to save the social security.

A strong stock market up or down causes a major opposite trend in real estate market.

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