“What happened was that citizens speculated on their homes. … Not only did their houses tend to rise in value about 20 percent faster than the price index, but with their small equity exposure they could gain higher percentage returns than all but the most phenomenally lucky shareholders.”
While George Gilder’s words might read like they were written last week, they were actually lifted from his 1981 classic, Wealth and Poverty. Gilder was describing the real estate market of the late 1970s. His account should temper fears that future interest-rate hikes will cause real estate to weaken.
James Grant said as much in the April 25 Forbes, arguing that interest-rate hikes will lead “to a drop in real estate prices.” Grant’s assertion was somewhat belied by Monday’s National Association of Realtors announcement that existing home sales had climbed to their third-highest pace on record, and it also runs counter to what happened in the late 1970s when real estate prices skyrocketed alongside rising interest rates.
Though the prime-lending rate rose from the single digits in 1976 all the way to 19 percent in 1979, real estate took off. Gilder noted that by 1979, “the value of individually owned dwellings had reached $1.3 trillion dollars, twice the worth of individually owned corporate stock.” He added that half of the newly minted multimillionaires in 1978 achieved their fortunes in real estate.
Grant cites three “brutal property bear markets: 1974-75, 1980 and 1990-92,” but in each case the prime rate was falling during the years mentioned. Internationally, real estate fell in Japan throughout the 1990s despite falling interest rates.
Grant says “an excess of dollars leads to a drop in interest rates,” but it’s often the reverse. An excess of dollars leads to higher rates, while a dearth of dollars leads to lower rates. Often low rates are an indicator of tight money, while rising rates indicate the opposite.
Looked at from the dollar liquidity standpoint that Grant mentions, real estate very often moves with commodities. Gold fell substantially during the three bear markets mentioned above, and more recently the Bloomberg/REIT Index rose a measly 1.2 percent (versus 79.9 percent for the S&P 500) from 1997 to 2000, a time in which gold fell from nearly $400 all the way to $255 an ounce.
Gold has rallied since the second half of 2001, and so has real estate. As Grant notes, the Bloomberg/REIT Index is up 19.1 percent annually over the last five years while the S&P is down 3.2 percent annually over the same timeframe.
Grant argues that it’s time to get out of real estate, and once again points to rising interest rates. But as history shows, rising rates do not always lead to cheaper commodity prices, just as low rates don’t always lead to expensive commodities. See Japan.
While today’s rising-rate environment doesn’t necessarily signal a real estate crash, it also doesn’t necessarily correlate with a booming economy. Adam Smith wrote in The Wealth of Nations, “though a house may yield a revenue to its proprietor, it cannot yield any to the public, nor serve in the function of a capital to it.”
Along the lines of Smith, George Gilder referred to art, gold, and real estate as those “sumps of wealth” which “divert money from productive use.” He lauded the Kennedy tax cuts for the massive investment shift from real estate to business that followed them. Monday’s strong housing news suggests that a shift in the opposite direction continues, and perhaps not surprisingly it began alongside a bull market for commodities, and a bear market for stocks.
While the Fed’s arrest of the 1997-2001 deflation should be applauded, its dollar management since 1997 deserves harsher scrutiny. There is a great deal of evidence that as the dollar jumps around in value, investment is distorted — often moving to stocks when the dollar is rising and to commodities when it’s falling.
Fed adoption of a dollar price rule would do a lot to reduce these distortions, and would allow investors to base investment decisions on real data rather than economic deformities.
–John Tamny is a writer in Washington, D.C. He can be contacted at jtamny@yahoo.com.