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November 18, 2005

Real Estate Dream or Nightmare?
by Sol Palha

I'll do my dreaming with my eyes wide open,
and I'll do my looking back with my eyes closed.
- Tony Arata American Song Writer

Once upon a time not so long ago real estate was a good investment, it was something that would appreciate slowly and it was something that almost everyone who saved had a chance of owning; that is no longer the case. Artificially low interest rates, the heavy promotion of the totally bogus concept that owning a house at any price is an American Dream, the huge amount of money pouring into pumping the false claim that anyone can make a fortune owning real estate, mass stupidity in believing that they should get on board before the train leaves the station etc have all contributed to create a monstrous bubble. We have spoken of this situation in 3 prior essays listed below.

Housing Problems
Housing: Consolidation or Potential Crash
Lumber and Real Estate

Unfortunately real estate is no longer the stuff dreams are made off; instead it is the main ingredient of nightmares. Prices have shot to such levels that most people who go out and buy a house right now with all these creative financing options should seriously consider checking themselves into ward 12. Some of these creative financing programs are extremely risky and carry almost the same risk if not more then playing with options or futures. We have interest only loans (after a certain period has lapsed the individual has to usually make a balloon payment to play catch up), we have teaser introductory interest rate mortgages as low as 1% (some even have the audacity to state that borrowing a million dollars is no longer such a big deal); they forget to mention how things could suddenly change when those rates revert to market rates, the biggest scam of all is that anyone with a pulse can get a loan to buy a house (the lending standards are so atrocious in fact one could say there are no standards anymore) and the list goes on. All these programs have suddenly enabled a huge group of individuals that should have never bought a house in the first place to go out and buy; as is the case with anything when demand suddenly overwhelms supply prices spike. When prices start to spike another phenomenon kicks in mass stupidity; suddenly everyone thinks they have found the Holy Grail to making a quick million. All of a sudden everyone is a real estate expert and now its time to buy the second and maybe third house; with logic out the window and with madness and greed in the driving seat prices can only but go up ( at least in the short term). These actions are eerily similar to those that occurred before the Internet bubble exploded; prior to the explosion everyone and his grandma had become experts in buying net stocks.

Many individuals jumped into real estate because it appeared to be the only way to protect themselves against inflation (since they know little about hard money such as Gold, Silver, etc) that was and is still being created by the Feds; the Feds are 100% responsible for creating this bubble. However the masses have not noticed a few simple facts:

Interest rates have been rising, which means the cost of buying a house has gone up significantly in the last 6 months or so.
The US dollar has been getting stronger, which means that technically speaking the cost of buying a house for foreigners is also going up; a lot of foreigners were buying property in the US because it appeared to be cheap when compared to prices in countries with stronger currencies.

We are running one the biggest budget deficits in history, more and more high-end jobs are being lost and are replaced with lower paying jobs, consumers are loaded to their gills with debt etc. To make matters worse a lot of individuals are taking out home equity loans and spending these real estate gains without a thought as to what they will do should this market crash. In addition many are using these new found gains to maintain old lifestyle habits that can no longer be supported with their current incomes. Add in all the factors above and buying a house right now is the one of the most insane things an individual can do. This is especially true for those who have a hard time coming up with the down payment and for those that do not have at least 10 months of mortgage payments tucked away for a rainy day.

The current situation in housing has all the ingredients to suggest that a top has already been put in and a nice long fall awaits this sector for the next 2-3 years. Housing prices have been dropping for several months ( real estate prices have been falling for approx 1 year in Britain and Australia and the markets in Beijing pulled back last month), inventories are building up and its taking a lot longer to sell higher end real estate; these are all subtle signs that a top is in the works.

If we take a look at the housing index, we can get an idea of what's going on right now.(We spoke of this in our last essay Housing Problems).

As you clearly see, the long-term up trend in the one-chart has been broken and this does not bode well for the housing sector.

It looks like it is going to test the 525 zone again then carry on correcting.

This is a more telling picture.

The long-term up trend line in the 3-year chart has been violated. It looks like we could eventually trade all the way down to 200-250 ranges in the next 2-3 years.

Toll Brothers has been smashed. In less then 5 months it has lost over 36% from its high in June to its low in November. This is precursor of things to come for the rest of the housing stocks. Once the stocks in the housing index sector start to break down like TOL brothers,it's not so hard to envision this Index testing the 200-250 ranges.

Conclusion

Mass psychology clearly indicated that it was time to bail out of this sector many months ago; signs were appearing all over the place stating how easy it was to become a realtor, seminars pumping the million dollar dream concept and everyone in the neighbourhood turning into a real estate expert overnight were all indications that it was time to flee. In terms of fundamentals everything stopped making sense a long time ago and in terms of TA the long term up trend in both the 1 and 3 year charts have been violated. So basically all three areas are clearly stating that real estate is a rather dangerous investment and we think it would be wise to listen to them. While the Crowd was busy admiring the Emperors new clothes it took a child to point out that he was actually naked; the same applies here most of the adults are asleep on the wheel and only those with clear minds will be in a position to spot the cliff that is just around the corner. Is real estate a dream no the dream has ended and the nightmare has just begun.

Initially I wanted to be Muhammad Ali. But then I got into a fight and I got my butt kicked, so I figured I could choose something else. - Babyface 1959-, American Musician, Producer, Songwriter

Sol Palha
TacticalInvestor.com

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at www.tacticalinvestor.com.

The information contained herein is deemed reliable but no guarantee is made about its completeness or accuracy. The reader accepts this information on the condition that errors or omissions shall not be made the basis for any claim, demand or cause for action. Any statements non-factual in nature constitute only current opinions, which are subject to change. The author/publisher may or may not have a position in the securities and/or options relating thereto, & may make purchases and/or sales of these securities relating thereto from time to time in the open market or otherwise. Neither the information, nor opinions expressed, shall be construed as a solicitation to buy or sell any stock, futures or options contract mentioned herein. The author/publisher of this letter is not a qualified financial advisor & is not acting as such in this publication. Investors are urged to obtain the advice of a qualified financial & investment advisor before entering any financial transaction.