Anatomy Of A Real Estate Crash

By: Clif Droke | Thu, May 29, 2003
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The last great financial bubble to blight the American economic landscape that has not yet popped, the real estate bubble, should realize its peak sometime this year and by no later than the first quarter of 2004. It will be my intention to prove this assumption using detailed cycle analysis and other forecasting methods in the article that follows. While Americans have enjoyed a generational speculative mania in the "ultimate" personal asset, namely housing, the doormat will soon be ripped out from under them as the bear continues to work out its vicious assault on everything the public holds dear.

There are at least three major reasons for believing that 2004 will be the first of many bad years to come for real estate and ultimately the "beginning of the end" of imploding the myth that real estate represents the ultimate financial asset. The first is that 2004 is the tenth year of the 10-year financial cycle, and as we've discovered painfully in recent years, major cycle bottoms always come down hard in a bear market. The K-wave itself is due (in theory at least) to bottom sometime in the next year or two, so this will have a strong negative impact on the entire economy, including real estate. And most importantly from a long-term cycle standpoint, the dominant 120-year cycle bottoms around 2014 which means that we are in the "hard down" phase of the cycle (defined as the final 10% of a cycle's duration). With all of these major long-term cycles leaning hard against the financial structure, it's hard to envision real estate escaping the forceful selling pressure (especially considering the enormous load of debt piled up underneath this sector).

In a recent article entitled "The K-wave and the coming credit collapse," I made reference to the likelihood that the final "blow-off" phase of the real estate bubble had begun and that we are currently in wave 5 of a 5-wave Elliott Wave bull market that should be ending within the next 8-10 months. I wrote the broad outline for this opinion in that article; now allow me to fill in the details.

Below is the long-term weekly chart of the Morgan Stanley REIT Index (RMS), discussed in previous articles. The RMS index has traced out four of five waves in a classic Elliott Wave bull market pattern with the fifth and final wave currently underway. Once the fifth wave peaks this will mark the end of the impressive runaway trend in real estate equities. RMS is a leading indicator for the real estate sector and I see this index peaking before the year is through.

Here is my play-by-play time line of how I envision the real estate crash going down:

1. The first signs of trouble will occur in September-October of this year as the dominant interim cycle is falling hard along with equities. There will be a sudden and conspicuous slow-down in new housing starts and overall home sales. The financial press will start calling into question the legitimacy of the real estate boom and will lightly begin asking the question "where have all the buyers gone?"

2. After a scary dip in the autumn season, stock prices (along with real estate) will launch a mild recovery at year's end and accelerate entering the first quarter of 2004. Many will embrace the erroneous belief that we have finally ended the 4-year-old bear market, especially if the 2002-2003 lows have not been violated, and that stocks and real estate are ripe for new buying. This will be the set-up for the ultimate "sucker's rally." Why? Because it is precisely in the first three months of 2004 that the Master Cycle will be peaking. This will set-up the overall decline and major crash to be experienced in the remaining nine months of 2004, especially in the fourth quarter. Real estate will join stocks to the downside as an investor's panic hits Wall Street, followed by steady liquidation.

3. The problem with real estate, though, is that unlike stocks it is much more difficult (and sometimes impossible) to unload in an all-out crash environment. Making matters worse, many mortgage owners will be contend to sit through their losses in the vain hope that "things will turn around sooner or later." This is further strengthened by the fact that low-interest loans have been made in recent years and many will be fearful of selling out of losing their low interest rate.

That brings us to the next point in this dissection of a real estate crash. According to the Wall Street Journal, a mere half-point rise in interest rates would price two million households out of the market for the media-priced home. Many analysts insist that interest rates must spike before the housing market begins to collapse, but is this necessarily so?

In the not-too-distant past, a generational bubble in stock prices was hinged, in part, on low interest rates and credit growth and the experts at that time were proclaiming that a major increase in interest rates would pop the stock market bubble, yet interest rates continued their overall decline even as stock prices peaked and the bear market in equities got underway. The stock bubble ended simply because there was too much supply relative to demand, which is to say that buying power from the general public dried up at some point after being dominant for the better part of the late 1990s.

The real estate bubble is no different, with the widespread public buying responsible for pushing housing prices above and beyond reasonable valuations. The '90s stock market bubble and today's real estate bubble both shared the same pivot from the declining trend in interest rates, as the extremely low interest rate was used in both cases to justify reckless buying on the part of the general public.

Michael Jenkins of Stock Cycles Forecast newsletter has made a very cogent observation concerning the interest rate/real estate bubble:

"The current bubble is in interest rates in the mistaken belief that they are here to stay. If they were, the depression would be so great the Dow Jones would certainly go back to 3,000. By forcing people to buy 10 year or longer bonds and locking in 3.5% to 4.5%, or buying an $800,000 house with a 5% mortgage, this bubble will burst, trapping trillions of dollars in capital at huge losses that will be held to maturity so as not to take a loss..."

In other words, the low interest rate becomes a double-edged sword: just as it helped to attract millions of home buyers in the past few years, so it will pierce those who refuse to sell because they don't want to lose their low-rate mortgage and fear that rates will only increase. This leads to the wise observation someone once made that when it comes to holding a loan in a bear market, "it's the principal of the thing" that really matters (not the rate at which the loan was made).

A reader sent me an e-mail recently that is worth sharing. He writes, "As a CPA, I get to listen to my clients talk about their plans to get rich. In the spring of 2000, I had one guy who owns a manufacturing company tell me he had to get $50,000 together so he could start getting into IPOs, and a massage therapist told me she was going to give some $$ to a friend who was making lots of money in stock options (she didn't even know what they were). It was like the "shoeshine boy" stories from the 20s.

"This past year, all I'm hearing about is real estate! Several clients are starting up companies to buy distressed fixer-uppers to flip and make money. Everyone is talking about rentals (even though Tucson is in the best TENANT'S market in years). I saw a half-page ad in the local paper featuring a seminar about "Real Estate - the True Way to Wealth." It featured many testimonials from people bragging about their skyrocketing net worth, which of course, was reminiscent of the big net worth of the owners of Cisco and Intel. All this tells me, just like your experience in the bank, that real estate is in a topping formation. There are too many apartments and not enough tenants. The P/E ratio for rentals houses is ridiculous. If everyone is buying rental properties, the prices go up, just when the tenants dry up because they have all been put into homes by aggressive banks and down payments donated by phony charities set up by the builders. How do you short real estate?

Not one person has told me they plan to get rich buying gold and silver stocks, or even foreign currencies. I'm happy to be loading up now."

Now how's that for perspective?


Clif Droke

Author: Clif Droke

Clif Droke

Clif Droke is a recognized authority on moving averages and internal momentum. He is the editor of the Momentum Strategies Report newsletter, published since 1997. He has also authored numerous books covering the fields of economics and financial market analysis. His latest book is Mastering Moving Averages. For more information visit

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