The Dynamics of a Housing Bubble

The 2008 financial crisis was spawned by an entire universe of shaky investments that involved the packaging of mortgages into securities. It turned out that many of these mortgages had virtually no chance of ever being repaid. When higher interest rates kicked in on these bad loans, the borrowers ended up defaulting en masse.

Much of this was related to an overarching characteristic of the pre-crash economy: there was a massive housing bubble. A housing bubble occurs when average home prices reach a level that is far higher than historic norms, based on things like the Consumer Price Index (CPI). In the case of the 2008 crash, the homes had reached all-time historic highs, with the average home across many communities being completely unaffordable to the average worker. Because so few people could afford these homes, many of the less solvent of them turned to the loose lending practices of companies like Countrywide. These were the mortgages that would go on to be repackaged into so-called collateralized debt obligations or CDOs. And it was these CDOs and the derivatives relating to them that nearly destroyed the entire Western economy.

Are we in a housing bubble today?

Over the last few years, the term housing bubble has been creeping back into the mainstream discourse. And to be sure, there are a few indicators that are pointing in the direction of a housing bubble forming today, especially in specific areas of the country.

What has caused today’s housing bubble?

Unfortunately, the conditions that caused the last housing bubble and subsequent financial disaster were never adequately addressed. One of the ways that the country was able to pull out of the recession that followed the 2008 market crash was a program known as quantitative easing and the Zero Interest Rate Policy (ZIRP). Combined, these two policies were enacted by the Federal Reserve to flood the markets with cash that would get the economy moving again.

However, all of that cash, easy credit and low-interest rates have conspired to run up housing prices to new all-time highs. Throughout much of the country, housing is once again completely unaffordable for the average worker. In Los Angeles, for example, the median wage earner would have to work nearly 120 hours per week just to afford the median home! And these sky-high prices are also driving up rents. Eventually, the fact that few people can afford the most basic apartment in major cities will force housing prices back to Earth, possibly sending them crashing.

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Neighborhood Factors To Consider When Buying A House

There are a lot of factors to consider when buying a new home. Of course, you’ll want to consider things like the number of bedrooms and the size of the yard, but it’s important to keep in mind that you will not spend 100% of your time on your own property. The area around your potential home is just as important as the area within it.

Vet possible properties by canvassing the potential neighborhood and surrounding areas. Specifically, you should check these six items or statistics prior to purchasing your next home.

School Districts
If you have or plan to have children, you will want to find out about the local school district. What school will your children attend? What are the average student test scores in the area? Are there extracurricular or athletic activities available for your child? How involved are parents expected to be in the school? These are all things you may want to consider before buying a home in the district.

Crime Rates
You probably don’t want to move to a neighborhood that is unsafe. Luckily, it is easy to look up crime rates for any town you’re interested in. You can also gauge the relative safety of a location by observing the number of people on the streets, especially after dark. If you see a lot of children and families playing or people taking walks at night, it’s probably a safe area.

If you have children or enjoy walking to local food and entertainment, you’ll definitely want to consider the walkability of your new neighborhood. Of course, this includes things like safety and proximity, but you’ll also want to take into account the cleanliness of the streets, traffic,  and maintenance levels of your intended routes.

Distance to amenities
Prior to moving, decide how far you’re willing to drive or walk for everyday things. Consider the distance to the local grocery store, your doctor, and any other places you’re likely to visit on a regular basis. Set a limit for your travel time and search for a neighborhood within an acceptable radius of these places.

Your drive to work is an important aspect of your new location given that you will need to do it nearly every day. Assess the distance to your place of employment, but also research the traffic and commuting patterns in your new area. Does the drive home take significantly longer than the drive to work? What kind of gas mileage can you expect to get? Is easily-accessible public transportation an option?

Internet/Cable Service
Finally, take some time to consider the connectivity of any potential location. Services like internet and cable can vary from town to town, so it’s important to make sure that you’ll have access to the level you require on a daily basis. Research local provider coverage areas and rates prior to choosing your new home.

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It has recently been estimated that among high-net-worth individuals, approximately 33 percent of their portfolios are currently made up of real estate holdings. Among those, a large percentage is made up of private real estate equity, typically including properties that the individuals are involved in managing on a daily basis, even if they have hired a professional management company to do the dirty work.

However, there is still a high demand for hands-off real estate equity investments. Many investors with large amounts of capital looking to diversify into significant real estate holdings are having trouble because there has previously been no middle ground between outright private ownership and the completely passive investing experience offered by real estate investment trusts, also known as REITs.

Many people simply don’t have the time, skillset or the inclination to jump headlong into managing commercial properties, even if the majority of tasks can be effectively delegated. That has left those with significant investment capital who would like to diversify into real estate grappling with the many shortfalls of REITs, at least until now.

Private real estate equity firms are gaining in popularity, and these firms have some huge advantages over REITs. The types of properties that typically make up a private equity real estate portfolio are office buildings, industrial properties, retail shops and multifamily apartment buildings. There are also specialized investments such as elderly and college dormitory housing, hotels, self-storage units and medical buildings, to name a few.

One of the reasons that people are drawn to this type of investing is that private real estate equity companies don’t suffer from the immense pressures that REITs are under to produce dividends. This means that they are under no obligation to quickly acquire properties when they are cash-rich but property-poor. A private real estate equity firm can sit on a pile of cash for as long as it chooses to do so. And this means that the well-run variants of this company structure never have to make questionable purchases in overbought markets. It also means that they can hoard cash, optimally positioning themselves to pounce when genuine market opportunities arise.

Additionally, REITs have become notorious for consuming large amounts of the funds’ capital through fees and costs. This has caused a steep decline in the amount of money being invested in the REIT market. Private real estate equity firms, on the other hand, can often maintain high levels of both vertical and horizontal integration, keeping all management, maintenance and construction functions in-house. This can dramatically reduce the costs associated with middlemen and outsourcing.

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The Problem With Intangible Investments

A new book called “Capitalism Without Capital” deals with a new form of capital allocation, intangible investments. Recently, the book was broken down by HuffPost Contributor Glenn C. Altschuler. Here’s what he had to say!

While intangible investments were once a primarily positive force in the economy, driving such innovations as the internet and jet airline travel, as the government has stepped back from its role in funding primary research and development, intangible investments have become an economic spoiler to some extent.

Intangible investments in the age of unlimited communications

At their core, intangible investments can be described as any form of produced knowledge or training that has a clear associated cost and that cannot be included in the realm of formal intellectual property. Examples of intangible investments include things like training company employees in a new manufacturing technique or developing a new product that is innovative but too broadly defined to be patentable.

The four major characteristics of intangible investments are scalability, a tendency towards the imposition of sunken costs, spillover effects, and creation of synergies. The problem arises when extremely expensive processes need to be funded to effectively innovate, but there are few or no borders designed to keep those investments from being pillaged by competitors.

This phenomenon, known as spillover effect, can be demonstrated by examining the development of the CT Scan. While some of the core technology required for the first CT scanners to function was patentable, the concept of a machine that used software to greatly enhance radiographic images was entirely too nebulous for the same.

As a result, the original company funding the development of the CT scan ended up being a minor player, receiving only small licensing fees on narrow proprietary technologies, in a multi-billion-dollar industry. Tech giants like General Electric and Siemens already possessed the necessary space and scalability to become the dominant players in the field and, because it’s near impossible to patent an intangible idea, they were able to circumvent any legal repercussions simply by “inventing around” an idea.

The above example also illustrates the problems that scalability and synergies create for any firm that is not a veritable industrial powerhouse. Siemens and General Electric had the capital on hand to immediately scale up to a size where both costs were significantly lowered and the barrier to entry into the business was made virtually insurmountable. At the same time, they were able to use their prior expertise to quickly outstrip the capabilities of the original CT scanners.

Authors Jonathan Haskel and Stian Westlake close by calling for change. They posit that intangible ideas and their investment environment can only be secured if we “encourage trust and strong institutions, expand opportunity, reduce inequality and social conflict, and check powerful corporations.”

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