Surviving A Global Depression – Real Estate: From Collapse To Black Hole
Although it may seem unthinkable in an age when millions of American houses are in foreclosure, there is little doubt that the global depression could turn the current property collapse into a real estate black hole.
In the past couple of decades the valuations of real property in most developed countries had increased well above the reach of the average worker. The unreasonable and unprecedented spike in property prices had created a new caste system. Those who already owned property could live lavishly just by remortgaging their ever-increasing asset, while many others were destined to rent for eternity, as the prospect of ever coming up with a down payment or qualifying for a sustainable and realistic mortgage payment was nothing but a vague dream. Then came the subprime crash and the huge balloon deflated with a sickening rapidity. Soon, millions of houses in the United States were valued at an amount which might have constituted a reasonable down payment for the same property a couple of years earlier.
The prices of property almost everywhere has massively deflated, but even in this collapsing worldwide market, there are still absolutely staggering differences in pricing for essentially the same house, simply based on geography. Let’s consider two houses, both listed for sale in January, 2009. Both have four bedrooms, cover about 2,000 square feet (186 square meters) on a reasonable-sized lot, and were built in the 20th century. They are both in pleasant, calm, neighborhoods in English-speaking, stable, peaceful countries. They contain similar fixtures and appliances. They are almost identical in every way. The difference is that one is on Bellevue in Chicago and the other is in Swift Current, Saskatchewan, Canada. Both these locations experience a very similar climate.
The real difference is in the price. The first house is on the market at $2,749,000. The latter is also for sale, but for $131,900. How one house can cost 21 times more than the other is not just an illustration of the tired old real estate agent’s chestnut “location, location, location,” but a sign of what the value of a house really is. The cost of the building materials, labor, etc. that went into the Saskatchewan house isn’t too different from the Chicago house. The former is fully detached and the latter is a townhouse but that doesn’t affect the cost to any great degree. The difference in the valuation is that Chicago's Near North Side is believed to be a more desirable place to live than Swift Current. Now, I’ve been to both places, and I can assure you that as long as you don’t go to Swift Current in January, it is a wonderful town. Personally, I’d pick it over Chicago. But while you can jump in your car and be at the Sears Tower in about half an hour from the house on Bellevue, traffic permitting, the only place you can be in half an hour from Swift Current is the middle of nowhere.
But what if the middle of nowhere became more attractive than downtown Chicago? What if the charms of a magnificent metropolis such as Chicago suddenly turned into nightmares? What if people shunned places such as Wrigley Field, Millennium Park, Shedd Aquarium or the Field Museum for their teeming masses of desperate, homeless, starving throngs, preferring to be isolated and safe? Then the house in Swift Current might be worth more than the one in Chicago.
You can take this relative economy one step further. I found a not-luxurious but perfectly serviceable two-bedroom house on a large lot not far from Swift Current selling for $10,900. That would barely buy you the area of a few floor tiles in the Chicago house and is less than its typical mortgage payment for a single month. And if you can’t handle chilly winters, you may find similar values in small out-of-the-way towns in western Australia or the U.S. southwest that might be better suited to you.
The lesson is to not be hypnotized by high property values. Property values are illusory at best. They are part hype, part expectation, and part delusion. You charge what the market will bear because everyone else around you is. The house itself is really only worth the cost of the materials and labor that turned the previously empty lot into a residence. The justification for asking those prices can swiftly dissipate and the entire pattern of real estate valuation can be tipped upside down to a point where the cost of the materials of the house itself is higher than the selling price!