Speculation or Investment?

Ask yourself this question:

Do you want to be rich?

I’ve got the brains,

you’ve got the looks

Let’s make lots of money

You’ve got the brawn,

I’ve got the brains

Let’s make lots of money

You can tell I’m educated,

I studied at the Sorbonne

Doctorate in mathematics,

I could have been a don

Oh, there’s a lot of opportunities

If you know when to take them, you know?

There’s a lot of opportunities

If there aren’t, you can make them

Make or break them

Opportunities — Pet Shop Boys



Speculation or Investment?

Real estate is viewed by many people as a good investment. Realtors often use this idea as part of their sales pitch. As was described in detail in the post What is a Bubble?, this view is fallacious and it is one of the beliefs responsible for creating an asset price bubble. To understand why houses are not a good investment, one needs to understand the difference between investment and speculation.

An investment is an asset purchased to obtain a predictable and consistent cashflow. This would include things such as bonds and rental properties or even cash in a savings account. The value of the asset is based on the cashflow, and this value can be determined in a number of ways. For a “point in time” analysis simple division will yield the rate of return (return = income / investment.) Risk is evaluated by comparing the rate of return of the investment to the safe return one can obtain in a savings account or government bonds. For more complex financial structures the value can be determined by a process known as discounted cashflow analysis. The sales price at the time of disposition is often not a major factor in the investment decision, particularly if the eventual disposition is many years in the future. In fact, true investments need never be sold to be profitable. As Warren Buffet noted “I buy on the assumption that they could close the market the next day and not reopen it for five years.” In contrast to investment, speculation is the purchase of an asset to sell at a later date at a higher price (Actually, you can also speculate by selling first and buying later in a process known as “selling short.”) Speculative assets are not valued based on cashflow but instead are valued based on the perceived probability of selling later for a profit. Houses can be purchased as an investment at the right price, but most often when people purchase a property they are engaging in speculation based on the belief they will be able to sell the house for a profit at a later date.

A study by Robert Shiller has shown that historically houses have appreciated at 0.7% over the general rate of inflation since 1890. Over the long term house values are tied to incomes because people buy houses with mortgages for which they must qualify based on their income. Inflation keeps pace with wage growth because people will bid up the prices of all goods and services with their available income. Therefore, long term house prices, wages and inflation all move in tandem. There are short term fluctuations in this relationship due to variations in financing terms and irrational exuberance, but any such deviations from the mean will be corrected over time by market forces. As an investment, houses serve as a hedge against the corrosive effect of inflation, but over the long term appreciation in excess of the general rate of inflation is not possible. In this regard, houses are little better than savings accounts as an asset class, and they are inferior to stocks or bonds in the long term.

Leverage and Debt

As a speculative investment, residential real estate has the potential to make or lose vast sums of money due to the impact of financial leverage (debt.) Houses are typically leveraged at 80% of their value. During the Great Housing Bubble, this leverage was often provided at 100% by various lenders. Leverage is a powerful ally when prices increase, but leverage works just as strongly against the speculator when prices decrease. For example, if a house is leveraged 80% and it increases in value 5% in one year, the return to the investor is actually 25% due to the 5 times multiplier created by leverage. With the effect of leverage, returns generated by speculation on housing can far exceed any competing investment strategy. However, the inverse is also true. If a house is leveraged 80% and it decreases in value 5% in one year, the loss to the investor is 25% of their downpayment not just the 5% the house declined in value. Leverage magnifies both the return and the risk of any speculative venture.

One of the worst mistakes lenders made during the Great Housing Bubble was to allow 100% financing and negative amortization loans. This was a boon for speculators because it allowed them to participate in the market without any of their own capital, and it allowed them to hold the speculative assets with a minimal debt service expense. Plus, there was the implicit idea that they would simply default if the deal did not go in their favor (which of course many did.) Combine these facts with the near elimination of loan underwriting standards allowing anyone to participate, and the conditions are perfect for rampant speculation and a wild increase in prices.

Why Speculators Fail

Despite the huge price spike in the final two years of the bubble caused by wild speculation, most speculators will lose a great deal of money. The causes are rooted in basic human emotions that work against making the proper decisions to profit in a speculative market. The moment a speculative asset is purchased and the speculator has taken a position in the market, emotions are immediately in play. If the potential resale price in the market is rising, the natural reaction is to want more. Greed takes over and the asset is strongly coveted by the speculator. If possible, the speculator will go out and purchase more of the asset in question. This was common in the bubble when people would take the equity from one property and purchase even more residential real estate. The problem with this natural emotional reaction is that it prevents the speculator from selling the asset and taking profits when they are available. People who make a living participating in speculative markets have learned to override this natural instinct and sell when their emotions are telling them to buy more. The average residential real estate speculator does not have this discipline or awareness. They will hold the asset through the good times.


When prices begin to fall in a speculative market, most speculators immediately lapse into denial. They were so emotionally rewarded by purchasing and holding the asset, they see no reason to believe the first signs of a declining market are anything other than a temporary aberration. As prices continue to fall, the emotions change: fear begins to creep in, and the battle between denial and fear goes on well past the breakeven point where the speculator could have closed the position without losing any money. As prices fall further, the fear begins to take an emotional toll and the speculator starts to feel pain. The further prices drop, the more pain is inflicted on the speculator. What is the natural reaction to pain? Push it away. As a speculative investment becomes painful, the natural reaction is to want to get rid of it. This prompts the speculator to sell the asset – only after they have lost money. A speculator’s emotions always work against them. When the asset is rising in price they want more of it, and when it is falling in price they want less. This is a natural reaction, and it is the cause of all losses in speculative markets. This is why most speculators fail.

Two Kinds of Real Estate Investors

There are two types of true real estate investors: Rent Savers and Cashflow Investors. These two groups will enter a real estate market without regard to future appreciation because either the cash savings or the positive cashflow warrant the purchase price of the asset. These people are largely immune to the emotional pratfalls of speculators because the value to the investment to them is not dependent upon a profit to be garnered when the asset is sold. They will hold the asset through any price declines because they are not feeling any pain when prices drop. Since these investors will purchase houses even if prices are declining, they are the ones who move in to create a bottom and end the cycle of declining prices.

In a declining market, a market where by definition there is more must-sell inventory than there are buyers to absorb it, it takes an influx of new buyers to restore balance. Since it is foolish to buy with the expectation of appreciation in a declining market, the buyers who were frantically bidding up the values of properties in the rally are notably absent from the market. With the exception of the occasional knife-catcher, these potential buyers simply do not buy. This absence of buyers perpetuates the decline once it starts. Add to that the inevitable foreclosures in a price decline, and the result is unending downward spiral. It takes Rent Savers and Cashflow Investors to enter the market to provide support, break the cycle and create a bottom.

Rent Savers are buyers who enter the market when it is less expensive to own than to rent. It doesn’t matter to these people what houses trade for in the market in the future. They are not buying with fantasies of appreciation. They just know they are saving money over renting, and that is good enough for them. Cashflow Investors have a different agenda; they want to turn a monthly profit from ownership. For them, the cost of ownership must be less than prevailing rent for them to make a return on their equity investment. Cashflow Investors form a durable bottom. If prices drop low enough for this group to get into the market, the influx of investment capital can be extraordinary.

Buyer Support Levels

When do Rent Savers and Cashflow Investors move in to a market and create a bottom? In the post Rent Versus Own there is a detailed analysis of the true cost of ownership. When comparative rents come into alignment with the total cost of ownership, Rent Savers enter the market and begin purchasing real estate. It makes sense for them to do so because ownership becomes a savings over renting (hence the term Rent Saver.) The “return” on the investment is the hedge against inflation the Rent Saver obtains by locking in the cost of housing with a 30-year, fixed-rate, fully-amortized mortgage. As rents in the area continue to increase, these costs are not borne by the Rent Saver. Utilizing the gross rent multiplier concept from that post, the Rent Savers will enter the market when the GRM falls to 160. There will be knife catchers who enter at higher prices, but there will not be enough of them to stabilize the market. It takes a decline in prices to where it is less expensive to own than to rent before enough new buyers enter the market to create a bottom. However, there are some properties that Rent Savers do not want because they really don’t want to live in them. This includes transitory housing like apartments or small apartment-like condominiums. Prices on these properties will generally drop below the 160 GRM breakeven for owner occupants until they reach price levels where Cashflow Investors will purchase them as rental properties. Since these investors do not want to merely break even, the price must be low enough for the rental rate to exceed the cost of ownership by enough to provide a return on the investor’s capital. Historically, GRMs from 100-120 are required to create the conditions necessary to attract Cashflow Investor’s capital.


When it comes time to consider purchasing a house, it is important to know if the motivation is one of an investor or one of a speculator. Investment in real estate requires an accurate assessment of the revenue (or savings) and the costs associated with the property. If the cashflow from the property warrants the purchase of the investment — without regard to future asset value — then it is a true investment, and the risks of ownership are much reduced. If the property’s asset resale value were to decline, the investment value would still be there, and the investor would feel no pain and no pressure to sell. In contrast, speculation is a loser’s game, and if the motivation is to capture a windfall from future appreciation, there is a good chance it may not work out as planned because the emotions of a speculator will cause a sale at the worst possible time. A few can put their emotions aside and properly evaluate the market and trade the asset, but most who profit from speculation simply sold at the right time due to life’s circumstances. In short, they were lucky. The people who bought late in the rally and are now holding on to the asset while they drift further and further underwater: they are not so lucky…

52 thoughts on “Speculation or Investment?

  1. zaleriana

    So, IR, what about a non-dividend paying stock held by a retail investor? Is it not an “investment” because it has to be sold to be profitable? Buffett’s approach isn’t really applicable to most of us, as we don’t have the capital to purchase entire companies.

  2. Law_Student

    Real estate is both investment and speculation for those of us you call “cash flow investors”.

    As opposed to most stocks (but similar to those who pay a dividend), with real estate we are getting a return on our investment while renting out property. The tax benefits are also better with real estate than stocks.

    We are also speculating on the price of homes, which have historically increased.

    Those of us who are capable of riding out the lows while buying and selling the right kinds of homes over a 10 year cycle make a lot of money. It is actually difficult to lose money in real estate if you have the financial strength to hold on to your property for a reasonable period of time. Of course it is possible that this will change, though highly unlikely.

    Those who wildly speculate over a short period of time are on average going to lose in real estate, just as those who day-trade stocks usually lose in the stock market.

    Your “rent saver investor” is not an investor at all. He is an ordinary homeowner who is smart enough to buy rather than rent. In the long run of history, it would not matter if he bought at the absolute peak of any real estate bubble. He would still be better off than the renters ten years later. Once again, some people will say that “this time is different”. I think we have all heard that one before.

    Whether we are talking about real estate bubbles or renting versus buying, history repeats itself and those who buy and hold real estate are better off financially in the long run. There may be a few “exceptions to the rule” who post on this board, but the rule stands the test of time.

  3. mav


    IMHO, this is in your top 5 post, excellent…..

    the only thing I could see adding is something on location

  4. Chris

    Fantastic post. Clear and concise. Well thought out. Great!

    I do think that many rent savers will assign some value to the intangible benefits of ownership, but I don’t think it impacts your analysis meaningfully.

    > So, IR, what about a non-dividend paying stock held by a retail investor?


    B-H itself doesn’t pay a dividend, but that does not mean you cannot analyze it as a cash-flow investment. Buffet himself assesses B-H (and each of its internal businesses) performance based on its incremental return on investment capital. Each year B-H produces earnings. The earnings need to be sufficient to cover the cost of B-H’s capital, plus a premium to reward investors.

    As long as the earnings are much greater than the cost of capital, and the earnings can be re-invested at a high rate of return, the stock appreciates based on its fundamentals. That is, it appreciates not because people think they can sell it for more in the future, but because they are buying the net present value of the earnings.

    Buffet has long stated that B-H will begin paying a dividend when it can no longer invest its earnings at a high rate of return. As the earnings have grown larger, finding high return uses for them has become a more difficult task. But as long as B-H can continue to get a high rate of return on its earnings, it makes sense for investors to forgo a dividend. The lack of a dividend doesn’t mean that the business is not producing free cash flow, nor does it mean you cannot do a discounted cashflow analysis on it, it just means that buffet is investing the cashflow instead of the individual investors (which up until now has been a pretty good deal for the investors, though that could change in the future).

  5. George8

    Excellent analysis on economic and financial basis. I believe some discussion on the emotional impact of owning a home may be warranted. After all, an owned home does create many emotional satisfactions beyond just financial consideration.

  6. Kelja

    Great informative & concise post. It should be required reading for any would-be real estate buyer.

    I rent a house in Carlsbad where the homes typically go for $650,000 to $800,000. My rent is $1800 per month – better than the typical rent around here which is around $2400. A GRM of 120 would have the homes around here selling for less than $300K (I’m using the average rent for the calculation.

    Possible? Certainly something to think about. What I do know is that if I were to buy right now, it’d be financial suicide.

  7. surfing in newport

    You can still be a “investor” with these types of stocks. However, you need to make a couple of assumptions.

    1) That the company can invest the cash it generates internally with a higher rate of return than the rest of the market.
    2) That management will only invest when #1 is true.

    In essence, you are trusting management of the company to invest your money (the profits it makes) for you.

    Under the above assumptions, the PE ratio is still a good guide. Cash Flow (with care taken with respect lumpiness of investments) is a better guide, but harder to determine.

  8. Bob


    Excellent post. One question that people continue to ask is what causes the rapid uptick in price caused by speculation to end? The 60 minutes piece last night didn’t mention what caused prices to stop rising, just that they did. I don’t see the cause / trigger mentioned in your article.

    I would assume one logical answer is there are no more speculators left to continue to bid up prices — but if money was so free during the boom, what caused these speculators to reach their end in purchase capacity? Or was the fed’s simple raising of rates enough to quash the 1% teaser rates that were key to funding the purchases near the top of the bubble enough to simply stop appreciation and let the bubble pop?

    I’m not disagreeing with your post / analysis of cycles — just want to get some views on what is the trigger that causes the bubble to pop? You do an excellent job of saying what will be the trigger to cause the downward cycle to pop but what is the converse.

    ps — you got me yesterday with your post to catch trolls — didn’t pick up your sarcasm– and yes I guess I was too polite in a post back thinking you were serious! Next time I’ll take the gloves off so to speak!

  9. profette

    Thank you for that thoughtful and well-written post. If there were such astute analyses in the MSM, we would have a better educated populace.

  10. IrvineRenter

    “I would assume one logical answer is there are no more speculators left to continue to bid up prices — but if money was so free during the boom, what caused these speculators to reach their end in purchase capacity?”

    Even with as loose as credit became, there is an ultimate limit reached when everyone is tapped out, and there are no more buyers to enter a market and push prices higher. The top of a bubble is like an airplane engine stalling in a steep climb, there is no immediate danger, but it will go down, and it will not end well.

  11. zaleriana

    I understand all of that. I was asking based on these two statements of IR ‘s:

    An investment is an asset purchased to obtain a predictable and consistent cashflow.


    In fact, true investments need never be sold to be profitable.

    There is NO WAY that both of those statements can be true and non-dividend paying stocks (i.e., most (not all, duh!) of NASDAQ) can be “true investments”.

  12. No_Such_Reality

    “I do think that many rent savers will assign some value to the intangible “

    And like last down cycle, most of the rent savers and many of the home owners will assign a negative value to those intangibles as they again recognize the risk, illiquidity, costs and hassles of owning are on par with renting.

    An abusive HOA, crappy neighbors, foreclosure brown lawns, leaking roof, inability to move with a job change, taxes, mello-roos are just the start. When the house isn’t an ATM, people will realize just how expensive it is to do the upkeep of everything in the house.

  13. zaleriana

    Sure, sure. But the key sentence in the post is In fact, true investments need never be sold to be profitable. So, to the retail investor in B-H (i.e, not Warren or Charlie), B-H is not a “true investment”, but is rather speculation.

  14. Chris

    I agree that the definition might benefit from more nuance, but it can actually still be true. The non-dividend paying stock can simply start paying a dividend at some point in the future, potentially after earnings have increased greatly, and the dividend is very large compared with the original investment.

    Since in the long term, the real value of any investment is based on cash actually paid to the owners, all purchasers of non-dividend paying stocks are betting that the stock will eventually pay a solid dividend relative to the purchase price (though maybe not in the near future, and maybe not even while they own the stock).

  15. surfing in newport

    It’s still a cash flow, just as if you had a mutual fund that invested in only divided paying companies. Just because they don’t send you a check, doesn’t mean that you don’t have a positive cash flow. Otherwise, we would all have zero cash flow (on average) because no one keeps a lot of cash around.

    The key difference is that when you invest in a company that does not pay dividends, you are trusting the investment discipline of the managers. I was a little obtuse in the sarcasm with respect to assumption #2. Managers have an incentive to keep the money and not pay dividends, because that makes the company larger and the chance for them to have larger paydays in the future more likely. Warren Buffet can get around that by buying enough of a company to get more direct oversight.

  16. tonye

    I think Amway is getting into the RE business.

    That should bring prices back up.

    May I show you my catalog?

  17. zaleriana

    Yes, and a house is a cashflow, too. A negative cashflow, but still a cashflow.

    “Obtain a cashflow” shouldn’t be dfined to include “obtain a indirect cashflow which doesn’t actually produce a cashflow to me, the holder of the ‘asset’ obtained”, especially when tied to an assumption that the asset need not be sold. Riddle me how those two statements work together.

  18. IrvineRenter

    Realistically, 98% of stock market investing is speculation. If you analyzed earnings and put a cap rate to it, most stocks on a pure cashflow basis rarely earn more than 4%-6%. The last time the stock market was at parity with its cash value was 1974. Most players in the stock market are betting on earnings growth and playing a risky game of speculation (me included.) That is why stock markets are prone to violent corrections. The fundamental valuation of most stocks on a cashflow basis is so far below its trading price that even the violent corrections do not generally push prices down to their cashflow value.

    Stocks, unlike real estate, spend almost all of their time well above cashflow value. Investors (speculators) began using historic P/E ratios to find low-risk entry points for various stocks to compensate for the rarity of stock prices falling to their cash value. Is this investment or speculation? It depends; mostly it is speculation.

  19. Alan

    My comment is that it is one thing to read about not acting on emotion. It is another thing entirely not to act on emotion. I’ve read similar analysis for over 20 years and I still haven’t been able to put the “non-emotional” thing completely into practice. People have great capacities to rationalize and even when you think you are leaving your emotions out, you can still rationalize a position in congrugence with your emotional state, giving youreself a false sense that you are acting rationally when you are not. And homes are the most emotional investments we make.

    The only way out is to follow the simple rule… Before buying ask yourself.. do I really want to live here? then if the answer is yes ask yourself.. can I really afford to live here?

    If people had only bought the house they could afford where they wanted to live, our country would not be in this mess today.

  20. ice weasel

    Well done IR. Despite a few nits here and there, your post is clear and concise dissection of how two common terms have been conflated in real estate.


  21. mark

    “The people who bought late in the rally and are now holding on to the asset while they drift further and further underwater: they are not so lucky…”

    I’m glad to see the rhetoric has toned down a bit. This blog has always been so well written with reason and analysis free of all the “grave and dire predictions” you can easily get elsewhere. People who bought late (a home they could afford and want to live in for 7+ years), have simlpy made an unfortunate financial decision leaving much less room for error with other financial decisions.

  22. mark

    Is this another “Alan” than the one from a month or two ago? I agree with everything this Alan is saying. Back then, not so much. Weird.

  23. irvinesinglemom

    And just to clarify, I definitely wasn’t looking to catch trolls. I was looking to trip up people who “get it” and who are just comparatively new to the bubble-blogging world. Like I said, was feeling uncharacteristically snarky yesterday. I was catching up on old Forums posts and awgee and eff must’ve gotten to me. 🙂

  24. IrvineRenter

    Last year, there were so many bulls in denial, some of the rhetoric was necessary to make a point. Now that it is becoming widely accepted that we have witnessed a bubble, and things are going to get worse, it doesn’t serve anyone to be over the top with the commentary.

    This does serve to underscore the main point I was trying to make in Houses Should not be a Commodity.


    People either make huge gains or huge losses depending more upon life’s circumstances and pure luck than anything else. Everyone likes the good times, but it is really a shame for those who have to endure the bad times. A stable real estate market without the highs and lows is far more beneficial to everyone.

  25. no_vaseline

    A median OC home last year was somewhere around $675K.

    On a 30 year fixed, you’re out somewhere in the neighborhoood of $5000 a month once you figure it all out.

    Is there a derth of pepole who bought late (a home they could afford and want to live in for 7+ years)? If the articles I read in the OCR are any indication, that answer is no.

    I was discussing markets with my dad and my brother this weekend. My dad and brother farm for a living, so they understand markets better than a lot of people. The discussion came to markets and fundamentals – you can have the fundamentals dead center perfect, and the market may not agree with you at that moment. At the end of the day, fundamentals are fundamentals for a reason and you can’t fight them.

    But you can run bad for a long time in the face of them. For me, that has been from 2002 till 2006. Before, it was 1998 and I sold my whole stock portfolio (roughly 20 months too early).

    When the GRM gets to 180 I’m dropping the hammer. I know I’m going to be a knife catcher. At 180 times rent, I don’t care. Since 2004, the GRM in every neighborhood I lived in was never below 400!

  26. PurpleHaze


    What have the historical GRMs been from 1985 to 2007? Is there a graph you might have posted that you could refer me to?

    Thank you.


  27. tonye

    Non dividend paying stocks are usually tied to growth companies.

    True, by IRs definition this would be speculation, however, the growth of a company can be measured and it is an active process. Growth companies create and control their own growth via their management. Dividends are paid indirectly to manage the growth of the company.

    Residential RE or other speculative “objects” ( futures, precious metals, etc…) are purely passive. Value growth is driven by outside forces.

    So, I guess you could say that growth companies are more of an investment than a speculation.

  28. Tesh

    Both “investing” and “speculation” are looking for money for nothing. (Or, in marketspeak, for their “money to work for them”.) Instead of working for a living, investors and speculators expect others to do the work for them, whether it’s a greater fool, a renter/flunkie, or a CFO with a plan for growth and an agreement to kick some of it back.

    For some reason, we as humans are obsessed with the idea that money can just come our way if we’re smart enough or lucky enough. Mock the “Puritan” work ethic of an honest day’s work for an honest day’s pay, but at least they produced something. Our “service economy” built on speculative “investment” schemes does not have the fundamentals to keep the music going forever.

  29. Kirk

    The value of a non-dividend paying stock is pretty abstract and I thought Surfing in Newport explained it very well from a cashflow perspective. I would explain it from an ownership perspective (linked back to cashflow). If you take over the company by buying all the shares you can simply divert all the cashflow to yourself. Or close it up and sell off all assets and keep the proceeds for yourself. How much profit do you require? This determines what you are willing to pay for the company. Take that and divide by all the outstanding shares and you have a price for the stock.

    Of course, it doesn’t work this way because there are too many players. But, at the core this is what gives the stock its value. How much would the company be worth (based on cashflow/assets/liabilities) to own outright? I’d call this the fundamental value.

    But, in reality, almost everyone speculates on stocks. “Oh, I think this company’s business will grow down the road, so I’ll pay a little more than the fundamentals to own the stock. Then I can sell when the fundamentals catch up and push the stock higher.”

    Anyway, yeah, IR’s statements would pretty mean that all non-dividend paying stock is speculation. It is. So is investing in most dividend paying stocks for that matter. That dividend isn’t fixed unless you’ve got preferred stock. Then you are speculating that the company won’t go under. How about money markets? Now you’re speculating that the commercial paper isn’t backed by fraudulent loans.

    Maybe we should separate rational speculation (call it investment) from blind speculation.

    I’ve bored myself and forgot my point. Oh well.

  30. mark

    “Is there a derth of pepole who bought late (a home they could afford and want to live in for 7+ years)? If the articles I read in the OCR are any indication, that answer is no.”

    I would agree that it’s likely the majority of late Irvine purchasers bought homes they could not reasonably afford. We are strongly influenced by the company we keep, and the few people I know that bought in the last 2-3 years bought homes they could afford. So my viewpoint is biased by this.

  31. surfing in newport

    Speculative investment must be good for the economy, what else would explain why it gets preferential tax treatment.

  32. skek

    Seems to me that the difference between speculation and investment is the “reason” the value is expected to increase. If the value is expected to increase because the company in which you own stock is profitable and growing, that would be an investment — dividend or not. If the value is expected to increase because you think someone will pay more than you did down the road (i.e., the tech boom), that is speculation. Because houses (structures) depreciate and land is fixed, it seems that an RE investment is speculation if you don’t meet IR’s cash flow guidelines.

  33. skek

    The argument against gold is that like fiat money, it can not achieve the three goals of a monetary system:

    1) stable domestic price level.

    2) stable relationship against other currencies.

    3) freely convertible into goods and other currencies.

    Pre-Bretton Woods, gold did #2 and #3, but was very bad at #1. There was violent domestic price volatility, periods of deflation and periods of inflation.

    In 1933, Roosevelt suspended the ability to convert dollars into gold, and regulations restricted the ability of Americans to hold foreign currency. Thereafter, Bretton Woods met #1 and #2, but not #3. Neither incarnation of the gold standard addressed all of our money policy goals.

    And while the current system does not achieve all three goals either, it is easier than gold to manage in a way that minimizes the extremes.

  34. ipoplaya

    Here’s a nice example of speculation gone awry:


    Purchased in 2006 for $1.3M. Fast-forward a bit less than two years later and they are listed at $949K… After commissions at that list price, we’re talking about a $400K+ loss.

    There is $32K worth of back taxes due on this property so obviously it’s a distressed sale.

  35. zaleriana

    Is there a derth of pepole who bought late (a home they could afford and want to live in for 7+ years)? If the articles I read in the OCR are any indication, that answer is no.

    I think you mean, the answer is Yes, that there such buyers were scarce (i.e., there was a derth (or dearth), but I’m a little unclear.

  36. tonye

    Look at it this way.

    When you buy into a growth stock, you buy into the company and its management. You take into account their sales market, their management plan and their track record. The company does have an intrinsic value but it’s future worth is as much at the hands of their managers as the marketplace.

    Hence, with a stock you are buying a “living entity” that is making active “investment” decisions for you. Instead of paying you, they are” investing” it back into their growth.

    OTOH, a house is just a lump of inanimate stuff that sits there. It’s value is tied to a host of external things over which the house has absolutely no control over.

    Thus, STUFF like a house is always speculation ( or more speculation than an equity ). Even if you have positive cashflow there is nothing the house is doing to protect itself from future downturns -price wise. Of course, you could get insurance, but that’s expensive and is reactive, not proactive.

  37. skek

    but what ‘other currencies’ would be considered in a gold-based system? oil? silver?

    Exactly. Oil. Silver. What is it about gold that makes it the only commodity suited to approximate currency? Gold is a commodity no different from oil or silver, and its price is volatile. A money fixed to gold will also be volatile.

    You point out that most of the known gold reserves have been mined. If the world’s gold reserves fail to keep pace with the global economy, gold backed money will suffer from deflation. Another strike against.

    You make some good points about the current system, and I agree that Paul’s contribution to the GOP primary has been refreshing, even if he’s destined to be a historical footnote. I wonder if you think returning to a gold standard is politically feasible? I think not.

  38. CapitalismWorks

    If the cost of owning of a home reaches bottom when the cost of ownership equals the cost of renting, then why would one ever buy a house? That would indicate that over market cycles the cheapest one could ever buy a home would be at a cost equivalent with renting. Assuming the cost of renting is either equal to, or less than the cost of owning at all times, then why shold anyone ever own a home?

  39. socalhousingbubble

    ISM, as IR has mentioned before, we are a housing blog, not a bubble blog, right? :]

    with love-


  40. IrvineRenter

    If you buy a home at rental equivalent, you do capture the inflation hedge, and if you finance with a fixed-rate amortizing mortgage, you build equity with the forced savings of principal repayment. Other than that, there are the emotional reasons everyone is familiar with. Of course, you can always speculate on the foolishness of our fellow man, and their ability to create another bubble…

  41. tenmagnet

    Great post, thanks for the insightful analysis.
    BTW, love today’s musical choice.
    Theme song from Beauty and the Geek, one my favorite shows on t.v.

  42. No_Such_Reality

    The cost of buying doesn’t bottom out at the cost of renting. The cost of buying bottoms out below the cost of renting in such a way that renting provides a positive ROI for investors after compensating them for the risk and expenses of managing the property.

    That’s why people in the rest of the country buy. It is cheaper than renting.

  43. Alan

    You could also say that they are trying to limit their loss to only $400k. Since this property hasn’t sold, the loss can only go higher.

  44. ipoplaya

    Owning your own home, it’s the American dream, or maybe American nightmare, not sure which. People buy when they think they can afford to buy… I think the Average Joe looks at affordability from a pretty short-term perspective. Bubble or no bubble, the psychology of the masses will remain unchanged. Most people simple want to own their own home.

  45. ipoplaya

    Indeed, very true Alan. Tustin Field is getting killed worse than Northwood II. Many houses came online in early to mid 2006, right at the peak, and the area is much less desirable location-wise than Woodbury or Northwood II. The declines at Tustin Field and some of the early VoC neighborhoods (like Alexandria – Desert Willow profiled here) will be quite spectacular…

  46. Red

    Almost no one likes their landlord? I know, I’ve been one.
    Plus, most rentals are just that – rental grade carpets, easy upkeep landscaping, mass appeal color paint – can you say beige? and rent increases just below what would make you find a better place.

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