Real Estate Valuation

Bubble or no bubble – for many, this is the dominating personal-finance question for many. I have been expecting the bubble to burst every year since 2000 when I purchased my second home, and I can barely express my amazement about how this market managed to put the inevitable off for so long. Finally, common sense seems to return into people’s purchasing decisions.

But that’s not what I want to talk about here, because this is an argument I could not win. Too many people who make a living off of selling real estate at inflated prices have argued that there is no bubble. Thinking about what I paid for my house and what it will actually be worth a few years from now gives me unpleasant feelings, though. Instead, what I want to talk about is an article by Russell Shorto in the New York Times Magazine from 3.5.2006 (the same article also appeared in the Herald Tribune on 3/3).

Mr. Shorto tells us about the Herengracht index, the result of a study that was done about the historic real estate values of a stretch of properties along the Herengracht in Amsterdam, based on records starting in the early 1600’s.
What is so compelling about this study is that it exposes real estate as a very poorly performing long-term investment. People who try to make us think that real estate values always go up do not have enough data and base their arguments on unreliable forcasts.

Annual adjusted growth of US house prices since 1890: 0.4 percent

All purchase and sales transactions since 1620 are documented without interruption. The records show that, over the course of a century in this period, the value of a property actually fell over 30%. After almost 400 years, the value of Pieter Fransz’s house roughly doubled in value.

What makes the Herengracht so interesting is three things.

• First, it has been a prime real estate location ever since the area was first developed in 1620. Prices on the Herengracht were always at the top end of the spectrum in Amsterdam, up until today.
• And second, the Netherlands have had a very turbulent history, with many wars, invasions, the plague, etc. This seems to be a good representation for today’s global real estate market that is much more subject to catastrophic events than the markets in the US have been traditionally.
• And finally, Amsterdam was the location of the first stock exchange in the world. The mutual influence of financial markets and real estate markets can be studied here further back than anywhere else.

What the study does not do is provide any means to forcast where today’s inflated market will go. Again, some think that a decline is inevitable, and the study seems to support this point of view, while others think that it will merely stagnate. Either way, I won’t care.