The Housing Market “Sales Activity Pyramid”

Last week on the Twitter feed I linked to a post that my friend Lennox Scott put up on his blog titled First Time Buyers Are Key To Housing Market Recovery. Here’s a brief excerpt:

In my travels around the country everyone wants to know what I think it will take to get the housing market moving again. The answer is simple: first time homebuyers.

Sales Activity Pyramid – Built On First Time Buyers
If you think of the housing market in terms of a pyramid, the base is made up of “more affordable” housing which is usually represented by first time buyers; in a healthy market, this accounts for about 40% of all home sales. The middle of the pyramid represents mid-priced homes and primarily repeat buyers. The top of the pyramid represents the smallest number of buyers and the most expensive part of the housing market. As first time home buyer activity increases at the base it sets off a chain reaction of sales up the price points. It is this process that drives and sustains a healthy housing market (see chart).

Lennox Scott's Housing Pyramid

So, his argument is that the best way to get the market rolling again is to recruit new buyers—investors, if you will—into this pyramid system? Intriguing…

Hey, wait a minute… This has a familiar ring to it… Where have I heard this model before? Oh yeah. Now I remember.

Federal Trade Commission:

Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public. Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure.

Securities & Exchange Commission:

In the classic “pyramid” scheme, participants attempt to make money solely by recruiting new participants into the program.

Investopedia:

HowStuffWorks Pyramid Scheme DiagramWhat Does Pyramid Scheme Mean?
An illegal investment scam based on a hierarchical setup. New recruits make up the base of the pyramid and provide the funding, or so-called returns, given to the earlier investors/recruits above them.

HowStuffWorks:

The main characteristic of a pyramid scheme is that participants only make money by recruiting more members.

Wikipedia:

A pyramid scheme is a non-sustainable business model that involves promising participants payment primarily for enrolling other people into the scheme, rather than from any real investment or sale of products or services to the public. Pyramid schemes are a form of fraud.

Is residential real estate inherently a pyramid scheme? No. At its most basic level, real estate is a place to live. If you buy a home you intend to live in, for a price that you feel is fair, why would you care whether or not new buyers are recruited into the market?

The problem comes when people start to view buying homes as a way to easy money (i.e. – a high-return investment). That most definitely is pyramid scheme thinking, and is exactly what caused the housing bubble to grow and continue for so long. If you’re justifying paying a high price for a home by telling yourself (or being told by a real estate “professional”) that it’s okay because more buyers will come into the market and drive up prices, you’ve fallen for a pyramid scheme.

Also, strictly speaking, Lennox’s pyramid diagram really doesn’t make any sense at all, since by definition the median price is the sale price which exactly half of all sales are above, and half below. In his pyramid, less than a quarter of the sales are shown above the median price, which is impossible.

I understand why Lennox, as a real estate salesman, would write posts and “white papers” promoting programs that get as many new people into the housing market as possible, and even why he would write nonsensical statements like “many first time buyers are in a strong position to buy but lack the necessary 3.5% down payment.” I just hope that people have learned their lesson from the bubble about the non-sustainability and consequences of real estate pyramids, and the risk of taking advice and market predictions from real estate professionals at face value.

Hat tip: EconE

  

About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

84 comments:

  1. 1
    EconE says:

    Wow…I’m honored.

    If you think about it, the “equity ladder” is another similar con. I’m pretty sure you debunked that one on your pricedoutforever.com website if I remember correctly.

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  2. 2
    Buy My House, Idiot Renters! says:

    “many first time buyers are in a strong position to buy but lack the necessary 3.5% down payment.”

    LOL. Because nothing says being “in a strong position to buy” like not having the cash to cover one thirty-third of the cost of the asset you want to purchase!

    “If you think about it, the “equity ladder” is another similar con.”

    I prefer to think of it as an “equity laundry chute”!

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  3. 3

    You’re leaving out a couple of important characteristics of a pyramid scheme. First, there’s either no product at all (which makes them illegal per se), or what I would call a fake product (one that is not commercially viable on it’s own, or at least not novel–e.g. detergent). Second, the main way to make money off a pyramid scheme is off the efforts of others, and how you perform is entirely dependent on your relative position.

    Real estate has neither of these characteristics. Real estate is a valid product, desired on its own accord without regard to how it’s marketed (e.g. owners of real estate will sometimes get unsolicited offers). Also, in real estate you could be near the top of the pyramid (own a $4,000,000 house) and have a return over 10 years that is less than someone who bought a $200,000 house. And whatever return you make on the $4,000,000 house is not directly related at all to any $200,000 sale.

    IMHO, all Lennox is describing with his pyramid is the demand curve. There’s a lot more demand for houses that cost $200,000 than there is for houses that cost $4,000,000, so there are a lot more houses in the lower price ranges. You could say the same thing about $14,000 cars and $50,000 cars. The difference is that historically houses have kept their value better than cars mainly because they hold their usefulness is a lot longer period, but there are other differences.

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  4. 4
    Buy My House, Idiot Renters! says:

    RE: Kary L. Krismer @ 3

    “You could say the same thing about $14,000 cars and $50,000 cars.”

    Yeah, except you don’t have car salesmen saying that the government should provide down payments to purchasers of $14,000 used cars, so the sellers can “trade up” to $50,000 cars.

    Obviously, real estate has value, but zero down payments and interest-only loans did transform the real estate market into a Ponzi scheme. The reason why Ponzi schemes fail is that eventually you run out of fresh money to inject into the scheme – which is why Lennox wants the government to keep injecting fresh money into the market via “down payment assistance” – anything to keep the carousel running a bit longer.

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  5. 5

    By Buy My House, Idiot Renters! @ 4:

    RE: Kary L. Krismer @ 3

    “You could say the same thing about $14,000 cars and $50,000 cars.”

    Yeah, except you don’t have car salesmen saying that the government should provide down payments to purchasers of $14,000 used cars, so the sellers can “trade up” to $50,000 cars.

    Obviously, real estate has value, but zero down payments and interest-only loans did transform the real estate market into a Ponzi scheme.

    1. Apparently you forgot about Cash for Clunkers.

    2. You don’t know the definition of a Ponzi scheme. Here’s a clue. A Ponzi scheme is not an investment that turns south.

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  6. 6
    Dave0 says:

    By Kary L. Krismer @ 3:

    You’re leaving out a couple of important characteristics of a pyramid scheme. First, there’s either no product at all (which makes them illegal per se), or what I would call a fake product (one that is not commercially viable on it’s own, or at least not novel–e.g. detergent).

    Second, the main way to make money off a pyramid scheme is off the efforts of others, and how you perform is entirely dependent on your relative position.

    Real estate has neither of these characteristics. Real estate is a valid product, desired on its own accord without regard to how it’s marketed (e.g. owners of real estate will sometimes get unsolicited offers). Also, in real estate you could be near the top of the pyramid (own a $4,000,000 house) and have a return over 10 years that is less than someone who bought a $200,000 house. And whatever return you make on the $4,000,000 house is not directly related at all to any $200,000 sale.

    IMHO, all Lennox is describing with his pyramid is the demand curve. There’s a lot more demand for houses that cost $200,000 than there is for houses that cost $4,000,000, so there are a lot more houses in the lower price ranges. You could say the same thing about $14,000 cars and $50,000 cars. The difference is that historically houses have kept their value better than cars mainly because they hold their usefulness is a lot longer period, but there are other differences.

    Kary, when real estate apprciated faster than normal based on historical ratios of price to rent and price to income, it no longer was “commercially viable on it’s own.” The only thing that kept it growing was the recruitment of new suckers. Also, if you bought a house in 2005 and sold it in 2007, you made a lot of money, through no real effort on your on (unless you were smart enough to time the market). The effort was made by the mass media, real estate agents, government, etc. pushing everyone to become a homeowner. Thus, real estate, during the bubble, had the characteristics of a pyramid scheme. Once we go through this current correction and get back to the historical price to rent and price to income ratios, then real estate will become “commercially viable on it’s own.”

    I completely agree that real estate was a pyramid scheme. After all, the common wisdom on why pyramid schemes don’t work is eventually you run out of new people to buy the product. That is exactly what happened when real estate prices peaked in 2007.

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  7. 7

    This topic/discussion pertains a bit to something I’ve been thinking about recently that was an offshoot of the heard mentality issue brought up.

    There was a poll several years ago where a large percentage of the population indicated that their best chance of retiring comfortably was by winning the lottery. As absurd as that sounds, due to the low probability, in reality that is a correct statement of fact for many people.

    So given that, is it that unexpected that people would flock to home ownership? Especially if they were in one of the bubble states and saw others making incredible returns? I think where they went wrong though was making short term investments (e.g. condos or “starter houses”) to meet a long term goal (owning outright). Now many of them are stuck in what they considered short term investments.

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  8. 8

    By Dave0 @ 6:

    Kary, when real estate apprciated faster than normal based on historical ratios of price to rent and price to income, it no longer was “commercially viable on it’s own.” The only thing that kept it growing was the recruitment of new suckers. Also, if you bought a house in 2005 and sold it in 2007, you made a lot of money, through no real effort on your on (unless you were smart enough to time the market). The effort was made by the mass media, real estate agents, government, etc. pushing everyone to become a homeowner. Thus, real estate, during the bubble, had the characteristics of a pyramid scheme. Once we go through this current correction and get back to the historical price to rent and price to income ratios, then real estate will become “commercially viable on it’s own.”

    I completely agree that real estate was a pyramid scheme. After all, the common wisdom on why pyramid schemes don’t work is eventually you run out of new people to buy the product. That is exactly what happened when real estate prices peaked in 2007.

    How would you distinguish any other investment, say investing in stocks or bonds? For most investments to be successful, you have to have someone willing to buy when it you want to get out.

    Also, you didn’t deal at all with my argument that your position in real estate doesn’t control your result, which is a feature of a Pyramid scheme.

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  9. 9
    EconE says:

    RE: Kary L. Krismer @ 8RE: Kary L. Krismer @ 7RE: Kary L. Krismer @ 5RE: Kary L. Krismer @ 7RE: Kary L. Krismer @ 3

    The lady doth protest too much, methinks.

    ;^)

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  10. 10
    David Losh says:

    In defense of Real Estate professionals everywhere let me explain, OK maybe it’s an excuse, or I’ll just talk for myself.

    I have been a big believer in the Asian market as an engine that would drive a global economy. I believed we were in a global economic war. The New World Order promised by Bush the First was supposed to be an economic take over. Well maybe that worked, just not the way I envisioned it.

    When China increased worker’s wages and factory out put was keeping pace with demand it seemed like we would see a massive inflation that would lift us out of debt. Inflation in this country just made sense to me.

    What I never saw was that our housing prices were nothing compared to the development schemes in every corner of the world.

    When you are talking Ponzi Schemes you can talk about development. Henderson Nevada, Miami Condos, West Port in Washington, were all development Ponzi Schemes where the development, construction, bank financing, and retail made an economy that just wasn’t sustainable.

    I never recognized that these developments were going on in every corner of the globe. I have a picture of a development in the middle of the desert in Morocco. There is nothing around it. I’m sure some one thought rich Europeans would want a summer home in the desert.

    In my opinion a Real Estate professional working in a local market place is just as much a victim as we all were. No one, or at least not me, ever saw the entire global market place except for maybe the banks and government regulators who were supposed to be monitoring the financial markets.

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  11. 11
    Dave0 says:

    By Kary L. Krismer @ 8:

    How would you distinguish any other investment, say investing in stocks or bonds? For most investments to be successful, you have to have someone willing to buy when it you want to get out.

    Stock valuation is tied to the net income generated by the company. True value of a stock grows as a company expands and generates a larger net income. Of course, investors are always looking into the future and pricing in future expectations of net income growth into the price of the stock, causing start-ups with no profit still to have a real value. This works in much the same way that real estate prices are tied to rents, incomes, and expected inflation.

    True value in bonds, or any debt investment where you are lending money out, is tied to future expectations in inflation and the likeliness that the party you are lending to will default.

    However, if any investment, whether it be stocks, bonds or real estate, enters a bubble state by not correlating with other metrics that relate to its value, then they become pyramid schemes in order to keep the values from going back to the historical correlations.

    Also, you didn’t deal at all with my argument that your position in real estate doesn’t control your result, which is a feature of a Pyramid scheme.

    Your position in the real estate bubble definitely controlled your result. If you bought in 2005 and sold in 2007, you won. If you bought in 2007, you lost.

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  12. 12

    By Dave0 @ 11:

    Your position in the real estate bubble definitely controlled your result. If you bought in 2005 and sold in 2007, you won. If you bought in 2007, you lost.

    As to the first part (not block-quoted), rather than use a pyramid analysis, I’d use the Tulip analysis. People are prone to driving the price of objects up in a completely irrational way. That happens with bizarre things (tulips, pet rocks, etc.) and truly valuable things (real estate, stocks, etc.)

    As to the quoted part, that’s just timing. By that analysis buying Microsoft stock at any point in time would be a pyramid.

    What I was addressing was this. If you bought a $200,000 house in 1998 and a $4,000,000 house in 1998, your return on the $200,000 house in 2008 would probably have been a lot greater than your return on the more expensive house. You probably would have more than doubled your value on the $200,000 house and possibly lost value on the $4,000,000 house. Your position getting into the market had little to do with your return–it was the product bought.

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  13. 13

    The Housing Pyramid Scheme is Different Than Normal Pyramid Schemes

    Normal Pyramid Schemes have initial buyers reaping the rewards of low prices propped higher by later buyers [the losers]. Today’s real estate pyramid has all buyers, from luxury homes to cheap condos, losing their shirts all at once.

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  14. 14

    RE: softwarengineer @ 13 – That’s true. Also to profit in the traditional pyramid scheme you don’t need to sell your investment–in fact you never do.

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  15. 15

    By EconE @ 9:

    The lady doth protest too much, methinks.

    ;^)

    In case you haven’t noticed, I’m a stickler for proper terminology. I don’t like it when people misuse or misunderstand certain terms, like: (1) Lie; (2) Mission; (3) Crime; (4) Fraud; (5) Ponzi Scheme; etc.

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  16. 16
    deejayoh says:

    I love how this thread has just taken three separate concepts and collapsed into one: Ponzis, Pyramids, and Bubbles.

    First, a Pyramid Scheme and Ponzi are two different things. A Ponzi is run by one person who orchestrates the entire thing, and uses funds from later investors to pay out earlier investors (think Bernie Madoff). A Pyramid Scheme is a setup where people in early recruit multiple salespeople behind them to pay the returns. The important distinction which separates both of these from a Bubble is intent. both a Pyramid and a Ponzi are set up to be fraudulent from the start. These differ from a bubble (be it in housing, stocks, or tulip bulbs) in that these are driven by the herd-mentaility but there is no central or organized intent to defraud.

    And Mr Scott’s description of housing as a pyramid may be unfortunate – but it’s a real stretch to call it a pyramid scheme.

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  17. 17
    James Baker says:

    This post reads as if it were a deliberate attempt to perpetrate a logical fallacy on its readers, casting something that has a triangular visual shape as if it were an illegal ‘scheme’ when in fact many things (how about the org chart of every business?) share the same surface similarity.

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  18. 18

    RE: James Baker @ 17 – Or to make something of the unfortunate use of a particular term.

    Maybe I should be like pfft was when Obama made the “heck of a job” comment on The Daily Show, and try to claim Lennox was joking! :-D

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  19. 19
    Daniel says:

    By Kary L. Krismer @ 3:

    IMHO, all Lennox is describing with his pyramid is the demand curve.

    IMHO all Lennox is describing is that he does not know what a median is.

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  20. 20
    The Tim says:

    RE: Kary L. Krismer @ 15 & deejayoh @ 16 – I very intentionally avoided referring to Ponzi Scheme, since real estate most definitely was not that. However, I still think it’s fair to say that it became a pyramid scheme when it turned into a “get rich quick” opportunity that only required people to buy early and sell sometime before we ran out of suckers. That’s practically the same way a pyramid scheme operates.

    RE: James Baker @ 17 – The pyramid drawing was only part of it. I focused primarily on the obsession with recruiting new people into the bottom. Note the bolded text in all the pyramid scheme quotes. And what was the very first thing I said after all those quotes? “Is residential real estate inherently a pyramid scheme? No.”

    Also, you’ll notice at the bottom of the post that this is posted under “humor.” I think people are taking it a bit too seriously. It was supposed to be good for a laugh on a Monday morning.

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  21. 21

    By Daniel @ 19:

    By Kary L. Krismer @ 3:
    IMHO, all Lennox is describing with his pyramid is the demand curve.

    IMHO all Lennox is describing is that he does not know what a median is.

    Well that too. For some reason that seems to be a tough topic for real estate agents.

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  22. 22

    RE: deejayoh @ 16 – I would agree with most all of that, but point out that some Ponzi schemes start out legitimate and turn Ponzi when there’s some sort of a setback.

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  23. 23

    RE: The Tim @ 20 – Buy My House . . . was the one that introduced Ponzi scheme in post 4.

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  24. 24
    Daniel says:

    By Kary L. Krismer @ 15:

    In case you haven’t noticed, I’m a stickler for proper terminology. I don’t like it when people misuse or misunderstand certain terms, like: (1) Lie; (2) Mission; (3) Crime; (4) Fraud; (5) Ponzi Scheme; etc.

    You mean you are a stickler for proper terminology when it suits you. When someone points out your improper terms with regard to Case-Shiller data and methodology you suddenly get very vague. Just like the rest of your industry (with which i mean lawyers nor real estate): They all act dumb when it suits them.

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  25. 25
    EconE says:

    Some of the financing used sure seemed like “Ponzi” financing. Getting a Neg-AM loan from Countrywide to pay off the ARM from WAMU that paid off the 30 year fixed from BECU is rather “Ponzi-ish”

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  26. 26
    Alex says:

    OMG!

    We are surrounded by Ponzi Bubbles!

    Now I’m suspicious about the “food pyramid” – is it a vast farmer health wing conspiracy?

    Representative democracy? It can definitely be drawn as a pyramid. Get out the vote & new voter registration drives look rather insidious in this light.

    Dollar bills even have a pyramid printed right on them!!! The Founding Fathers, Abraham Lincoln, and Jesus probably put the eye of providence above the pyramid because a wink would have been too obvious.

    -Alex

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  27. 27

    RE: Daniel @ 24 – Example please?

    It’s easy to make claims that are not backed up.

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  28. 28
    EconE says:

    RE: Alex @ 26

    Strawman much?

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  29. 29
    Lurker says:

    I was speaking to a very attractive man the other day that had a pink triangle emblem on his T-Shirt. He was telling me something about tops and bottoms but it didn’t really make much sense to me until now.

    I’m sure glad I didn’t join his pyramid scheme, I could have gotten really screwed!

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  30. 30
    Scotsman says:

    One of the defining legal characteristics of a pyramid scheme is that the people on the bottom (last in?) never have the opportunity to make as much as they people closer to the top. I’m not sure that’s really the case in real estate, which seems to better fit the definition of a Ponzi scheme.

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  31. 31
    One Eyed Man says:

    Whether you think of the real estate bubble as a pramid is largely irrelevant to the real issue. Kary’s right, move up buyers are important but only because they made a significant return on money at the bottom which allowed them to move up and that doesn’t happen in a traditional pyramid scheme. The mechanical advantage in real estate investment isn’t in a demographic price pyramid. It’s the financial leverage that allows you to multiply your cash on cash return. The most unfortunate thing in The Tim’s post is his concluding statement:

    “I just hope that people have learned their lesson from the bubble about the non-sustainability and consequences of real estate pyramids, and the risk of taking advice and market predictions from real estate professionals at face value.”

    The last California housing bubble collapsed in 1990 and resulted in approximately a 25% drop in So Cal real estate prices between 1990 and 1995. In 10 years, any lesson had clearly been ignored if not forgotten and they were at the peak of another bubble. If left to their own devices, the lemmings will rush to the sea. All you need to do is toss a piece of cheeze at the edge of the cliff to start the stampeed. It might take more than 10 years, but some inventive capitalist with a somewhat predatory instinct will come up with a new financial vehicle that offers enough cheeze to draw in the buyers and it will start all over again.

    Everyone knows the odds, but most still can’t resist buying a lottery ticket. And in a society where most people can’t reconcile their checkbook, how can you expect the majority to use their understand of real estate economics and finance to avoid unwarranted risk. Bubbles are the result of unrestrained human nature in a capitalist system. You might be able to control the size of the bubble and the amount of damage, but as long as you provide leveraged financing you can’t stop them from forming, unless of course, you think you can change human nature.

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  32. 32
    EconE says:

    By One Eyed Man @ 31:

    move up buyers are important but only because they made a significant return on money at the bottom which allowed them to move up

    You just described the “equity ladder”

    Could you run some example numbers for me?

    Start with a $100k house that doubles in value to $200k and show me how one can move into a $200k house that also doubled in value and is now $400k.

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  33. 33
    NumberMonkey says:

    By Kary L. Krismer @ 8:

    How would you distinguish any other investment, say investing in stocks or bonds? For most investments to be successful, you have to have someone willing to buy when it you want to get out.

    RE: Kary L. Krismer @ 8

    Long long ago in a galaxy far far away investments were valued based on the net present value of future cash flows. Stocks paid dividends, bonds paid coupons and face value at maturity.

    The fact that you think a future buyer (or as some people say” “bigger fool”) is a necessary ancillary to an investment is pretty incredible.

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  34. 34

    RE: EconE @ 32 – I’m not sure what you’re asking, but many people who did that would have also re-leveraged their investment. So they would have had $100k from the sale of the first house, which would then allow them to borrow $300k or even $320k on the $400k house. Ignoring interest rate changes and RE taxes, they would have also tripled their payments.

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  35. 35

    RE: NumberMonkey @ 33
    By NumberMonkey @ 33:

    Long long ago in a galaxy far far away investments were valued based on the net present value of future cash flows. Stocks paid dividends, bonds paid coupons and face value at maturity.

    The fact that you think a future buyer (or as some people say” “bigger fool”) is a necessary ancillary to an investment is pretty incredible.

    – Let’s try to keep the discussion to the something after the 19th Century.

    With the exception of bonds, what type of investments don’t need a future buyer?

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  36. 36
    EconE says:

    By Kary L. Krismer @ 34:

    RE: EconE @ 32 – I’m not sure what you’re asking, but many people who did that would have also re-leveraged their investment. So they would have had $100k from the sale of the first house, which would then allow them to borrow $300k or even $320k on the $400k house. Ignoring interest rate changes and RE taxes, they would have also tripled their payments.

    Just like I thought. Appreciation doesn’t help you move up.(It actually hurts) A larger payment does.

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  37. 37
    NumberMonkey says:

    RE: Kary L. Krismer @ 35 – Why don’t you google dividend discount model there chief, and find out that it’s still used today.

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  38. 38

    RE: NumberMonkey @ 37 – Unable to explain your position? A common approach when someone can’t is to ask someone to do something else.

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  39. 39

    By EconE @ 36:

    By Kary L. Krismer @ 34:
    RE: EconE @ 32 – I’m not sure what you’re asking, but many people who did that would have also re-leveraged their investment. So they would have had $100k from the sale of the first house, which would then allow them to borrow $300k or even $320k on the $400k house. Ignoring interest rate changes and RE taxes, they would have also tripled their payments.

    Just like I thought. Appreciation doesn’t help you move up.(It actually hurts) A larger payment does.

    It does help you move up. Absent saving $80,000 they wouldn’t be able to buy a $400,000 house (or they would pay even more with a smaller down payment). But yes, one of the disadvantages of re-leveraging is higher payments. In the scenario you gave it would probably be better for them to buy a $300,000 house, unless their income had increased 4x too.

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  40. 40
    NumberMonkey says:

    RE: Kary L. Krismer @ 38 – I don’t have the time to explain dividends to you. Nor do I have time to explain the difference between speculation and investment. It’s not that I’m unable, I just don’t have time. Besides, I’m sure Google will provide you with more depth and clarity than I can.

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  41. 41
    LA Relo says:

    Here’s a question: Why do homes appreciate at all?

    Take cars for instance: just like a house, cars wear out, break down, require maintenance, upkeep, etc. No one would ever expect to buy a car today and sell it for more in 7 years. Unless it’s are a rare collectible, in which case it’s probably not used for transportation, we all accept that cars lose value.

    So why doesn’t a home? Or, why do we accept that over the long term home prices will rise?

    And please don’t say because they’re not making any more land.

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  42. 42

    By NumberMonkey @ 40:

    RE: Kary L. Krismer @ 38 – I don’t have the ability to explain dividends to you or answer your question.. Nor do I have the ability to explain the difference between speculation and investment. It’s [material omitted] that I’m unable . . .. Besides, I’m sure Google will provide you with more depth and clarity than I can.

    Fixed your post, and you sure hit the nail on the head with the last sentence, which didn’t require fixing.

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  43. 43

    RE: LA Relo @ 41 – I think it’s mainly due to increased population more than any other factor. That would mainly be local (e.g. people moving some place for jobs). I would point out though that a 1920 house would be like your collectible car.

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  44. 44
    EconE says:

    By Kary L. Krismer @ 39:

    By EconE @ 36:
    By Kary L. Krismer @ 34:
    RE: EconE @ 32 – I’m not sure what you’re asking, but many people who did that would have also re-leveraged their investment. So they would have had $100k from the sale of the first house, which would then allow them to borrow $300k or even $320k on the $400k house. Ignoring interest rate changes and RE taxes, they would have also tripled their payments.

    Just like I thought. Appreciation doesn’t help you move up.(It actually hurts) A larger payment does.

    It does help you move up. Absent saving $80,000 they wouldn’t be able to buy a $400,000 house (or they would pay even more with a smaller down payment). But yes, one of the disadvantages of re-leveraging is higher payments. In the scenario you gave it would probably be better for them to buy a $300,000 house, unless their income had increased 4x too.

    It doesn’t work.

    The ONLY way is if the person’s income increased substantially or they somehow came up with additional funds.

    Stop playing dumb, You’re insulting your own intelligence.

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  45. 45
    NumberMonkey says:

    RE: Kary L. Krismer @ 42 – Slow down there, you’re clearly upset and not capable of civil conversation.

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  46. 46
    NumberMonkey says:

    Thinking back I guess it may not be obvious to you, the difference between investment and speculation. So here it is: investments are productive economic activity. Fertilizer, education, factory machinery, livestock, and whatever else you can think of. Firms offer stock to raise money to invest, and returns that profit from the investment in the form of a dividend.

    Speculation does not help produce anything. Sitting on a bar of gold made a lot of people a lot of money in the last few years, but it is purely speculative. A house is (generally) not productive, and trying to make money from buying a house is speculative.

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  47. 47
    The Tim says:

    As I mentioned in the post:

    Also, strictly speaking, Lennox’s pyramid diagram really doesn’t make any sense at all, since by definition the median price is the sale price which exactly half of all sales are above, and half below. In his pyramid, less than a quarter of the sales are shown above the median price, which is impossible.

    I decided to see what the actual volume and price points are for the pyramid as drawn in the source post. Here’s where the price and volume breakdowns are for October King Co. SFH if you just draw three lines evenly spaced like that:

    Note that in the above version, the median price ($369,000 in my data set) comes in slightly above the line between the blue and red sections. In the diagram as drawn in the original post, 75% of sales take place below the line that was incorrectly marked as the “median.”

    And here’s what the pyramid looks like if you actually want to draw it such that each section represents 25% of the total volume.

    The line between the red and green sections represents the median price in this view.

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  48. 48
    Snigliastic says:

    RE: Lurker @ 29
    I think the technical term is that you would have “gotten bent over.”

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  49. 49
    Scotsman says:

    RE: LA Relo @ 41

    “Here’s a question: Why do homes appreciate at all?”

    They don’t. They inflate, or at least they have historically. That’s what Case/Shiller is all about, 100+ years of history that show, after adjusting for inflation, home values stay pretty close to 100/0 on an indexed scale.

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  50. 50
  51. 51
    The Tim says:

    RE: Alex @ 50 – Sorry I should have turned off those labels. They represent # of sales, but they just indicate the # of sales at each vertical line (as if it’s just a linear chart), not really how many sales there are by volume in the pyramid.

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  52. 52
    per_se says:

    RE: NumberMonkey @ 46 – Actually, that’s not entirely correct. Just merely buying something that creates “productive” economic activity is a misnomer. The majority of stocks don’t offer a dividend and only the initial sale of the stock goes directly to the company. Even a dividend doesn’t classify something as an investment or not. A stock for a company that has negative cash flow doesn’t all of a sudden go from speculation to investment because it offers what amounts to a .01% dividend.

    You’ll tend to find various definitions of investments and speculation but I’ve typically seen this as the book definition:

    gambling – a transaction where profit is based solely on mathematical chance, i.e. the lottery

    speculation – a transaction that has significant risk of losing the principal, i.e. stocks, bonds, real estate

    investment – a transaction offering a return with little to no risk of losing the principal, i.e. T-bills, FDIC insured savings

    Realistically, I think you differentiate speculation and investment by the amount of risk taken and the basis of the analysis. Buying a stock of a company whose book value is greater then the outstanding stock would not be very speculative. Buying a stock of a company that has negative cash flow but is in a “hot” sector is speculative, dividend or not.

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  53. 53
    NESeattleSeller says:

    The Tim said in his original blog post: “In his pyramid, less than a quarter of the sales are shown above the median price, which is impossible.” Thankfully gave us a diagram in his comment that showed that the percentage of sales on either side of the median price is equal. Median means half the sales have prices above and half below. But the shape is still pretty triangular – few sales at the top end of prices, many sales at lower prices. Real estate agents are essentially profit extractors – friction in the system. In an ideal world the basic education adults receive coupled with great online tools like Redfin and county records would enable people to engage in real estate transactions without agents at all or with just fixed price staging and showing staff.

    Houses don’t actually appreciate, except in exceptional situations where some aspect of the building or it’s style becomes more desirable. The house starts depreciating as soon as it is built. The roof starts falling in value, the kitchen starts losing value, the HVAC starts declining in value, the floors, walls, wiring, etc lose value. The property as a whole gains value because of the scarcity of real estate and increases in demand for real estate in a particular area. Without population pressures OR stable population and inflation (rising wages and commodities prices) OR inflation rising fast enough to offset declining population real estate declines in value over time.

    If we can ever get to a stable human population with nearly zero net migration this will become incredibly apparent. The idea that growth is necessary is misleading. We can increase the net utility of everyone by investing in education and in tools and systems that reduce the total effort required to create the lives we want. Understanding this basic idea in economics would be a great foundation to helping people make better choices.

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  54. 54
    numbermonkey says:

    RE: per_se @ 52 – The terms bleed into each other, and are encouraged to do so by people trying to sell speculation as an investment opportunity. It’s particularly hard to understand the difference as an individual, as we very rarely invest (education being the exception). Usually we park our money with someone else who can invest, and collect a part of that profit as interest.

    You are quite right that equities don’t send any money back to a firm after the IPO; rather they stand as a placeholder for the benefit of that initial investment.

    You are also quite right that many stocks do not pay dividends today. This has not always been the case, and is a strong example of how speculative the market has become. The tech bubble for example was almost entirely speculative. Microsoft’s first dividend was in 2003, well after the bust (driven largely by investors realizing that without dividends, they were holding nothing but speculation!).

    Loans occupy a strange space. Current financial theory says that most loans are productive: they allow the borrower to consume now instead of later, which is seen as preferable and therefor productive. Interest paid on that loan would be the “value” of early consumption.

    And certainly a single transaction can be a little of both. Buying equipment to make accessories for iphones is both an investment and a speculation on the future popularity of the device. Houses however are never productive. They are consumed as has been noted many, many times.

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  55. 55
    Macro Investor says:

    By Kary L. Krismer @ 35:

    RE: NumberMonkey @ 33
    By NumberMonkey @ 33:

    Long long ago in a galaxy far far away investments were valued based on the net present value of future cash flows. Stocks paid dividends, bonds paid coupons and face value at maturity.

    The fact that you think a future buyer (or as some people say” “bigger fool”) is a necessary ancillary to an investment is pretty incredible.

    – Let’s try to keep the discussion to the something after the 19th Century.

    With the exception of bonds, what type of investments don’t need a future buyer?

    Since you love terminology so much I’ll help you out.

    Stocks, bonds and real estate bought for appreciation are “speculations”, not investments. Investments would be stocks or businesses bought for dividends, or bonds for the coupon payments. Real estate investment is either development or rental. The difference is in one case you are gambling on future appreciation. In the other, you are paying up front for a payment stream aka a return.

    When the term is used correctly, no investment needs a future buyer. And every speculation is a pyramid, though not necessarily dishonest.

    …macro investors love a good speculation ;)

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  56. 56
    Racket says:

    Whaty business couldn’t be viewed as a pyramid?

    I can’t blame j lennox for his views. He sells real estate, so if real estate is selling, hes making money. Isn’t that why we are all in business.??.

    I don’t quite understand why you constantly make him look like a villan.

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  57. 57
    patient says:

    Ritsch…the sound of Lennox ripping The Tim’s Christmas Card…again.

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  58. 58
    patient says:

    RE: Racket @ 56
    “I don’t quite understand why you constantly make him look like a villan.”

    Then you just having been paying attention to what has happened the last couple of years with our economy and the causes. He’s a villan among many.

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  59. 59
    Hugh Dominic says:

    RE: NESeattleSeller @ 53 – That’s what’s so great about immigrants, especially when the existing population stops reproducing. An immigrant may only earn $5 an hour, but you can saddle him with $100,000 in debt in practically no time.

    In that way, each $1 trillion in lost asset value can be replaced by 10,000,000 new immigrants. Hand them each a credit application and a toliet brush as they arrive.

    Seriously, people. This entire nation is a pyramid scheme. The new citizens prop up the old.

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  60. 60
    Low Ball Jones says:

    The other side of this tragic tale is the high density crowd.

    The reason people came to Seattle was because it was the last city where people could buy middle class single family housing with the feel of a real neighborhood.

    Then the condo scam artists came in and started promoting a vision of wall to wall towers with one bedroom cells for “urban professionals”. Thing is — density causes all sorts of problems for both the dense livers and the former single family neighborhoods…some of which are now blighted with violent crime that would have been unthinkable two decades ago.

    Yes, it’s a sorry sorry state that we’ve gotten ourselves into…all for the sake of some unscrupulous wheeler dealers who promised a golden stratus and gave us a tin cup.

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  61. 61
    Low Ball Jones says:

    RE: Hugh Dominic @ 59

    Well, that’s essentially what WA state property tax laws do (and Prop 13). They saddle a new homeowner with a fully assessed, fully levied tax for his 3 bedroom in Kent, while the “farmer” who sold 10 of his 100 acres for the new development probably pays next to nothing. Even though “fair use” would imply that he should pay as if his whole “farm” were converted to single family homes (so called “air condoes” because there is little or no land around the house).

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  62. 62
    Low Ball Jones says:

    By NESeattleSeller @ 53:

    The Tim said in his original blog post:
    If we can ever get to a stable human population with nearly zero net migration this will become incredibly apparent. The idea that growth is necessary is misleading. We can increase the net utility of everyone by investing in education and in tools and systems that reduce the total effort required to create the lives we want. Understanding this basic idea in economics would be a great foundation to helping people make better choices.

    First of all the US would have experienced negative population without immigration…and immigration has all but ground to a halt since 2006.

    Second, worldwide its the same thing except for India and Africa who have replacement rates of 6 still. So if those Rajiv and Abioye would keep it in their pants, we’d all have more stuff.

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  63. 63
    Pssing Match says:

    By Kary L. Krismer @ 27:

    RE: Daniel @ 24 – Example please?

    It’s easy to make claims that are not backed up.

    Demonstrate clearly to all of us why you exist and what your purpose is here on this planet, and that you are made of something tangible (hard material that is static), and perhaps your wish will come true. In other words, it’s all a pissing match. Ego vs. ego. Everything.

    Sales pitch vs. sales pitch. Belief system vs. belief system, while neither are absolutely true except to the subscriber.

    One may easily attack and refute any well-documented claim. There is always a belief modality that exists or may be conjured up that may be used to undermine the claim.

    The most solid ground one may walk on is science, based in sound statistical methodology. Even if someone provided that to you (which I have here on several occasions), the reader’s ego over-rides the argument and tries to make it align to their own belief system.

    So you ask for claims but you have none of your own. You walk on anything but solid ground. I point this out to you to demonstrate how manipulative your statement is — “It’s easy to make claims that are not backed up.”

    Again, who are you and what are you doing here? Show me solid static material that exists in the universe — it has not been found yet, Sir. The hairless apes are still looking…

    All claims are equally valid as your own, because when it comes right down to it, you think you know something — you really believe — but you know nothing. It’s all an illusion that you subscribe to.

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  64. 64
    Pssing Match says:

    Let me introduce yet another religion to believe in, based on my own experience — back in 2000, as the dot com bubble was crashing, I was daytrading on a regular basis. When the market crashed, some of the market makers went public, out of intense guilt. They were writing spontaneous detailed documentation on the trading IRC channels, about how the bubble was intentionally created, and how they were instructed and paid to inflate the bubble. The end goal was to rape the common investor of their savings and transfer that wealth over to the private bankers.

    None of this made it into the mainstream news.

    I then watched the housing bubble form a similar bubble. Home appraisers have written articles about how they were coerced into moving values up to help create a bubble. We have seen how our own privately-owned Federal Reserve central bank has manipulated the market to foment this bubble. We have seen how the mainstream media and all of its local tentacles have worked collectively and endlessely to instill a sense of buying panic in the common investor.

    I believe we have ample evidence already to suggest that this bubble again served the purpose of a wealth transfer.

    When you include the political aspect, the UN legislation that is going on all around us at this time in history, and include the UN’s own well-documented detailed guidance on how to transfer wealth in order to create a more “sustainable” world economy, you really don’t have to do much thinking beyond this point.

    You will never see such things in certain blogs, however, since the truth is perhaps intentionally made to be out of reach. Depends on who is being paid by who, I suppose.

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  65. 65

    By EconE @ 44:

    By Kary L. Krismer @ 39:
    By EconE @ 36:
    By Kary L. Krismer @ 34:
    RE: EconE @ 32 – I’m not sure what you’re asking, but many people who did that would have also re-leveraged their investment. So they would have had $100k from the sale of the first house, which would then allow them to borrow $300k or even $320k on the $400k house. Ignoring interest rate changes and RE taxes, they would have also tripled their payments.

    Just like I thought. Appreciation doesn’t help you move up.(It actually hurts) A larger payment does.

    It does help you move up. Absent saving $80,000 they wouldn’t be able to buy a $400,000 house (or they would pay even more with a smaller down payment). But yes, one of the disadvantages of re-leveraging is higher payments. In the scenario you gave it would probably be better for them to buy a $300,000 house, unless their income had increased 4x too.

    It doesn’t work.

    The ONLY way is if the person’s income increased substantially or they somehow came up with additional funds.

    Stop playing dumb, You’re insulting your own intelligence.

    I pointed out that the expense would increase 3X if interest rates stayed the same, and that it would make sense to buy something cheaper unless their income increased dramatically. How is that playing dumb?

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  66. 66

    RE: NumberMonkey @ 45 – I’m sorry and apologize. Trying to claim that one valuation method is somehow what was traditional and right is absurd. It is also absurd to claim that any investment that relies on other people buying it is somehow defective or dishonest. Being able to trade 30 year bonds is a huge part of what makes them attractive. Not that many people get into any investment planning on holding it until it or they terminate (whichever comes first).

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  67. 67

    By NumberMonkey @ 46:

    Thinking back I guess it may not be obvious to you, the difference between investment and speculation. So here it is: investments are productive economic activity. Fertilizer, education, factory machinery, livestock, and whatever else you can think of. Firms offer stock to raise money to invest, and returns that profit from the investment in the form of a dividend.

    Speculation does not help produce anything. Sitting on a bar of gold made a lot of people a lot of money in the last few years, but it is purely speculative. A house is (generally) not productive, and trying to make money from buying a house is speculative.

    You can have speculative action that results in investment. That would be say investing in companies that to date have not earned a profit and thus do not fit within your system for valuing them. Stated differently, speculation in the stock market can lead to investment by the companies traded.

    And I don’t know how you can say a house is not productive. Are people that pay rent paying for nothing? Is renting a Ponzi scheme? ;-)

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  68. 68

    RE: numbermonkey @ 54 – I’ve always suspected that Microsoft’s lack of dividends was driven more by the tax considerations of its largest shareholders. It certainly wasn’t driven by their earnings or their cash position.

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  69. 69

    RE: Macro Investor @ 55 – They are speculative investments–a fairly common term, e.g.: http://wiki.answers.com/Q/What_is_speculative_investment

    Rate this comment: Thumb up 0

  70. 70
    ChrisM says:

    Getting rather astray from real estate, but I think significant improvement could be done by removing the tax penalties to dividends. Companies have to have actual cash on hand to issue dividends, unlike the accounting games played today.

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  71. 71

    By Macro Investor @ 55:

    Since you love terminology so much I’ll help you out.

    Stocks, bonds and real estate bought for appreciation are “speculations”, not investments.

    BTW, is “speculations” even a word in the sense used? You can speculate. You can be a speculator. You can buy something that is speculative. But I’m not sure you can buy a speculation.

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  72. 72
    NumberMonkey says:

    RE: Kary L. Krismer @ 67 – People pay rent for the right to consume a good (the use of the house). Just because money changes hands doesn’t mean anything is being produced.

    If we both owned our homes, and we decided to trade, and pay each other equal rents, would we be any better off?

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  73. 73

    RE: NumberMonkey @ 72 – I would agree with the example you gave of a bar of gold not producing anything. But a house does produce things–just not things that are tangible. Shelter, security, etc.

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  74. 74
    Cristian says:

    RE: Scotsman @ 49 – Unfortunately, we are currently devaluing the dollar to make inflation match house prices.

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  75. 75
    NumberMonkey says:

    RE: Kary L. Krismer @ 73 – So like a stock the initial investment produces something, and then people can trade it between themselves after the fact, reaping the benefit of that initial investment.

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  76. 76
    patient says:

    By Cristian @ 74:

    RE: Scotsman @ 49 – Unfortunately, we are currently devaluing the dollar to make inflation match house prices.

    Explain how a lower dollar causes home price inflation? If there is no salary inflation the demand for higher priced homes do not get stronger. I suspect it will get weaker since people need more of the unchanged income to pay for energy and commodities which will have price inflation due to the global demand and currency balance. I doubt we’ll see much of salary inflation until unemployment gets below 5-6%.

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  77. 77
    LA Relo says:

    RE: Scotsman @ 49

    Exactly, and inflation is predominantly the result of added debt thanks to our fractional reserve system.

    Population density explains the fluctuation in average home prices from one area to another, but it doesn’t explain why prices over the long term go up.

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  78. 78
    Dirty_Renter says:

    RE: NumberMonkey @ 40
    What do you call it when an investment turns into speculation?
    I hate when that happens.
    Dirty Renter

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  79. 79
    David Losh says:

    RE: Pssing Match @ 63RE: Pssing Match @ 64

    Good comments and very much to the point here. There does seems to be a lot of speculation about what an investment is. A little grounding could go a long way.

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  80. 80

    RE: NumberMonkey @ 75 – I guess you could view it that way, but the initial investment in a house is much less speculative and “cutting-edge” than some in the stock world.

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  81. 81
    deejayoh says:

    By patient @ 76:

    By Cristian @ 74:
    RE: Scotsman @ 49 – Unfortunately, we are currently devaluing the dollar to make inflation match house prices.

    Explain how a lower dollar causes home price inflation? If there is no salary inflation the demand for higher priced homes do not get stronger. I suspect it will get weaker since people need more of the unchanged income to pay for energy and commodities which will have price inflation due to the global demand and currency balance. I doubt we’ll see much of salary inflation until unemployment gets below 5-6%.

    Here, this might help: Google “How a lower dollar contributes to inflation”

    Or, you might just think of the word “oil”

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  82. 82

    RE: deejayoh @ 81 – But the question was home price inflation–not just general inflation.

    You Bubbleheads are always just so optimistic, thinking this or that will lead to increased house prices! ;-) :-D

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  83. 83
    Jonness says:

    Since two common traits of psychopaths are persistent lying and superficial charm, how can a psychopath be reliably identified?

    Each item is scored on a three-point scale of 0, 1 or 2. A value of 0 is assigned if the item does not apply, 1 if it applies somewhat, and 2 if it fully applies. Scores are used to predict the probability of rehabilitation. A score of 20 or higher indicates psychopathic urges so strong that there is no possible chance of rehabilitation.

    Key Symptoms of Psychopathy

    * glib and superficial – (score 2)

    * grandiose sense of self-worth (score 2)

    * lack of remorse or guilt (score 2 – many buyers have been harmed during the current economic downturn, but the lies continue)

    * lack of empathy (score 2 – many buyers have been harmed during the current economic downturn, but the lies continue)

    * deceitful and manipulative (score 2 – now is not a good time to buy)

    * shallow emotions (score 2 – lying about RE in order to line one’s own pockets at the expense of one’s clients demonstrates shallow emotions)

    * impulsive (score 2 – lying about RE in order to line one’s own pockets at the expense of one’s clients demonstrates lack of thinking things through to the point of understanding the impact of one’s actions upon others)

    * poor behavioral control (score 2 – lying about RE in order to line one’s own pockets at the expense of one’s clients demonstrates an inability to direct one’s behavior in a positive manner)

    * need for stimulation/prone to boredom (score 2 – lying about RE in order to line one’s own pockets at the expense of one’s clients demonstrates the need for extra stimulation gained from having more money than the next guy)

    * lack of responsibility (score 2 – lying about RE in order to line one’s own pockets at the expense of one’s clients demonstrates a complete disregard for taking personal responsibility for one’s clients’ best interests)

    * early behavioral problems (score 2 – The need to obtain more wealth than others at the expense of one’s clients demonstrates a break in being well-grounded to the world around oneself)

    * adult antisocial behavior (score 2 – lying about RE in order to line one’s own pockets at the expense of one’s clients demonstrates anti-social behavior)

    Total score = 24 (A perfect score like this indicates no possible chance of rehabilitation)

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  84. 84

    […] rear its head again. In other news… It’s a FRENZY! You know it has to be true because Pyramid Expert J. Lennox Scott says […]

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