“Mark R. Crovelli writes: As a graduate student and construction worker in San Diego from 2003-2005, I was afforded an up-close view of the inflation of the last real estate bubble. It was a truly exciting time to work in the building industry in Southern California because there was so much money sloshing around. I literally couldn’t even walk into Home Depot without being accosted by hordes of greedy homeowners and slippery contractors offering to pay cash to anyone willing to do construction work.
Everyone I knew was making piles of easy money buying and flipping homes, and I often heard that I was just plain stupid to not be buying and flipping some of my own. I was content to just be able to finance graduate school without debt, however. I decided to move back to Colorado to finish graduate school at almost precisely the moment that my friends started making really big money in real estate. They all thought that I was insanely stupid to leave.
A year later, I wrote an article predicting the collapse of the real estate bubble. A year after that, my friends in Southern California started losing their jobs, and a year after that many of my old friends started losing big money. My decision to avoid real estate investment looked a lot less stupid at that point.
Only six years have passed since the largest housing bubble in world history imploded, and I am once again receiving investment advice from my friends involving real estate. Instead of buying and flipping homes, they are now promising me piles of easy money if I purchase “investment homes” to rent out. My friends are not quite as exuberant as Californians were in 2006, but the pitch of their excitement is definitely rising.
I am not sold on the idea at all, however. In fact, I think my friends who are piling into “investment properties” right now are setting themselves up for losses on a scale only surpassed by the losses suffered in the last real estate crash. Real estate is still extremely dangerous, and only people with a solid financial cushion and who are willing to take gargantuan risk should be moving into it.
In order to see why this is the case, first consider the role of property taxes in real estate investment. Quite obviously, the higher the rate at which a property is taxed, ceteris paribus, the lower the value of that piece of property. This much is obvious. But what most real estate investors do not consider at all is the fact that property taxes can change. The fact that taxes have been X amount for the past ten or twenty years is completely irrelevant if a government decides to raise or lower the rate at which it taxes property.
Given this, the important consideration from an investment standpoint is the rate at which real estate will be taxed in the future. In order to make an informed guess about future property taxes, however, the investor must attempt to forecast the financial condition of the government that taxes the real estate in any given area. Governments facing serious financial difficulty in the future should be expected to try to gouge property owners to make up for budget and pension shortfalls.
The problem is, however, that it is almost impossible to figure out the financial health of any given municipality. The municipal bond market, which is a decent proxy measure of municipal financial health, is one of the most opaque, illiquid and misleading markets out there. Even the incompetent SEC admits this, by the way. Not only that, but many municipalities that are seemingly healthy, and which are still able to borrow massive amounts of money at low rates today, are completely bankrupt from a long term perspective. Many school districts in California, for example, have been engaging in myopic borrowing schemes that basically ensure their future insolvency. More accurately, these municipalities will assuredly be bankrupt in the future if they don’t raise property taxes dramatically.
To think that these bankrupt municipal governments and the hoards of government workers and pensioners they parasitically support are going to just file for bankruptcy and lay off massive numbers of teachers, police officers and firemen is just plain silly. Of course they are going to try to pry as much money out of their tax bases as they can. If you are a property owner that means you, and your property taxes are going up – potentially substantially – at some point in the future.
If you think this is merely idle speculation…”