Catching a Falling Dagger, Part I: Predicting Future Real Estate Values

This expression comes from the conjecture that it is hard to catch a falling dagger by the handle. Most likely you will miss it, and there is some probability that you get cut. Catching it by the handle is rare, and not likely due to your agility.

As we have seen property values drop significantly, it is now possible in many areas to buy a home at the same price is was at in 2002. This creates a great buying opportunity either for a first-time homeowner or for someone who wishes to buy an investment property.

Now, whenever I have written about this in the past, I have invariably gotten a few responses from readers who think I am crazy – with prices still falling, you are in danger of paying more for a property than you would in, say, another six months. There is no question that it's possible, but if you had said that in June 2008 and it's now January 2009 and prices have fallen more, that judgment would have been correct. That is the danger in such thinking.

You cannot predict the future. You can only look at the past and present. In our example above, we know now that prices were higher last June because we can see back six months and we can compare those number with today's numbers. Last June you did not know what was going to happen in January 2009. Neither do you know now what values will be like in June 2009 or January 2010.

You can only look at history. At some point in time, say January 2010, you will be able to look and say, "It looks like the bottom was in February 2009 (or April 2009, or whatever it ends up being). That's when I should have bought." A lot of good that does! In May 2009 or January 2010 you won't be able to go back and buy at February or April 2009's price. All you can see is that prices are, for example, 5% lower now than they were back then.

Buying at the bottom is like catching the falling dagger.

So what do you do? You have to buy at the January 2010 price that is higher than the bottom. You could just as easily have bought in January 2009 at the same price. Yes, you could have seen it fall 5% more. BIG DEAL! What difference does it make buying at 2009 or 2010 if the price is the same?

Now I know some people are reading this and saying to themselves, "But I'm smart enough. I'll see the market bottoming out and I'll be able to buy at the bottom." Sorry folks, but that's just whistling Dixie. You can't pick the bottom. That is the first maxim of investment managers like John Bogle who runs Vanguard Funds and legendary investor Warren Buffett.

Still not convinced?

You probably own some stocks or mutual funds in your IRA, 401(k), or investment account. You have the option of buying and selling any day of the year. If you are the kind of person who can pick the bottom in the housing market, you should also know what day the stock market will hit the bottom. You would miraculously know to buy at that time and sell at the next market top. You would make a fortune. So where's all your money? The honest truth is that you can't time the market. If you are not the savant I described above, you will get the same kind of return all the rest of us do in this unpredictable market.

It isn't any different with buying and selling real estate. You will find people who have spent their lives in residential and commercial real estate who echo these thoughts. They may have bought, managed, and sold many properties during their careers. If you ask them about their success, they would say that on balance they made good money; otherwise they would have perished long ago.

If you ask them about the best deals they ever did, most would say that it was a matter of luck, sometimes just being in the right place at the right time. Most would acknowledge that the great deals were not due to shrewdness or an ability to foresee the future. They would also say that they did not know until well into the transaction, and perhaps not until years later, that this particular deal would be the big winner.

You should take comfort in this knowledge. My point is that in times like this, if you are a first-time homebuyer and find a home you both like and can afford (!!), go ahead and make an offer. If you are an investor, you'll look back upon 2009 as one of those few great buying opportunities.

Read Part II of this article: Predicting Future Interest Rates.