Real estate priced in gold

2012-NOV-10

Throughout history many fortunes have been made and lost in real estate. Luck has of course played a part in these outcomes, but the main reason for changing fortunes is the decisions that were made, whether good or bad. Often the bad decisions were made because of the misunderstanding of some basic elements needed to choose real estate wisely.

For example, returning from a business trip not too long ago I got into a conversation with the driver of a car that I had arranged to meet me at the airport and take me home. This gentleman was in his late 60s and in a very jovial mood because it turns out, he had just sold his house in the outskirts of London. Thus, he was now ready to retire and was excited about the prospect of moving to the southwest of England where he planned to buy a cottage to enjoy his retirement. But as it turns out, that wasn’t the only reason that made him happy.

He crowed about how well he had done on his “investment”. Apparently, he bought the house in 1964 for £3,100, and was now quite delighted by the £212,000 selling price it had achieved.

When I arrived home, I decided to see just how well he really did and grabbed my calculator. I recognised that £3,100 was a lot of money in terms of 1964 purchasing power, and was curious what £3,100 would presently buy in real terms after adjusting for inflation. So using gold as the base for my calculations, I determined that the cost of his house in 1964 was 248 ounces, which at the £985 per ounce exchange rate prevailing when he sold his house were worth £244,000.

In other words, if he bought gold in 1964 and simply held on to it, he would have had £32,000 more purchasing power than he did in 1964. Thus, in real terms his house was worth £32,000, or 31.5 ounces of gold less than what he paid for it.

So despite being delighted by how well he had done, all things considered, he did not make a very good “investment”. In fact, his investment lost money, and I am not even considering here the amount of money he spent for maintenance, upkeep, taxes and other running expenses. But here is another important point he missed completely.

He was not making an investment by buying his house. He was buying shelter. That is the principal use of any home, and it is what he enjoyed for nearly five decades. And the shelter his house still provides is the reason that he was able to sell his house to someone else.

I think this example shows how misguided mainstream thinking has become. The ever-inflating fiat currencies used worldwide have terribly distorted what should be a simple, straightforward decision making process and means for thereafter evaluating your decision, like whether to buy a house for the shelter it provides.

The economies of many countries today have been devastated by real estate speculation. Easy money policies of central planners encouraged bank lending that created an artificial boom, much of which was the result of real estate speculation. These excesses that distort and make more difficult the decision-making process inevitably need to be unwound as banks and borrowers reduce their leverage to bring their balance sheets back to normal levels, a process which has been underway now for a few years. To better understand this process, I always recommend using gold to assist in your decision making process.