This article was posted on Saturday, Aug 01, 2020

Continued . . . 

In the mid 1600’s the Dutch Republic was beginning its climb to global power. The Dutch traders, having a monopoly of trade with Japan and the East Indies, had become the middlemen between European nations and the Far East. For a period, Amsterdam’s population was doubling every 20 years (an annual growth of 3.53% compounded). Pressed for space, the city leaders authorized the three concentric canals referenced above (Canals, vide supra) that would arc around the city. The land along the canals would be divided into housing lots. It was a massive undertaking that doubled the size of the city and diverted the river. It required driving thousands of piles dozens of feet below the land surface and building scores of bridges . . . and thousands of brick houses. It took fifty years to complete.

Then the tulip mania met the plague.

Connected with the wealth flaunted by traders and ship owners, the Dutch had begun speculating on everything from tobacco to tulips. Over one 30 day period in 1637 the price of White Crown tulip bulbs shot from 64 guilders per 8 ounces in January to 1,668 guilders (the price of some houses in Amsterdam) in February. Then the bottom dropped out, and the market stabilized at around 38 guilders – about half the beginning price in the previous January. It has been argued that the plague, which hit the Netherlands in 1635 and arrived in Amsterdam in 1636, wiping out 14% of the population (~ 17,000 deaths) contributed to the ending of the tulip bulb bubble by creating a “gambling binge” mentality. 

These two concomitant catastrophes, one physical and the other financial, saw housing prices drop 36%. Piet Eichholtz says that that sort of thing, in which unpredictable disasters combine unpredictably, is relevant today. Think of COVID-19 and the Bubble-of-Everything: Nassim Nicholas Taleb’s “Black Swan” writ large. This should not be understood as a claim that housing crashes always follow a calamity. Sometimes they do and sometimes they don’t. They didn’t in New York City after September 11, 2001. Home prices there soared.

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Early on, the master plan marked the Herengracht, the new canal closest to the city center, as the most desirable. Lots were larger than they were on later canals. Noisy and smelly trades were prohibited. Wealthy traders (Nutmeg, Japanese porcelain) snapped up lots and built their large homes. In the five years from 1628 – 1633, the economy soared and real, inflation-adjusted prices of houses along the Herengracht doubled. Think of the prices of prime United States locations between 2000 and 2007. 

With wealth came new architectural fashions: new gable types and, on the Herengracht, larger houses built in the Italian fashion. The Franz family still lived at the oldest end of the canal, but their home’s Renaissance-style architecture dropped out of fashion. Newer homes along the classical Italian lines made the Franz house look dated. Prices peaked as the Dutch Republic achieved the apogee of its golden age in the 1650s and 1660s. By the mid-1600s, houses that sold in the 4,000-guilder range decades earlier were now selling for 9,000 to 15,000.

Then France and England declared war on the Dutch. The English attacked Dutch shipping and the French invaded by land. Holland got it from both sides and in the seven years from 1670 to 1677, houses on the Herengracht lost 56% of their value. At some point, the cycle began all over again as prices started back up. The long-term trend was that prices reach a cyclical peak then [something happens] and prices collapse, only to recover / collapse / recover / collapse, ad nauseam. That is no surprise to long-term real estate investors.

Every culture has expectations regarding how things should be. In some cultures, polite children do not look at the adult who is talking to them.  It is thought to be challenging the adult’s authority. In other cultures, the opposite is true; it is considered indifferent or disrespectful for a child to avoid looking at the adult who addresses them. Similarly, nomadic cultures do not have the same expectations regarding land as feudal cultures. And rational people in a flyover country do not normally anticipate rapid land appreciation (there is so much of it still undeveloped), whereas most landowners in gateway cities expect quite the opposite (due to limited undeveloped land). Fact is … most people who buy real estate in or around the larger cities have heard the pitch, “Real estate goes up significantly over time”. That phrase has sold a lot of property.

On an inflation-adjusted basis, however, that is incorrect.  Over long periods of time, real estate kind of keeps up with local inflation. Beachfront property goes up at a different rate than desert lots. The observation that real estate always appreciates faster than the rate of inflation is an artifact of the short term view. Sometimes it does, sometimes it doesn’t. When graphed, the cycle of real estate values appears as a sinesoidal wave reflecting the yield on available substitutable investments. Substitute investments because the upper level of real estate value is, at any given moment, capped at the yield on equally desirable substitute investments.

The Franz house illustrates the graph of the price cycle superimposed over the line of inflation. For conceptual purposes, think of inflation rising from the lower left corner of the graph to the upper right corner. There will be peaks and valleys, but over a long enough stretch the line will appear to smooth out – and with the Franz house we’re referencing a multi-century period so the drawn line will seem smooth.

When the arc of price is drawn over the line of inflation, the result will be a cyclical line, sometimes rising above inflation and sometimes dipping below it. The Franz data shows that over an extended time (a few centuries, in this case), the price line will swing reasonably equally on both sides of the line of inflation.

It is no surprise that price is heavily influenced by interest rates (i.e., the cost of money). As interest rates rise, prices soften and values decline. Think of the collapse in income properties in 1982, when the interest offered on Treasury bonds rose to the double-digits. Alternatively, in periods of cheap money (i.e., low interest rates), prices will rise above – sometimes well above – the cumulative rate of inflation. Consider 2017 to present. When this data is graphed and the cyclical line of price is drawn over the upwardly sloped line of inflation it becomes pretty clear that the price line crosses the inflation line twice in each secular economic cycle. After all, even a stopped clock is right twice a day.

An investor may experience several business cycles in his lifetime. If he is alert and buys income producing assets when interest rates are high (and values low) he can benefit mightily as rates subsequently decline and prices naturally rise. It is a myopic view of the highs and lows of the interest rate cycle that causes folks to observe only the part where rates decline and conclude that “Real estate goes up significantly over time”. Real estate values naturally fluctuate during any given business cycle, but (to repeat) over the long term, the intrinsic value of real estate rises with local inflation, as established with the Eichholtz study and referenced by Robert Shiller. Over the shorter term, the price of real estate is heavily impacted by the cost of money, expressed as the yield achievable on alternative investments.

The Fransz house illustrates the cycle of value superimposed on the line of compound inflation.  In 1855, a real estate agent named Robertus van Zoelen bought the house for 6,850 guilders. In 1881, (26 years later) his children sold it to a carpenter, Johann Diederich Brinkmann, for 12,100 guilders. That is an increase of 93% in real (inflation- adjusted) returns. But when Brinkmann sold it in 1888, (seven years later) it was for 10,000 guilders, a net loss. The next sale, (1899) at 9,600 guilders was also at a loss. Fifteen years later, on the eve of WWI, a real estate agent named Georges Jean Josef Salen bought it for 10,000 guilders, another loss in real terms. And in 1955, (41 years later and a full 100 years from van Zoelen’s purchase in the previous century) when Grietje Uitentuis bought the house, she paid 15,000 guilders. After adjusting for inflation, that was 30% less than the house sold for in 1855. Value cycled over time, but over a period of 100 years the house lost value in real terms. 

Pieter Fransz’s house last sold in 1983 when a Hungarian financial advisor and his wife, an English actress, sold it to a pair of doctors for 440,000 guilders. Prices on the Herengracht currently run from 1,000,000 guilders for a basic family house to 3,000,000 or more for mansions. Even assuming the Fransz house sold on the lower end, and accounting for inflation, this means that after taking 350 years to double its real value, the house tripled in value in the last 22 years.

Low or even negative long term appreciation is not surprising to Yale economist Robert J. Shiller. An analysis he made of home prices in the U.S., (1890-2005) showed an average annual increase of 0.4% – ($10,000 turned into $15,826).  Compare that to Prof. Jeremy J. Siegel (Wharton School of Business) whose calculations determined that over a long period, the stock market had an average annual real (inflation adjusted) rate of return of 6.8%. Applying that return to Shiller’s 115 year span would turn $10,000 into $19,306,000.

Eichholtz’s original study of the Fransz house on the Herengracht canal covered the period from 1628 to 1973. It established two investment-related characteristics of real estate:

  1. Over the long term, real estate values roughly track local inflation. Between 1628 and 1973, (the period of Eichholtz’s original study) real property values on the Herengracht (adjusted for inflation) went up 0.2% per year. That, approximately supports Shiller’s finding that U.S. home prices went up 0.4% annually between 1890 and 1973.
  2. Over any normal business (real estate) cycle, because it is capitalized at the rate of equally desirable alternative investments, real estate is vulnerable to significant fluctuation.

Notwithstanding miserly long-term appreciation cycling around the rate of inflation, there are reasons why institutions increasingly hold real estate as part of their portfolio.

NOTE:  This article is based on:

This article is for informational purposes only and is not intended as professional advice. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker specializing in difficult-to-place mortgages for any kind of property. If you are thinking of refinancing or purchasing real estate Klarise Yahya can help. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].