How falling real estate prices can affect an equities investor

One of my big mistakes as an investor was not seeing that a U.S. house price bubble deflation could affect the price of industrial equities (my main investment; I had faith in GE’s ability to sell jet engines in China and India even though I thought houses in Cincinnati were overvalued). Clearing off my desk from 2010, here’s a story from the Wall Street Journal (“Shareholders hit the roof over relocation subsidies”, October 25, 2010) about how whenever top managers at public companies change job, they’re compensated for any loss they might incur from selling their house. The Microsoft shareholders had to pay Stephen Elop $5.5 million in relocation costs, including $3.7 million to make up for the loss on his Los Altos mansion (separately, I would have loved to have gotten the $1.8 million furniture moving contract!).

How much will this take out of shareholders’ pockets? Let’s assume 5000 substantial public companies (e.g., the Wilshire 5000). Let’s assume that each company has 10 top executives, that turnover occurs every five years (2 execs per year), and that each one gets an average of $1 million if he or she sells a house in a down market. Peter Schiff in the WSJ on December 30, 2010 said they’d have to decline another 20 percent to get to the historical trend line (and Philip says the trend line itself is too high because it factors in continued robust growth for the U.S. economy, whereas in fact there has been little growth since 2007); the Dallas Federal Reserve Bank economists say another 23 percent drop is due. So let’s assume the down market in real estate lasts at least another 5 years. The Case-Shiller index peaked in 2006, so that means a total of 10 years of decline. That’s $2 million per public company per year and a total of $100 billion that will go to employees rather than shareholders.