But have Honolulu homeowners really reaped fantastic returns during the 2002-2007 real estate bubble? We have to look beneath the surface statistics to find out. While this exercise is specific to Honolulu, I believe it may be equally valid in many other markets in the U.S.

Here is my conclusion: the real (inflation-adjusted) gains in Honolulu were reaped in the 1970-1981 period; all buyers since 1981 have essentially made nothing. Yes, the nominal value of their house has risen, but when we factor in inflation, we find no real gains from the top of the last real estate bubble in 1980-81.

The house I am using in located in the highly desirable neighborhood of Manoa Valley; I am familiar with this house because I used to live there.

My parents bought the modestly sized house (one-car garage) in 1971 for $45,000-- slightly less than the cost of a brand-new, much larger subdivision home in Hawaii Kai. A job transfer to the Mainland caused them to sell it two years later (1973) for $75,000. (I stayed to finish college, paying $120/month for a tiny studio in a rooming house, not far from President-Elect Obama's apartment.)

When my stepfather visited the property eight years later in early 1981, it was being sold for about $275,000.

The house has just sold for $550,000--even though the tax appraisal is listed at $805,000. I have no idea why the house was sold for $250,000 under its recent county valuation, but the MLS records show that it languished on the market for months in the $779,000 range earlier this year.

The sales price certainly suggests that appraised values as reflected by zillow.com and tax rolls may well be far above actual market prices as reflected by what people are willing to pay in November, 2008.

According to the Bureau of Labor Statistics inflation calculator, $275,000 in 1981 equals $655,000 in 2008 dollars. Thus an owner who bought this home in 1981 for $275,000 and sold it for $550,000 in 2008 actually lost money--$100,000 in 2008 dollars (more if we consider sales commission and transaction costs).

(I have no idea how many times the property was sold in the intervening years--the county records don't reflect that data.)

If the house had appreciated only at the rate of inflation in the years 1971-1981, the $45,000 value would have grown to $100,000. But at the top of the last housing bubble in 1980-81, the house was valued at around $275,000.

So the property more than doubled in real value (inflation-adjusted) in the years 1971-1981, but has since gained no real value, or even lost value. Even if this house had sold for $650,000, it would have gained no value at all since 1981 ($275,000 in 1981 = $655,000 today.)

Let's be generous and say the house "should have sold for $750,000." The owner would have gained $95,000 above the inflation-adjusted value of $655,000. Deduct the usual 7% transaction costs (about $50,000), and that leaves a rather modest $45,000 gain (in 2008 dollars) for 27 years of ownership--less than 1% per year.

Real estate is of course leveraged, so let's look only at the cash down payment. If we assume the buyer in 1981 put down 20% cash ("exotic" mortgages were unknown), then they invested $55,000 in cash. Adjusted for inflation, that $55,000 is worth $131,000 today--so a $45,000 gain works out to about a return of 34% on cash invested-- just slightly above 1% per year on 27 years of ownership.

Meanwhile the Dow Jones Industrial Average rose from around 800 in 1981 to 8,000 today, even after falling about 35% from its October 2007 peak: a ten-fold return. $55,000 invested in 1981 would still be worth over $600,000, if dividends had been reinvested.

Yes, I know about the tax benefits of home ownership, but let's not forget all the maintenance costs, too. Owning a house is not "free" even if you paid the entire purchase price in cash; there are property taxes and substantial upkeep costs. So as an investment, the calculations are not simple.

What is simple is that someone buying this house in 1980-81 for $275,000 actually lost $100,000 in selling it for $550,000 in 2008 when inflation is factored in. The evidence strongly suggests that Honolulu real estate has basically treaded water for 27 years, and all the nominal gain is just that: the real gains are either extremely modest (less than 1% per year) or actually negative.

Is this situation unique to Honolulu? Perhaps; but it does raise the question: how much of the supposedly gigantic gains of the 2002-2007 bubble were actually gains from the 1970-1981 period carried forward to the 2000s via inflation?

If this analysis holds true for other areas of the nation, we may find that the housing gains of the past 27 years have been essentially illusory.

New essay by Chris Sullins:

Operation SERF, Part I
(Chris Sullins, December 1, 2008)

Eduard Morgan sat in his wheelchair looking at a laptop on the kitchen table. A household wireless unit connected to a two-way home satellite system fed his browser with the latest news. He and a handful of other residents in his gated community were among the small minority of people in their city who still had regular access to the internet. Given the city’s frequent power outages and cable thefts outside his secure subdivision, household usage of the internet had dropped from its national peak only a few years ago.

The internet was well on its way to reverting back to its original users within the walls of government, education, and large corporations. Even without the loss of physical infrastructure supporting the hard-wired, few could afford it given the economic situation. The two-way home satellite system was a luxury even in Eduard’s neighborhood, but he still had some personal connections from his past professional career that cut him a good deal.

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