Wednesday, June 14, 2006

The best new articles

It seems there has been an explosion of "bubble danger" articles in the MSM during the last month. Seriously, what you've been reading in the blogs all this year (I started reading them 4 months ago and began blogging shortly thereafter) has finally been noticed/believed/corroborated/reported by the MSM. 2 months ago you still heard the NAR spin stated page and verse, with maybe 1 negative bubble article. The kool-aid was still flowing and the MSM seemed to be essentially agents (or the PR wing) of the RE/Mortgage lending industry. 1 month ago, we saw inclonclusive and/or mixed news articles, but still the blogs were mostly ignored or demonized (as if jinxed it). This month the MSM is dominated by stories of the impending housing bust and the repercussions that come along with it. The greater public is learning that the cynicism over the NAR's spin is well deserved and that the industry has been unethical - corruption and greed, while not all-inclusive seems to be "built-in" at some level (like many other industries). If it's human nature or the nature of business, I can't really object to systematic problems, but it's very sad that a lot of people have been suckered into financial ruin. Yikes, I sound like a liberal, which I'm definitely not. I think we need some good regulation to protect the general public from predatory lending. On the other hand, freedom means letting people make their own stupid choices. When there is money involved, keep your bullshit detector on high alert mode. In the end you have to be personally responsible to protect yourself - and maintain a skeptical attitide. Never believe the bullshit.

Here are some of the better and more relevant articles I've read in the last few days.

I Want My Bubble Back!

How to Profit From a Cooling Real Estate Market
Look who's renting
San Diego County home prices take a tumble
Housing bubble correction could be severe
More housing markets overvalued

Friday, June 02, 2006

Misconception: Renting is for Suckers

Misconception: Renting is for Suckers

I've been discussing this issue with friends recently and this article really does a nice job at delivering the relevant points. Timely indeed. I've copied this one in it's entirety but have bolded a few bits I find particularly insightful.

You’ve heard all the reasons that people want to stop renting. “I don’t want to waste my money.” Heck, you may have even said them yourself. Many of my friends are reaching that point in their lives where they’re considering buying a home. However it’s unfortunate that so many choose to buy over rent, especially in this expensive market, because many well-intentioned people are buying homes that are actually damaging their finances.

Despite the fact that many people disagree with me that the real estate market is going to deflate, there is a rule of thumb that I use that should give you an idea about how much you should spend on a home even if the market is in a slump.

For every $100 you spend in rent a month, you’d be better off buying up to $12,500 in property instead.

For example, I live in Northern New Jersey, and currently pay $1,000/mn for my 1 bedroom apartment. I would be better of financially if I were to buy a condo that cost up to $125,000. The only problem is that where I live, there’s nothing habitable that I can buy for under $125,000, and if I spend much more than that, it’ll actually cost me more money to buy than rent!!! Unfortunately this is a problem shared by my friends in major cities around the country.

Okay, you’re skeptical. I know it and I don’t blame you. So I’m going to prove to you right now, why my rule of thumb works.

The Proof is in the PITI

The great thing about a home is that you get to build equity. It’s like your home becomes this great big piggy bank and with every mortgage payment you’re saving more money. But, this privilege is not free. Unless you can pay for the entire cost of your house in cash, which is rare, banks offer loans to help individuals purchase the properties in exchange for interest.

Like rent money, mortgage interest is essentially “wasted.” It goes neither to improving the property nor to building equity. It’s simply a fee for the privilege of living in your house. And in addition to interest, you’re also required to pay property taxes and insurance every month as well. All these payments are known as the PITI payment, which stands for Principle, Interest, Taxes and Insurance, and is a single payment you pay to your bank, who then distributes your money to the government and insurance company.

Houses also have additional expenses, such as lawn care, maintenance, and big ticket expenses like a new roof, new appliances, or a new furnace. As renters we don’t have to worry about any of these expenses because most leases include them as part of your rent, meaning no extra money out of your pocket when the freezer stops freezing, and someone will install it for you! A responsible homeowner should set aside some money every month to pay for these expenses when they eventually occur (and they always do).

So there are a lot of extra expenses that are essentially wasted when you buy a home. Wasted in the sense that they don’t build equity, which aside from taxes and appreciation is the only real advantage to owning a home.

So let’s compare renting and buying

Buying a home should not be about what you can afford. It should be about wasting as little money as possible. For example, let’s say you can afford to pay $1,200/mn for a condo, but rents in your area are only $800/mn for a nice 1-bedroom. You’d actually be building more assets if you rented, and saved the extra $400/mn in a mutual fund.

So again, how do you determine when you should rent and when you should buy? When the combined home expenses, interest, taxes, and insurance equals your rent, that’s the point when you can and should buy a home.

I’ve run all kinds of numbers to prove out my theory, and when I look at it $12500:$100 seems to be the ratio I keep coming up with. If you pay more than that (especially as you near the $1400 level), you’re actually spending more money on your home than if you were renting. Of course this number changes slightly depending on your tax and insurance rates, but I’ve built a comfortable cushion in this ratio to cover the wide range of rates.

What about taxes, appreciation and multi-families?

Look, I like being appreciated just like the next guy, but this rule of thumb takes into account two assumptions. First, we can’t take into account taxes or price appreciation. With few exceptions, a home purchase should first make financial sense without taking appreciation into account, so that no matter what the price of your home does, you won’t be perched precariously over a financial disaster.

Because personal mortgage interest is deductible on your taxes, your overall tax burden is minimized at the end of the year. Because most of the interest in a mortgage is paid at the beginning of loan, your first year you would receive the greatest benefit. For a typical mortgage on a $125,000 house at today’s interest rates, you’d be spending about $7,400 on interest for the first year (it drops to $7300 in year 2). Of the deductible amount, the standard deduction may chop off a good hunk of that right away, so you’d be saving maybe an extra $1,200 on your taxes, and that’s for only the first year! The longer you have a mortgage the less you pay in interest a year, and the more inflation will eat away at your deduction. In either case, I don’t believe you should spend more money to have a bigger deduction.

In terms of appreciation, I think most people agree that the real estate market is going to slow. I personally believe that we’re going to experience serious price drops in major metropolitan areas, such as here in New Jersey. Renting is just too attractive an option for consumers, and the rents are too low for investors. If the prices of housing at the very least stagnate, we’ll see appreciation of less than 5% for the next few years, if not longer. That being the case, you’d be better off buying a mutual fund making 8 to 12%, even if you’d be affected by long-term capital gains taxes. Unless the real estate market is red hot in your area and you want to flip your property, don’t rely too much on appreciation.

[NOTE] Home price appreciation is magnified by leverage. If housing prices increase 5% and you only put 5% down, you’ve doubled your money your first year on paper. With a mutual fund, though, a 10% return is always 10% no matter how much you invest. In real estate taking control of a property for less than its value is known as leverage, and can lead to serious returns in booming markets. However housing prices are softening in many areas, and selling your home with a real estate agent can cost as much 6% of the value of your home, eating away at your sale price. For Sale By Owner (FSBO - “Fiz’ bow”) will help you avoid those costs, but in a buyer’s market can also lead to a significantly lower sale price. Is it possible to make a lot of money with price appreciation in the next 5 years? Of course. But don’t bank on it unless it’s a sure thing.

Additionally, this discussion only makes sense if you’re talking about buying a single family home (house/condo). When you throw multi-family into the mix, the discussion gets more complicated, so since the vast majority of people start off with a one-family we’ll use that as our basis. Becoming a landlord can be very financially rewarding and hopefully more people will choose that as an option to first-time home ownership.

Wrapping it up

If you take away anything from this article, I hope it’s the fact that there are many expenses involved in owning a home, especially when you’re just starting out and are struggling to afford a place to live. While it may be easy to think that home ownership is a way out of the rent trap, consider how much money (and don’t forget time) you’d actually be wasting every month just to own your home.

Unfortunately in most major cities these days, buying property is so darned expensive it doesn’t make sense for many of us to own until we get married and start families. But how bad is that really? Sure you have to deal with your neighbors, but renting means that someone else worries about your leaky faucet and broken washer, and that kind of good night’s rest is truly money in the bank.

Don’t get me wrong. I think homeownership is a wonderful thing, but think long and hard about the decision before you make the leap. Unless you can find a cheap condo somewhere or live in a market that hasn’t had the kind of price runups we’ve seen in the past 10 years, I think it makes more sense to start saving for your downpayment in a diversified mutual fund, and wait for prices to stabalize.

root cause of the housing bubble, pt. duex

From The Dallas Morning News Danielle DiMartino Column: Housing Troubles? Bank on It

The answer gets to the root cause of the housing bubble -- the credit binge.

Consider that only one of the 53 banks surveyed by the Federal Reserve through the three months ended in April said it had tightened lending standards. About 10 percent had the gumption to loosen standards further.

With no lending standards to speak of, it's been almost impossible to corral the speculation that drove sales and home prices to their bubbly heights.

"The Credit Binge"
- I love it!

Related to this issue is, of course, demand. Home sales are dropping and mortagage applications dropped, which obviously go hand in hand. But why? Fixed interest rates haven't gone up that much - their still in the mid-sixes. Well, 1.) the speculators are gone 2.) too many first time buyers have been priced out (esp. compared w/ the cheap rents). The Lenders loose standards (no-doc) and "creative loans" (I/O, neg am) have been the great enabler. It has in effect raised the ceiling of affordability, allowing people to buy homes they couldn't really afford. So as crazy as it is, the lenders who have loosened their lending standards, are doing so because their business is drying up. It's a downward spiral and a self fufilling prophecy of the worst sort.

My advice - Live Free. Debt free, that is!


This Forbes article is mcuh more pessimistic than I would expect. His predictions are stated very matter-of-factly. Here are some of the highlights.

With inventories high and sales falling, the ratio of inventory to sales flow is rising. Inventories for both new and existing homes have jumped from 3.5 months in 2003 to 5.8 months and 6 months, respectively. It is reasonable to expect those ratios to climb into the 6-to-8-month range of the real-estate-troubled early 1990s.

Already inventories since last year have jumped 91% in Boston, 236% in Miami and 149% in Los Angeles. Asking prices have been cut on one-third of listings in Boston, San Diego, Sacramento, Los Angeles and Miami. Nationwide median prices will probably fall at least 20% before the break is over. It will take a 35% fall to return prices to their long-run link to the Consumer Price Index; markets overshoot on the downside as well as the up.

Even a 20% price decline will be devastating for many homeowners. On average, those with mortgages have 37% equity in their abodes. Of those who borrowed or refinanced in 2005, 29% have zero or negative equity, calculates First American Real Estate Solutions.

A house-price collapse will be far worse than the 2000--02 bear market on Wall Street and will bring a serious global recession. Half of households own stocks or mutual funds, but 69% own homes. The resulting unemployment will kill many subprime borrowers' ability to make payments. Both Toll Brothers at the high end and dr Horton in the starter market will suffer.

Thursday, June 01, 2006

Prospering in the Housing Bust

How can you protect your savings or even find good investments during the downturn in the housing market?

Here's an interesting article from Forbes.

What if the U.S. goes into a full-on recession? Any ideas? Please list your comments and links in the commments (hint: use tinyurl if necessary)