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US Housing Crash Continues
It's A Terrible Time To Buy
Why?
Prices still disconnected from fundamentals. House prices are still far beyond any historically known relationship to rents or salaries. Rents are still less than half of mortgage payments. Salaries cannot cover mortgages except in the very short term, by using adjustable interest-only loans. Anyone who buys now will suffer losses immediately, and for the next several years at least.
Buyers borrowed too much money and cannot pay the interest. Now there are mass foreclosures, and senators are talking about taking your money to bail them out. Banks happily loaned whatever amount borrowers wanted as long as the banks could then sell the loan, pushing the risk onto Fannie Mae (ultimately taxpayers) or onto buyers of mortgage backed securities. Now that it has become clear that a trillion dollars in mortgage loans will not be repaid, Fannie Mae is under pressure not to buy risky loans and investors do not want mortgage backed securities. This means that the money available for mortgages is falling, and house prices will keep falling, probably for 5 years or more.
A return to traditional lending standards will mean a return to traditional prices, which are far below current prices.
Interest rates increases. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate.
For example, if interest rates are 5%, then $1000 per month ($12,000 per year) pays for a loan of $240,000. If interest rates rise to 7%, then that same $1000 per month pays for a loan of only $171,428.
Even if the Fed does not raise rates any more, all those adjustable mortgages will go up anyway, because they will adjust upward from the low initial rate to the current rate.
Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.
It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is 6%. On a $300,000 house, that's $18,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.
Shortage of first-time buyers. According to the California Association of realtors, the percentage of San Francisco Bay Area buyers who could afford a median-price house in the region plunged from 20 percent in July 2003 to 14 percent in July 2004. Strangely, the CAR then reported that affordability fell another 4 percent in 2005, yet claims affordability is still at 14%.
Surplus of speculators. Nationally, 25% of houses bought in 2005 were pure speculation, not houses to live in. It is now possible to buy a house with 103% financing. The extra 3% is to cover closing costs, so the speculator needs no money down. Even the National Association of House Builders admits that "Investor-driven price appreciation looms over some housing markets."
Fraud. It has become common for speculators take out a loan for up to 50% more than the price of the house he intends to buy. The appraiser goes along with the inflated price, or he does not ever get called back to do another appraisal. The speculator then pays the seller much less than the loan amount, and uses the extra money to make mortgage payments on the unreasonably large mortgage until he can find a buyer to take the house off his hands for more than he paid. Worked great during the boom. Now it doesn't work at all, unless the speculator simply skips town with the extra money.
Baby boomers retiring. There are 77 million Americans born between 1946-1964. One-third have zero retirement savings. The oldest are 61. The only cash they have is equity in a house, so they must sell.
Huge glut of empty housing. Builders are being forced to drop prices even faster than owners. They overbuilt and have huge excess inventory that they cannot sell at current prices.
The best summary explanation, from Business Week: "Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low interest rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken."
Who disagrees
that house prices will continue to fall? Real estate related businesses disagree, because they don't make money if buyers do not buy. These businesses have a large financial interest in misleading the public about the foolishness of buying a house now.
Buyers' agents get nothing if there is no sale, so they want their clients to buy no matter how bad the deal is, the exact opposite of the buyer's best interest. Agents take $100 billion each year in commissions from buyers. Agents claim the seller pays the commission, but always fail to mention that the seller gets that money from the buyer. Think about it: who brings the money to the table - the seller or the buyer? All money comes from buyers. No buyer, no money.
If a stock broker were to charge 6% on the sale of stock, he would go out of business that same day. Real estate brokers don't do much more than stock brokers, so why should you give up nearly two years of your working life earning money to pay a realtor for the few hours they may put into helping you buy or sell a house? 6% of the 30 years it takes to pay off a house is 1.8 years of donating your working time to your realtor.
There are good buyer's agents who really believe they are helping the buyer, but they in denial about their conflict of interests. Author Upton Sinclair had a great explanation for this: "It is difficult to get a man to understand something when his salary depends on his not understanding it."
Mortgage brokers take a percentage of the loan, so they want buyers to take out the biggest loan possible.
Banks get origination fees and then sell most mortgages, so they do not care about the potential bankruptcy of borrowers. They will lend far beyond what buyers can afford because they lose nothing if the buyer defaults. Banks sell most loans to the government agencies Fannie Mae or Freddie Mac. The conversion of low-quality housing debt into "high" quality Fannie Mae debt with the implicit backing of the federal government is the main support for the housing bubble. That is ending as Fannie Mae shrinks.
The alternate way for banks to dump the risk of loan default has been the Wall Street market for mortgage backed securities. Now that mass foreclosures have eliminated the subprime portion of the loan-resale market, banks are under pressure to increase loan quality.
Appraisers are hired by mortgage brokers and banks, so they are going to give the appraisals that mortgage brokers and banks want to see, not the truth. Appraisers that kill a deal by telling the truth do not get called back to do other appraisals.
Newspapers earn money from advertising placed by realtors, lenders, and mortgage brokers, so papers are pressured to publish the real estate industry's unrealistic forecasts, and to avoid the fatal words: "prices are falling". Instead, we may sometimes hear about "softening" or "easing" prices, which sounds so pleasant...
Worse, realtors have a near-monopoly on sale price information, and newspaper reporters never ask realtors hard questions like "how do we know you're not lying about those prices?" The result is an endless stream of stories reporting that David Lereah of the NAR says it's a good time to buy. Asking the NAR about housing is like walking into a used car dealership and asking the salesman if today would be a good day to buy a car.
Owners themselves do not want to believe they are going to lose huge amounts of money.
What are their arguments?
Renting is just throwing money away.
FALSE, renting is now much cheaper per month than owning. If you don't rent, you either:
Have a mortgage, in which case you are throwing away money on interest, tax, insurance, maintenance.
Own outright, in which case you are throwing away the extra income you could get by converting your house to cash, investing in bonds, and renting a place to live. This extra income could be 50% to 200% beyond rent costs, and for many is enough to retire right now.
Either way, owners lose much more money every month than renters. Currently, yearly rents in the San Francisco Bay Area are about 2% of the cost of buying an equivalent house. This means a house is returning about 2%, and it is a bad investment. Pretty much any other investment is better. If you don't like risk, put your money in US Treasuries at 5%. If you don't mind some risk, you may want to try index funds, which typically return about 10%.
Landlords are loaning a house to their tenants at a 2% interest rate. This is a fantastic deal for renters. When it is possible to borrow a million dollar house for 2% yearly rent at the same time a loan of a million dollars in cash costs 6% interest, plus 1% property tax, plus 1% maintenance, something is clearly broken. Renters are enjoying an extreme discount.
There are great tax advantages to owning.
FALSE. The tax advantage is not significant compared to the large monthly loss from owning. Renting is a loss of course, but buying is a much bigger loss.
Compare the cost of owning to renting.
Many people believe you can just reduce your income tax by the amount you pay in interest, but they are wrong. Buyers may not deduct interest from income tax; they deduct interest from taxable income. Interest is paid in real pre-tax dollars that buyers suffered to earn. That money is really entirely gone, even if the buyer didn't pay income tax on those dollars before spending them on mortgage interest. You don't get rich spending a dollar to save 30 cents!
Buyers do not get interest back at tax time. If a buyer gets an income tax refund, that's just because he overpaid his taxes, giving the government an interest-free loan. The rest of us are grateful.
If you don't own a house but want to live in one, your choice is to rent a house or rent money to buy a house. To rent money is to take out a loan. A mortgage is a money-rental agreement. House renters take no risk at all, but money-renting owners take on the huge risk of falling house prices, as well as all the costs of repairs, insurance, property taxes, etc. Since you can rent a house for 2% of its price, but have to pay 6% to borrow the equivalent amount of money, it is much cheaper to rent the house than to rent the money.
A rental house provides good income.
FALSE. Rental houses provide very poor income in the most bubble areas and certainly cannot cover mortgage payments.
Remember that it's pointless to do the work of being a landlord if you can make more money with no risk, no work, and no state income tax by buying a US treasury bond. And money in treasury bonds would be liquid and secure.
That said, there are many parts of the US where it does make sense to buy because mortgage payments are less than rents in those areas. They are generally rural areas away from the coasts, and have not seen the same bubble that the coasts have.
OK, owning is a loss in monthly cash flow, but appreciation will make up for it.
FALSE. Appreciation is negative. Prices are going down, which just adds insult to the monthly injury of crushing mortgage payments.
As soon as prices drop a little, the number of buyers on the sidelines willing to jump back in increases.
FALSE. There are very few buyers left, and those who do want to buy will be limited by increasing difficulty of borrowing now that many subprime lenders have gone bankrupt.
No one has to buy, but there will be more and more people who have no choice but to sell as their payments rise. That will keep driving prices downward for a long time.
House prices never fall.
FALSE. San Francisco house prices dropped 11 percent between 1990 and 1994. Buyers in SF in 1990 did not break even in dollar amounts until about 1998. So those buyers effectively loaned their money to the sellers for 8 years at no interest, losing all the while to inflation. With inflation, 1990 buyers truly broke even only about the year 2000, ten years after buying.
Los Angeles' average house plummeted 21 percent from 1991 to 1995, and of course there have been many similar crashes all around the US. The worst may have been after the oil bust in the 1980's, when Colorado condos lost 90% of the value they had at their peak.
House prices don't fall to zero like stock prices, so it's safer to invest in real estate.
FALSE. It's true that house prices do not fall to zero, but your equity in a house can easily fall to zero, and then way past zero into the red. Even a fall of only 4% completely wipes out everyone who has only 10% equity in their house because realtors will take 6%. This means that house price crashes are actually worse than stock crashes. Most people have most of their money in their house, and that money is highly leveraged.
We know it will be a soft landing, since it says so in the papers.
FALSE. Prices could fall off a cliff. No one knows exactly what will happen, but the risk of a sudden crash in prices is severe. As Yale professor Robert Shiller has pointed out, this housing bubble is the biggest bubble in history, ever. Predictions of a "soft landing" are just more manipulation of buyer emotions, to get them to buy even while prices are falling.
Most newspaper articles on housing are not news at all. They are advertisements that are disguised to look like news. They quote heavily from people like realtors, whose income depends on separating you from your money. Their purpose is not to inform, but rather to get you to buy. When you see an statistic that says everything is fine, look at the source. Is it from someone who needs you to believe in the housing market so that they can take your money?
The bubble prices were driven by supply and demand.
FALSE. Prices were driven by low interest rates and risky loans. Supply is up, and the average family income fell 2.3% from 2001 to 2004, so prices are violating the most basic assumptions about supply and demand.
The www.census.gov site has data for Santa Clara County for the years 2000-2003 which shows that the number of housing units went up at the same time that the population decreased: year units people
2000 580868 / 1686474 = 0.344 housing units per person
2001 587013 / 1692299 = 0.346
2002 592494 / 1677426 = 0.353
2003 596526 / 1678421 = 0.355
So housing supply in Santa Clara County increased 3% per person during those years. There is an oversupply compared to a few years ago, when prices were lower.
At a national level, there is a similar story in the years 2000 to 2005:
2000 115.9M / 281M = 0.412 housing units per person
2005 124.6M / 295M = 0.422
At a national level, there is 2.4% more housing per person now than in 2000. So national prices should have fallen as well.
The truth is that prices can rise or fall without any change in supply or demand. The bubble was a mania of cheap and easy credit. Now the mania is over.
They aren't making any more land.
TRUE, but sales volume has fallen 40% in the last year alone. It seems they aren't making any more buyers, either.
As a renter, you have no opportunity to build equity.
FALSE. Equity is just money. Renters are actually in a better position to build equity through investing in anything but housing. Renters can get rich much faster than owners, just by investing in reasonably conservative stocks or index funds. The stock market is much better than the housing market in the long run.
Owers are losing every month by paying much more for interest than they would pay for rent. The tax deduction does not come close to making owing competitive with renting.
Owers are losing principal in a leveraged way as prices decline. A 14% decline completely wipes out all the equity of "owners" who actually own only 20% of their house. Remember that the agents will take 6%.
Owers must pay taxes simply to own a house. That is not true of stocks, bonds, or any other asset that can build equity. Only houses are such a guaranteed drain on cash.
Owers must insure a house, but not most other investments.
Owers must pay to repair a house, but not a stock or a bond.
If you rent you are a buyer. You are just buying it for someone else.
FALSE. It may be true that rent covers mortgage payments in some places like South Dakota, but not in any of the markets that have shot up in the last few years. Rents are much less than mortgages in most places now. No landlord buys with the intention to rent out in California because that's not profitable. The owner is generously subsidizing the renter, a wonderful thing for renters during this crash.
If you don't own, you'll live in a dump in a bad neighborhood.
FALSE. For the any given monthly payment, you can rent a much better house than you can buy. Renters live better, not worse. There are downsides to renting, such as being told to move at the end of your lease, or having your rent raised, but since there are thousands of vacant rentals, you can take your pick and be quite happy renting during the crash. There are similar but more severe downsides to owning anyway, such as being fired and losing your house, or having your interest rate and property taxes adjust upward. Remember, property taxes are forever.
Some people want the mobility that renting affords. Renters can usually get out of a lease and move anywhere they want within one month, with no real estate commission.
It is much easier and cheaper to rent a house in a good school district than to buy a house in the same place.
A fun trick to rent a good house cheap: go to an open house, take the real estate agent aside, and ask if the owner is interested in renting the place out. Often, desperate sellers will be happy to get a little rental cash coming in and give you a great deal.
The biggest upside is hardly ever mentioned: renters can choose a short commute by living very close to work or to the train line. An extra two hours every day of free time not wasted commuting is the best bonus you can ever get.
Owners can change their houses to suit their tastes.
FALSE. Even single family detached housing is often restricted by CC&Rs and House Owner's Associations (HOAs). Imagine having to get the approval of some picky neighbor on the "Architectural Review Board" every time you want to change the color of your trim. Yet that's how most houses are sold these days.
In California, the HOA can and will foreclose on your house without a judicial hearing. They can fine you $100/day for leaving your garage door open, and then take your house away if you refuse to pay. There's a good HOA blog here.
If and when the market goes south, you can walk away.
FALSE. If you hand the bank the keys, they are likely to hand you a 1099 form showing "passive income" for the amount of your debt. You then owe tax on that amount.
A reader who lived through the 1989 housing crash in LA gave the following example:
Let's say you buy a house for $400,000, with a $350,000 mortgage.
Then the house drops in value to $300,000, you lose your job, or otherwise must move.
If you can't make your payments, the bank forecloses on you and nets $250,000 on the sale of your house at auction.
The bank's $100,000 loss on the mortgage is "forgiveness of debt" in the eyes of the IRS, and effectively becomes $100,000 of reportable income you must pay tax on. In many states, like California, the bank issues a 1099 to you for that amount and informs the IRS.
This is true even for "non-recourse" loans, where the bank cannot go after any of your personal assets. They let the IRS punish you instead.
If you refinance or take a home equity loan, the new loan is probably a recourse loan, and the bank can get very aggressive in going after your bank accounts, your stock, your car, etc.
It is true that buyers who put zero down, have no assets, and have nothing invested in the house are much more likely to walk away. The large number of new and essentially bankrupt buyers increases the risk of a horrifying crash in prices rather than a "soft landing".
The house down the street sold for 25% over asking, and that proves the market is still hot.
FALSE. Realtors try to create the false impression of a hot market by deliberately "underpricing" a house. Say a seller's agent knows that house will probably go for $400,000. He places ads asking $300,000 instead. (Bait-and-switch is illegal when selling toasters, but apparently not when selling houses.) The goal is to first of all prevent buyers from knowing what a realistic price is, and secondly to get buyers to blindly bid against each other. There are four players in this game and three of them are against the buyer -- the seller, the seller's agent, and the buyer's agent. Yes, the buyer's own agent works against the buyer, because there is no commission if there is no sale. There's a saying in Las Vegas: "There's a patsy in every game, and if you don't know who the patsy is, you're it."
If you want to prove your agent is not on your side, ask to see houses "for sale by owner" or houses listed by discount brokers. If the agent cannot make a commission, you will not be told about the house.
There is a way around the conflict of interest inherent in being a buyer's agent: let the seller's agent be your agent too, just for that one house he's trying to sell. Then the seller's agent has a big motive to lower the price, because he will get double the comission if you buy it rather than some buyer with his own agent.
Update: the underpricing game is now over. You are free to bid far lower than the asking price. You might be pleasantly surprised to find out how desperate the sellers are. Another good reason to start low: you can always raise your offer, but you can't lower it. A suggestion from a reader: have all your friends bid extremely low for the house before you, then your own low bid will seem more reasonable.
I was lucky that my realtor told me to increase my bid by $50,000. Otherwise I would have lost, because my realtor knew about a secret bid $40,000 above mine.
FALSE. Your agent gets paid nothing if you don't buy the house, and he gets more if you waste more money by bidding too high. Those are two big motives to invent false bids.
The MLS proves things are great.
FALSE. All sorts of funny things happen in the MLS (Multiple Listing Service, a private database controlled by real estate agents). For example, if a house just doesn't sell, realtors can remove its record in the MLS so that you cannot see that it failed to sell. Then the house comes back on the market at a lower price, and unsuspecting buyers think it's on the market for the first time. Their realtor can "prove" it's a new listing by showing the MLS record to the buyer: "See, here's the listing date, just came on the market. Better hurry and buy it, this one is hot."
There is nobody checking that the MLS shows true transaction prices. The MLS prices are often just wrong.
Furthermore, the MLS will not list any house for sale by owner or for sale through a discount broker, except perhaps those listed by Help U Sell. Those cheaper prices are just not in the system, because if you save money, they lose money.
My city is a special place that will always be expensive.
TRUE, but it was just as special when it was half as expensive ten years ago, so being special does not account for the run up in prices.
Many people are confused about the difference between high prices and increasing prices. Prices are high, but they are not increasing. They are falling. Falling prices make housing a bad investment.
Rich Chinese (or Europeans, or Arabs) are driving up housing prices.
FALSE. The percentage of US houses bought by rich foreigners is tiny. Furthermore, American housing is clearly a bad investment at this point. Foreigners can just wait and watch both the dollar and American housing continue to fall, and then buy for much less in a few years. Rich foreign investors are not dumb enough to buy into a badly overpriced market, but your broker is hoping that you are.
There's always someone predicting a real estate crash.
TRUE, yet irrelevant. There are very real crashes every decade or so. Even a broken clock is right twice a day.
But housing was high when interest rates were 21%, so higher interest rates don't matter.
FALSE. Inflation was much higher then, so fixed debt was easier to pay off with increasing salaries. Now we have adjustible mortgages and stagnant salaries.
House price increases exactly mirror the increase in mortgage debt. According to the Washington Times: "Consumers have doubled their mortgage debt from $3.5 trillion to $7 trillion since 1996, borrowing and spending profusely on the assumption that house prices will keep rising." So the increase in house prices is not backed by assets. It's backed by debt. The debt in turn is backed by the houses. It's just smoke and mirrors.
Local incomes justify the high prices.
FALSE. Most bankers use a multiple of 3 as a "safe" price to income ratio. We are well beyond the danger zone, into the twilight zone. The price to income ratio is currently around 10.
Look, housing continued to rise after the 2001 stock market crash, so it will always rise.
FALSE, consider the turkey in the farmer's barnyard. He thinks the farmer will always come feed him and not ask for anything. Then Thanksgiving comes. Whack. Past performance is no indication of future results.
Rent can go up, but a 30-year fixed mortgage payment cannot.
TRUE, but irrelevant. House owners lose even with a fixed mortgage, because the price of a house falls as interest rates go up. Most owners want to sell within 7 years of moving in, and many have to sell because of job loss, illness, or divorce. No one can afford what the owner paid for it, so the owner has to take a large loss. Renting it out will not come close to covering the mortgage. Inflation-adjusted rents have actually fallen in the last few years.
You have to live somewhere.
TRUE, but that doesn't mean you should waste your life savings on a bad investment. You can live in the same kind of house by renting during the crash. A renter could save hundreds of thousands of dollars, not only by paying less every month, but by avoiding the devastating loss of his downpayment.
Newspaper articles prove prices are not falling.
FALSE. The numbers in the papers are not complete and have murky origins. Those prices are "estimated" from the county transfer tax and making that tax public record is optional. A buyer who does not want you to see how little he paid has only to ask to put the transfer tax on the back of the deed and it will not show up on computer searches of the deed, which show only the front. Others voluntarily pay more tax than they have to, in order to inflate the apparent price to fool the next buyer. At a tax rate of about $1 per thousand of sale price, as in San Mateo county, you have to pay only $100 extra tax to make your purchase price look $100,000 higher.
Even though you can in theory go to your county building and get sale price information, in reality the county will give it to you in a painfully slow and inconvenient way. For example, in Redwood City's county building there are PC's where you can look at data for any particular house, but you cannot print, you cannot save to a floppy disk, you cannot email data out. All you can do is write things down manually, one at a time. And that's how real estate interests like it. Your elected representatives are serving them, not you.
Supposedly impartial sources like Dataquick are paid for entirely by people with a large financial interest in "proving" that prices are not falling, like realtors. This makes it unwise to take their numbers at face value.
For the obviously biased sources like the National Association of realtors, you can be sure that their sales price numbers do not include the effective price reductions from "incentives" like upgrades, vacations, cars, assumed mortgages and backroom cash rebates to buyers.
If you remember the definition of the median (the number for which half the prices are above, and half the price are below) you'll see that the elimination of sales at the low end of the market makes the median rise, even though the actual price of all houses is falling. And this is what is happening, as first-time buyers find themselves completely priced out of the market. So a rise in the median price can mask the fact that the price for every house is falling.
Finally, note that housing prices per square foot have been falling much longer and by a larger amount than "average house price".
My appraisal proves what my house is worth.
FALSE. "An appraisal in its typical residential real estate form is little more than a comparative analysis conducted by someone with no skin in the game offering confirmation that other lemmings are paying too much for their houses as well." -from an article on morningstar.com
Amazingly, government house price measures do not include houses with mortgages greater than $417,000. This excludes well over half of all houses in California. So the government can report a slight price rise, but fail to mention that prices actually fell for the other 60% of houses in California.
It's not a house, it's a home.
FALSE. It's a house. Wherever one lives is home, be it apartment, condo, or house. Calling a house a "home" is a manipulation of your emotions for profit.
As a realtor said to me, "a house is a wooden box that sits out in the rain and slowly rots. No one would buy in this market if they really thought about how much pain it's going to cause them in the long run. That's why we have to sell them a home, not a house."
If you don't buy now, you'll never get another chance.
FALSE. This argument was also popular in 1989 in Los Angeles, just before a huge crash. It's silly. If no one like you ever gets another chance to buy a house, then you will not be able to sell your house in a few years either, because there will be no more buyers like you ever again.
Here is a great quote from June Fletcher, a Wall Street Journal reporter, that says it all: "The real issue isn't whether you will be stuck being a renter all your life, she says. Its whether you'll get so scared about being shut out that you'll buy at the market's peak and be stuck in a property you can't afford or sell."
Property in the Bay Area is a luxury good, and so will be less affected by economic downturns.
FALSE. 82% of last year's Bay Area mortgages were ARMs, and ARM loans are not taken out by the rich. People on the border of bankruptcy take out ARMs because they can't afford fixed rate loans. The rich don't have loans at all.
Many of these ARM loans have exceptionally deadly repayment terms, and so are known as "neutron mortgages". Like the neutron bomb, they destroy people, but leave buildings standing. They are also known as "suicide loans".
Housing will be permanently higher since downpayments are now obsolete.
FALSE. The current wave of defaults is making downpayments suddenly seem like a good idea again. Lending standards are already improving.
House ownership is at a record high, proving things are affordable.
FALSE. The percentage of their house that most Americans actually own is at a record low, not a high. We do have a record number of people who have title to a house because they have dangerous levels of mortgage debt, but that is no cause to celebrate.
Houses are worth whatever fools will pay for them.
FALSE. At interest rates of 6%, houses are worth at most 17 times what you can rent them out for per year. You can get 6% with no work and very little risk in the bond market, so why accept less than 6% return (called rent) on your capital in the very risky housing market?
Here is a page explaining how to value a house.
Limited land means prices will always go up.
FALSE. Japan has a much more severe land shortage than America, but that hasn't stopped prices from falling for 14 years straight. Prices in Japan are now at the same level they were 23 years ago. If we really had a housing shortage, there would not be so many vacant rentals.
All my owner friends are telling me that prices are going up. They must be right.
FALSE. Owners never admit that prices are falling, because they would have to admit they made a huge mistake by buying. For a less biased view, do a poll of renters instead.
Rents could shoot up, making it a better deal to buy.
FALSE. Rents are limited by the money people actually earn, not by how much they can borrow. Try walking into a bank and asking for a million dollar loan to pay rent with.
What if the market goes up and sellers stop offering price reductions and paid closing costs to buyers? I am a renter and I have been thinking that is time to buy RIGHT NOW.
FALSE. The odds that prices will suddenly reverse and start going up are pretty much zero. This is the biggest bubble in history, ever, and it has years to go to unwind. Foreclosures have been rising exponentially. Prices are likely to go much lower every year for five to ten years before they go higher.
It would take another 911 terrorist attack or a major earthquake that wipes out this area in order for the price to fall by 50%.
FALSE. Even with a 50% decline in prices to $350,000 or so, the median price in the Bay Area will still be roughly double the median price in most of America, and the median Bay Area household income of about $70,000 will still not be sufficient to buy a house. So a 50% decline is well justified by the fundamentals.
You can easily verify for yourself that rents are less than half of long-term house ownership costs. Just look in the papers at sale prices, multiply by 6%, and divide by 12 to get the approximate monthly interest payment + property tax + repairs. Costs are actually about 8% with all that, but the income deduction brings it down to about 6%. Then look at the rental rates for equivalent houses. Which loss per month is larger?
Housing is a hedge against inflation, so you should buy now anyway.
FALSE. Interest rates go up with inflation, and higher interest will be the last straw for ARM mortgages in the Bay Area. Their defaults and foreclosures will drive down the cost of housing for everyone else around here. Remember that 82% of recent Bay Area mortgages were adjustable. There is little chance that salaries of ARM owners can keep up with inflation because of two billion people in India and China who would be happy to do their jobs for much less money.
Inflation will wipe out most of my mortgage for free.
FALSE. Banks would rapidly go out of business if they did not account for inflation. Since banks have been in business for a long time, you can be pretty sure your mortgage interest checks pay for inflation as well as for a good profit for the bank. That profit to the bank is a real loss to you.
Inflation does have the effect of making people think they have housing value gain when they really do not. If your house price rises only at the rate of inflation, you are not actually gaining anything at all. Any nominal gain below the rate of inflation is a nominal gain, but a real, adjusted-for-inflation loss.
Houses always increase in value in the long run.
FALSE. House values are actually constant. Adjusted for inflation, prices in the Netherlands, for example, rose less than one quarter of one percent annually in the 350 years since their tulip bubble. Warren Buffett and Charles Schwab have both pointed out that houses don't increase in intrinsic value. Unless there's a bubble, house prices simply reflect current salaries and interest rates. Consider a 100 year old house. Its value in sheltering you is exactly the same as it was 100 years ago. It did not increase in value at all. It did not spontaneously get bigger, or renovate itself. Quite the opposite - the house drained cash from its owners for 100 years of maintenance and taxes. Its price went up about as much as salaries went up.
My grandmother always used to complain about the cost of milk. "Why, when I was a girl, a gallon of milk cost a dime! Just look at how much people are overcharging for milk now." I asked her how much people got paid back then. "Oh, about $15 a week", came the reply. Hmmm, sounds very much like the reasoning people use now when they talk about how much their father's house appreciated "in the long run" without considering that salaries rose a proportional amount.
Maybe we should just accept that we missed out on a great opportunity to get into the real estate in the past N years.
FALSE. Did we all miss out on a great opportunity to get into the stock of pets.com or other Internet companies with no business model? The real question is what is likely to happen in the next few years according to fundamental economics. The answer is a huge crash. The last guy to buy into the bubble will get hurt the most.
You're saying no one should ever buy a house.
FALSE. While a house is almost always a poor investment, it is a safe time to buy a house for enjoyment when:
a 30-year mortgage + tax + insurance + maintenance is less than 30% of your gross pay and
the loss from interest, tax, insurance, and maintenance is less than rent on an equivalent place and
you plan on staying put for 10 years or more
You failed to factor in emotion. More houses are sold on emotion than will ever be sold based on perceived value. They buy all they can afford plus.
FALSE. Buyer emotion doesn't matter at all to the lenders, not on the way up or on the way down. Most people will borrow more than they can afford, but only if the lender goes along. The whole thing was a party of cheap and easy credit. When the credit machine gets sober again, millions of people are going to be ruined. Foreclosure rates are already going up exponentially.
My wife will divorce me if I don't buy a house.
FALSE. She will divorce you after you do buy a house and go bankrupt trying to pay the mortgage. She won't divorce you if you rent a much nicer place than you can buy, and take her to Paris for a month each spring, which you can do just by avoiding that mortgage.
If she's religious, you could also point out Proverbs 22:7: "The rich rule over the poor, and the borrower is servant to the lender."
I just want to own my own house.
TRUE, most people do and that's fine. Buyers will get their chance when housing costs half as much and they have saved a fortune by renting. House ownership is great - unless you ruin your life paying for it. If you can save even just 10% on the price of a house, you can retire several years earlier than you would otherwise. If you can save 50%, then you can easily take a ten year vacation and still come out ahead.
As reader Sean Olender put it: "Many people have forgotten that the number one restriction on their future freedom to do what they want, when they want, and to go where they want isn't the Iraqis, or Iranians, or North Koreans -- it's their mortgage lender."
What should you do?
If you own, consider selling so you can actually keep some of that funny money that appeared out of thin air. Otherwise, it will be painful to watch it vaporize back into thin air. Investors in mortgage-backed securities subsidized the increase in the price of your house. Now they want their money back, and your challenge is to prevent them from getting it. The only way is to sell before your neighbors do.
If you want to buy, look around and see that house prices are falling. Why hurry to buy into a falling market? Save your cash and buy for much less in the future. Find a nice cheap rental, invest your savings every month, and enjoy the show till then
It's A Terrible Time To Buy
Why?
Prices still disconnected from fundamentals. House prices are still far beyond any historically known relationship to rents or salaries. Rents are still less than half of mortgage payments. Salaries cannot cover mortgages except in the very short term, by using adjustable interest-only loans. Anyone who buys now will suffer losses immediately, and for the next several years at least.
Buyers borrowed too much money and cannot pay the interest. Now there are mass foreclosures, and senators are talking about taking your money to bail them out. Banks happily loaned whatever amount borrowers wanted as long as the banks could then sell the loan, pushing the risk onto Fannie Mae (ultimately taxpayers) or onto buyers of mortgage backed securities. Now that it has become clear that a trillion dollars in mortgage loans will not be repaid, Fannie Mae is under pressure not to buy risky loans and investors do not want mortgage backed securities. This means that the money available for mortgages is falling, and house prices will keep falling, probably for 5 years or more.
A return to traditional lending standards will mean a return to traditional prices, which are far below current prices.
Interest rates increases. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate.
For example, if interest rates are 5%, then $1000 per month ($12,000 per year) pays for a loan of $240,000. If interest rates rise to 7%, then that same $1000 per month pays for a loan of only $171,428.
Even if the Fed does not raise rates any more, all those adjustable mortgages will go up anyway, because they will adjust upward from the low initial rate to the current rate.
Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.
It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is 6%. On a $300,000 house, that's $18,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.
Shortage of first-time buyers. According to the California Association of realtors, the percentage of San Francisco Bay Area buyers who could afford a median-price house in the region plunged from 20 percent in July 2003 to 14 percent in July 2004. Strangely, the CAR then reported that affordability fell another 4 percent in 2005, yet claims affordability is still at 14%.
Surplus of speculators. Nationally, 25% of houses bought in 2005 were pure speculation, not houses to live in. It is now possible to buy a house with 103% financing. The extra 3% is to cover closing costs, so the speculator needs no money down. Even the National Association of House Builders admits that "Investor-driven price appreciation looms over some housing markets."
Fraud. It has become common for speculators take out a loan for up to 50% more than the price of the house he intends to buy. The appraiser goes along with the inflated price, or he does not ever get called back to do another appraisal. The speculator then pays the seller much less than the loan amount, and uses the extra money to make mortgage payments on the unreasonably large mortgage until he can find a buyer to take the house off his hands for more than he paid. Worked great during the boom. Now it doesn't work at all, unless the speculator simply skips town with the extra money.
Baby boomers retiring. There are 77 million Americans born between 1946-1964. One-third have zero retirement savings. The oldest are 61. The only cash they have is equity in a house, so they must sell.
Huge glut of empty housing. Builders are being forced to drop prices even faster than owners. They overbuilt and have huge excess inventory that they cannot sell at current prices.
The best summary explanation, from Business Week: "Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low interest rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken."
Who disagrees
that house prices will continue to fall? Real estate related businesses disagree, because they don't make money if buyers do not buy. These businesses have a large financial interest in misleading the public about the foolishness of buying a house now.
Buyers' agents get nothing if there is no sale, so they want their clients to buy no matter how bad the deal is, the exact opposite of the buyer's best interest. Agents take $100 billion each year in commissions from buyers. Agents claim the seller pays the commission, but always fail to mention that the seller gets that money from the buyer. Think about it: who brings the money to the table - the seller or the buyer? All money comes from buyers. No buyer, no money.
If a stock broker were to charge 6% on the sale of stock, he would go out of business that same day. Real estate brokers don't do much more than stock brokers, so why should you give up nearly two years of your working life earning money to pay a realtor for the few hours they may put into helping you buy or sell a house? 6% of the 30 years it takes to pay off a house is 1.8 years of donating your working time to your realtor.
There are good buyer's agents who really believe they are helping the buyer, but they in denial about their conflict of interests. Author Upton Sinclair had a great explanation for this: "It is difficult to get a man to understand something when his salary depends on his not understanding it."
Mortgage brokers take a percentage of the loan, so they want buyers to take out the biggest loan possible.
Banks get origination fees and then sell most mortgages, so they do not care about the potential bankruptcy of borrowers. They will lend far beyond what buyers can afford because they lose nothing if the buyer defaults. Banks sell most loans to the government agencies Fannie Mae or Freddie Mac. The conversion of low-quality housing debt into "high" quality Fannie Mae debt with the implicit backing of the federal government is the main support for the housing bubble. That is ending as Fannie Mae shrinks.
The alternate way for banks to dump the risk of loan default has been the Wall Street market for mortgage backed securities. Now that mass foreclosures have eliminated the subprime portion of the loan-resale market, banks are under pressure to increase loan quality.
Appraisers are hired by mortgage brokers and banks, so they are going to give the appraisals that mortgage brokers and banks want to see, not the truth. Appraisers that kill a deal by telling the truth do not get called back to do other appraisals.
Newspapers earn money from advertising placed by realtors, lenders, and mortgage brokers, so papers are pressured to publish the real estate industry's unrealistic forecasts, and to avoid the fatal words: "prices are falling". Instead, we may sometimes hear about "softening" or "easing" prices, which sounds so pleasant...
Worse, realtors have a near-monopoly on sale price information, and newspaper reporters never ask realtors hard questions like "how do we know you're not lying about those prices?" The result is an endless stream of stories reporting that David Lereah of the NAR says it's a good time to buy. Asking the NAR about housing is like walking into a used car dealership and asking the salesman if today would be a good day to buy a car.
Owners themselves do not want to believe they are going to lose huge amounts of money.
What are their arguments?
Renting is just throwing money away.
FALSE, renting is now much cheaper per month than owning. If you don't rent, you either:
Have a mortgage, in which case you are throwing away money on interest, tax, insurance, maintenance.
Own outright, in which case you are throwing away the extra income you could get by converting your house to cash, investing in bonds, and renting a place to live. This extra income could be 50% to 200% beyond rent costs, and for many is enough to retire right now.
Either way, owners lose much more money every month than renters. Currently, yearly rents in the San Francisco Bay Area are about 2% of the cost of buying an equivalent house. This means a house is returning about 2%, and it is a bad investment. Pretty much any other investment is better. If you don't like risk, put your money in US Treasuries at 5%. If you don't mind some risk, you may want to try index funds, which typically return about 10%.
Landlords are loaning a house to their tenants at a 2% interest rate. This is a fantastic deal for renters. When it is possible to borrow a million dollar house for 2% yearly rent at the same time a loan of a million dollars in cash costs 6% interest, plus 1% property tax, plus 1% maintenance, something is clearly broken. Renters are enjoying an extreme discount.
There are great tax advantages to owning.
FALSE. The tax advantage is not significant compared to the large monthly loss from owning. Renting is a loss of course, but buying is a much bigger loss.
Compare the cost of owning to renting.
Many people believe you can just reduce your income tax by the amount you pay in interest, but they are wrong. Buyers may not deduct interest from income tax; they deduct interest from taxable income. Interest is paid in real pre-tax dollars that buyers suffered to earn. That money is really entirely gone, even if the buyer didn't pay income tax on those dollars before spending them on mortgage interest. You don't get rich spending a dollar to save 30 cents!
Buyers do not get interest back at tax time. If a buyer gets an income tax refund, that's just because he overpaid his taxes, giving the government an interest-free loan. The rest of us are grateful.
If you don't own a house but want to live in one, your choice is to rent a house or rent money to buy a house. To rent money is to take out a loan. A mortgage is a money-rental agreement. House renters take no risk at all, but money-renting owners take on the huge risk of falling house prices, as well as all the costs of repairs, insurance, property taxes, etc. Since you can rent a house for 2% of its price, but have to pay 6% to borrow the equivalent amount of money, it is much cheaper to rent the house than to rent the money.
A rental house provides good income.
FALSE. Rental houses provide very poor income in the most bubble areas and certainly cannot cover mortgage payments.
Remember that it's pointless to do the work of being a landlord if you can make more money with no risk, no work, and no state income tax by buying a US treasury bond. And money in treasury bonds would be liquid and secure.
That said, there are many parts of the US where it does make sense to buy because mortgage payments are less than rents in those areas. They are generally rural areas away from the coasts, and have not seen the same bubble that the coasts have.
OK, owning is a loss in monthly cash flow, but appreciation will make up for it.
FALSE. Appreciation is negative. Prices are going down, which just adds insult to the monthly injury of crushing mortgage payments.
As soon as prices drop a little, the number of buyers on the sidelines willing to jump back in increases.
FALSE. There are very few buyers left, and those who do want to buy will be limited by increasing difficulty of borrowing now that many subprime lenders have gone bankrupt.
No one has to buy, but there will be more and more people who have no choice but to sell as their payments rise. That will keep driving prices downward for a long time.
House prices never fall.
FALSE. San Francisco house prices dropped 11 percent between 1990 and 1994. Buyers in SF in 1990 did not break even in dollar amounts until about 1998. So those buyers effectively loaned their money to the sellers for 8 years at no interest, losing all the while to inflation. With inflation, 1990 buyers truly broke even only about the year 2000, ten years after buying.
Los Angeles' average house plummeted 21 percent from 1991 to 1995, and of course there have been many similar crashes all around the US. The worst may have been after the oil bust in the 1980's, when Colorado condos lost 90% of the value they had at their peak.
House prices don't fall to zero like stock prices, so it's safer to invest in real estate.
FALSE. It's true that house prices do not fall to zero, but your equity in a house can easily fall to zero, and then way past zero into the red. Even a fall of only 4% completely wipes out everyone who has only 10% equity in their house because realtors will take 6%. This means that house price crashes are actually worse than stock crashes. Most people have most of their money in their house, and that money is highly leveraged.
We know it will be a soft landing, since it says so in the papers.
FALSE. Prices could fall off a cliff. No one knows exactly what will happen, but the risk of a sudden crash in prices is severe. As Yale professor Robert Shiller has pointed out, this housing bubble is the biggest bubble in history, ever. Predictions of a "soft landing" are just more manipulation of buyer emotions, to get them to buy even while prices are falling.
Most newspaper articles on housing are not news at all. They are advertisements that are disguised to look like news. They quote heavily from people like realtors, whose income depends on separating you from your money. Their purpose is not to inform, but rather to get you to buy. When you see an statistic that says everything is fine, look at the source. Is it from someone who needs you to believe in the housing market so that they can take your money?
The bubble prices were driven by supply and demand.
FALSE. Prices were driven by low interest rates and risky loans. Supply is up, and the average family income fell 2.3% from 2001 to 2004, so prices are violating the most basic assumptions about supply and demand.
The www.census.gov site has data for Santa Clara County for the years 2000-2003 which shows that the number of housing units went up at the same time that the population decreased: year units people
2000 580868 / 1686474 = 0.344 housing units per person
2001 587013 / 1692299 = 0.346
2002 592494 / 1677426 = 0.353
2003 596526 / 1678421 = 0.355
So housing supply in Santa Clara County increased 3% per person during those years. There is an oversupply compared to a few years ago, when prices were lower.
At a national level, there is a similar story in the years 2000 to 2005:
2000 115.9M / 281M = 0.412 housing units per person
2005 124.6M / 295M = 0.422
At a national level, there is 2.4% more housing per person now than in 2000. So national prices should have fallen as well.
The truth is that prices can rise or fall without any change in supply or demand. The bubble was a mania of cheap and easy credit. Now the mania is over.
They aren't making any more land.
TRUE, but sales volume has fallen 40% in the last year alone. It seems they aren't making any more buyers, either.
As a renter, you have no opportunity to build equity.
FALSE. Equity is just money. Renters are actually in a better position to build equity through investing in anything but housing. Renters can get rich much faster than owners, just by investing in reasonably conservative stocks or index funds. The stock market is much better than the housing market in the long run.
Owers are losing every month by paying much more for interest than they would pay for rent. The tax deduction does not come close to making owing competitive with renting.
Owers are losing principal in a leveraged way as prices decline. A 14% decline completely wipes out all the equity of "owners" who actually own only 20% of their house. Remember that the agents will take 6%.
Owers must pay taxes simply to own a house. That is not true of stocks, bonds, or any other asset that can build equity. Only houses are such a guaranteed drain on cash.
Owers must insure a house, but not most other investments.
Owers must pay to repair a house, but not a stock or a bond.
If you rent you are a buyer. You are just buying it for someone else.
FALSE. It may be true that rent covers mortgage payments in some places like South Dakota, but not in any of the markets that have shot up in the last few years. Rents are much less than mortgages in most places now. No landlord buys with the intention to rent out in California because that's not profitable. The owner is generously subsidizing the renter, a wonderful thing for renters during this crash.
If you don't own, you'll live in a dump in a bad neighborhood.
FALSE. For the any given monthly payment, you can rent a much better house than you can buy. Renters live better, not worse. There are downsides to renting, such as being told to move at the end of your lease, or having your rent raised, but since there are thousands of vacant rentals, you can take your pick and be quite happy renting during the crash. There are similar but more severe downsides to owning anyway, such as being fired and losing your house, or having your interest rate and property taxes adjust upward. Remember, property taxes are forever.
Some people want the mobility that renting affords. Renters can usually get out of a lease and move anywhere they want within one month, with no real estate commission.
It is much easier and cheaper to rent a house in a good school district than to buy a house in the same place.
A fun trick to rent a good house cheap: go to an open house, take the real estate agent aside, and ask if the owner is interested in renting the place out. Often, desperate sellers will be happy to get a little rental cash coming in and give you a great deal.
The biggest upside is hardly ever mentioned: renters can choose a short commute by living very close to work or to the train line. An extra two hours every day of free time not wasted commuting is the best bonus you can ever get.
Owners can change their houses to suit their tastes.
FALSE. Even single family detached housing is often restricted by CC&Rs and House Owner's Associations (HOAs). Imagine having to get the approval of some picky neighbor on the "Architectural Review Board" every time you want to change the color of your trim. Yet that's how most houses are sold these days.
In California, the HOA can and will foreclose on your house without a judicial hearing. They can fine you $100/day for leaving your garage door open, and then take your house away if you refuse to pay. There's a good HOA blog here.
If and when the market goes south, you can walk away.
FALSE. If you hand the bank the keys, they are likely to hand you a 1099 form showing "passive income" for the amount of your debt. You then owe tax on that amount.
A reader who lived through the 1989 housing crash in LA gave the following example:
Let's say you buy a house for $400,000, with a $350,000 mortgage.
Then the house drops in value to $300,000, you lose your job, or otherwise must move.
If you can't make your payments, the bank forecloses on you and nets $250,000 on the sale of your house at auction.
The bank's $100,000 loss on the mortgage is "forgiveness of debt" in the eyes of the IRS, and effectively becomes $100,000 of reportable income you must pay tax on. In many states, like California, the bank issues a 1099 to you for that amount and informs the IRS.
This is true even for "non-recourse" loans, where the bank cannot go after any of your personal assets. They let the IRS punish you instead.
If you refinance or take a home equity loan, the new loan is probably a recourse loan, and the bank can get very aggressive in going after your bank accounts, your stock, your car, etc.
It is true that buyers who put zero down, have no assets, and have nothing invested in the house are much more likely to walk away. The large number of new and essentially bankrupt buyers increases the risk of a horrifying crash in prices rather than a "soft landing".
The house down the street sold for 25% over asking, and that proves the market is still hot.
FALSE. Realtors try to create the false impression of a hot market by deliberately "underpricing" a house. Say a seller's agent knows that house will probably go for $400,000. He places ads asking $300,000 instead. (Bait-and-switch is illegal when selling toasters, but apparently not when selling houses.) The goal is to first of all prevent buyers from knowing what a realistic price is, and secondly to get buyers to blindly bid against each other. There are four players in this game and three of them are against the buyer -- the seller, the seller's agent, and the buyer's agent. Yes, the buyer's own agent works against the buyer, because there is no commission if there is no sale. There's a saying in Las Vegas: "There's a patsy in every game, and if you don't know who the patsy is, you're it."
If you want to prove your agent is not on your side, ask to see houses "for sale by owner" or houses listed by discount brokers. If the agent cannot make a commission, you will not be told about the house.
There is a way around the conflict of interest inherent in being a buyer's agent: let the seller's agent be your agent too, just for that one house he's trying to sell. Then the seller's agent has a big motive to lower the price, because he will get double the comission if you buy it rather than some buyer with his own agent.
Update: the underpricing game is now over. You are free to bid far lower than the asking price. You might be pleasantly surprised to find out how desperate the sellers are. Another good reason to start low: you can always raise your offer, but you can't lower it. A suggestion from a reader: have all your friends bid extremely low for the house before you, then your own low bid will seem more reasonable.
I was lucky that my realtor told me to increase my bid by $50,000. Otherwise I would have lost, because my realtor knew about a secret bid $40,000 above mine.
FALSE. Your agent gets paid nothing if you don't buy the house, and he gets more if you waste more money by bidding too high. Those are two big motives to invent false bids.
The MLS proves things are great.
FALSE. All sorts of funny things happen in the MLS (Multiple Listing Service, a private database controlled by real estate agents). For example, if a house just doesn't sell, realtors can remove its record in the MLS so that you cannot see that it failed to sell. Then the house comes back on the market at a lower price, and unsuspecting buyers think it's on the market for the first time. Their realtor can "prove" it's a new listing by showing the MLS record to the buyer: "See, here's the listing date, just came on the market. Better hurry and buy it, this one is hot."
There is nobody checking that the MLS shows true transaction prices. The MLS prices are often just wrong.
Furthermore, the MLS will not list any house for sale by owner or for sale through a discount broker, except perhaps those listed by Help U Sell. Those cheaper prices are just not in the system, because if you save money, they lose money.
My city is a special place that will always be expensive.
TRUE, but it was just as special when it was half as expensive ten years ago, so being special does not account for the run up in prices.
Many people are confused about the difference between high prices and increasing prices. Prices are high, but they are not increasing. They are falling. Falling prices make housing a bad investment.
Rich Chinese (or Europeans, or Arabs) are driving up housing prices.
FALSE. The percentage of US houses bought by rich foreigners is tiny. Furthermore, American housing is clearly a bad investment at this point. Foreigners can just wait and watch both the dollar and American housing continue to fall, and then buy for much less in a few years. Rich foreign investors are not dumb enough to buy into a badly overpriced market, but your broker is hoping that you are.
There's always someone predicting a real estate crash.
TRUE, yet irrelevant. There are very real crashes every decade or so. Even a broken clock is right twice a day.
But housing was high when interest rates were 21%, so higher interest rates don't matter.
FALSE. Inflation was much higher then, so fixed debt was easier to pay off with increasing salaries. Now we have adjustible mortgages and stagnant salaries.
House price increases exactly mirror the increase in mortgage debt. According to the Washington Times: "Consumers have doubled their mortgage debt from $3.5 trillion to $7 trillion since 1996, borrowing and spending profusely on the assumption that house prices will keep rising." So the increase in house prices is not backed by assets. It's backed by debt. The debt in turn is backed by the houses. It's just smoke and mirrors.
Local incomes justify the high prices.
FALSE. Most bankers use a multiple of 3 as a "safe" price to income ratio. We are well beyond the danger zone, into the twilight zone. The price to income ratio is currently around 10.
Look, housing continued to rise after the 2001 stock market crash, so it will always rise.
FALSE, consider the turkey in the farmer's barnyard. He thinks the farmer will always come feed him and not ask for anything. Then Thanksgiving comes. Whack. Past performance is no indication of future results.
Rent can go up, but a 30-year fixed mortgage payment cannot.
TRUE, but irrelevant. House owners lose even with a fixed mortgage, because the price of a house falls as interest rates go up. Most owners want to sell within 7 years of moving in, and many have to sell because of job loss, illness, or divorce. No one can afford what the owner paid for it, so the owner has to take a large loss. Renting it out will not come close to covering the mortgage. Inflation-adjusted rents have actually fallen in the last few years.
You have to live somewhere.
TRUE, but that doesn't mean you should waste your life savings on a bad investment. You can live in the same kind of house by renting during the crash. A renter could save hundreds of thousands of dollars, not only by paying less every month, but by avoiding the devastating loss of his downpayment.
Newspaper articles prove prices are not falling.
FALSE. The numbers in the papers are not complete and have murky origins. Those prices are "estimated" from the county transfer tax and making that tax public record is optional. A buyer who does not want you to see how little he paid has only to ask to put the transfer tax on the back of the deed and it will not show up on computer searches of the deed, which show only the front. Others voluntarily pay more tax than they have to, in order to inflate the apparent price to fool the next buyer. At a tax rate of about $1 per thousand of sale price, as in San Mateo county, you have to pay only $100 extra tax to make your purchase price look $100,000 higher.
Even though you can in theory go to your county building and get sale price information, in reality the county will give it to you in a painfully slow and inconvenient way. For example, in Redwood City's county building there are PC's where you can look at data for any particular house, but you cannot print, you cannot save to a floppy disk, you cannot email data out. All you can do is write things down manually, one at a time. And that's how real estate interests like it. Your elected representatives are serving them, not you.
Supposedly impartial sources like Dataquick are paid for entirely by people with a large financial interest in "proving" that prices are not falling, like realtors. This makes it unwise to take their numbers at face value.
For the obviously biased sources like the National Association of realtors, you can be sure that their sales price numbers do not include the effective price reductions from "incentives" like upgrades, vacations, cars, assumed mortgages and backroom cash rebates to buyers.
If you remember the definition of the median (the number for which half the prices are above, and half the price are below) you'll see that the elimination of sales at the low end of the market makes the median rise, even though the actual price of all houses is falling. And this is what is happening, as first-time buyers find themselves completely priced out of the market. So a rise in the median price can mask the fact that the price for every house is falling.
Finally, note that housing prices per square foot have been falling much longer and by a larger amount than "average house price".
My appraisal proves what my house is worth.
FALSE. "An appraisal in its typical residential real estate form is little more than a comparative analysis conducted by someone with no skin in the game offering confirmation that other lemmings are paying too much for their houses as well." -from an article on morningstar.com
Amazingly, government house price measures do not include houses with mortgages greater than $417,000. This excludes well over half of all houses in California. So the government can report a slight price rise, but fail to mention that prices actually fell for the other 60% of houses in California.
It's not a house, it's a home.
FALSE. It's a house. Wherever one lives is home, be it apartment, condo, or house. Calling a house a "home" is a manipulation of your emotions for profit.
As a realtor said to me, "a house is a wooden box that sits out in the rain and slowly rots. No one would buy in this market if they really thought about how much pain it's going to cause them in the long run. That's why we have to sell them a home, not a house."
If you don't buy now, you'll never get another chance.
FALSE. This argument was also popular in 1989 in Los Angeles, just before a huge crash. It's silly. If no one like you ever gets another chance to buy a house, then you will not be able to sell your house in a few years either, because there will be no more buyers like you ever again.
Here is a great quote from June Fletcher, a Wall Street Journal reporter, that says it all: "The real issue isn't whether you will be stuck being a renter all your life, she says. Its whether you'll get so scared about being shut out that you'll buy at the market's peak and be stuck in a property you can't afford or sell."
Property in the Bay Area is a luxury good, and so will be less affected by economic downturns.
FALSE. 82% of last year's Bay Area mortgages were ARMs, and ARM loans are not taken out by the rich. People on the border of bankruptcy take out ARMs because they can't afford fixed rate loans. The rich don't have loans at all.
Many of these ARM loans have exceptionally deadly repayment terms, and so are known as "neutron mortgages". Like the neutron bomb, they destroy people, but leave buildings standing. They are also known as "suicide loans".
Housing will be permanently higher since downpayments are now obsolete.
FALSE. The current wave of defaults is making downpayments suddenly seem like a good idea again. Lending standards are already improving.
House ownership is at a record high, proving things are affordable.
FALSE. The percentage of their house that most Americans actually own is at a record low, not a high. We do have a record number of people who have title to a house because they have dangerous levels of mortgage debt, but that is no cause to celebrate.
Houses are worth whatever fools will pay for them.
FALSE. At interest rates of 6%, houses are worth at most 17 times what you can rent them out for per year. You can get 6% with no work and very little risk in the bond market, so why accept less than 6% return (called rent) on your capital in the very risky housing market?
Here is a page explaining how to value a house.
Limited land means prices will always go up.
FALSE. Japan has a much more severe land shortage than America, but that hasn't stopped prices from falling for 14 years straight. Prices in Japan are now at the same level they were 23 years ago. If we really had a housing shortage, there would not be so many vacant rentals.
All my owner friends are telling me that prices are going up. They must be right.
FALSE. Owners never admit that prices are falling, because they would have to admit they made a huge mistake by buying. For a less biased view, do a poll of renters instead.
Rents could shoot up, making it a better deal to buy.
FALSE. Rents are limited by the money people actually earn, not by how much they can borrow. Try walking into a bank and asking for a million dollar loan to pay rent with.
What if the market goes up and sellers stop offering price reductions and paid closing costs to buyers? I am a renter and I have been thinking that is time to buy RIGHT NOW.
FALSE. The odds that prices will suddenly reverse and start going up are pretty much zero. This is the biggest bubble in history, ever, and it has years to go to unwind. Foreclosures have been rising exponentially. Prices are likely to go much lower every year for five to ten years before they go higher.
It would take another 911 terrorist attack or a major earthquake that wipes out this area in order for the price to fall by 50%.
FALSE. Even with a 50% decline in prices to $350,000 or so, the median price in the Bay Area will still be roughly double the median price in most of America, and the median Bay Area household income of about $70,000 will still not be sufficient to buy a house. So a 50% decline is well justified by the fundamentals.
You can easily verify for yourself that rents are less than half of long-term house ownership costs. Just look in the papers at sale prices, multiply by 6%, and divide by 12 to get the approximate monthly interest payment + property tax + repairs. Costs are actually about 8% with all that, but the income deduction brings it down to about 6%. Then look at the rental rates for equivalent houses. Which loss per month is larger?
Housing is a hedge against inflation, so you should buy now anyway.
FALSE. Interest rates go up with inflation, and higher interest will be the last straw for ARM mortgages in the Bay Area. Their defaults and foreclosures will drive down the cost of housing for everyone else around here. Remember that 82% of recent Bay Area mortgages were adjustable. There is little chance that salaries of ARM owners can keep up with inflation because of two billion people in India and China who would be happy to do their jobs for much less money.
Inflation will wipe out most of my mortgage for free.
FALSE. Banks would rapidly go out of business if they did not account for inflation. Since banks have been in business for a long time, you can be pretty sure your mortgage interest checks pay for inflation as well as for a good profit for the bank. That profit to the bank is a real loss to you.
Inflation does have the effect of making people think they have housing value gain when they really do not. If your house price rises only at the rate of inflation, you are not actually gaining anything at all. Any nominal gain below the rate of inflation is a nominal gain, but a real, adjusted-for-inflation loss.
Houses always increase in value in the long run.
FALSE. House values are actually constant. Adjusted for inflation, prices in the Netherlands, for example, rose less than one quarter of one percent annually in the 350 years since their tulip bubble. Warren Buffett and Charles Schwab have both pointed out that houses don't increase in intrinsic value. Unless there's a bubble, house prices simply reflect current salaries and interest rates. Consider a 100 year old house. Its value in sheltering you is exactly the same as it was 100 years ago. It did not increase in value at all. It did not spontaneously get bigger, or renovate itself. Quite the opposite - the house drained cash from its owners for 100 years of maintenance and taxes. Its price went up about as much as salaries went up.
My grandmother always used to complain about the cost of milk. "Why, when I was a girl, a gallon of milk cost a dime! Just look at how much people are overcharging for milk now." I asked her how much people got paid back then. "Oh, about $15 a week", came the reply. Hmmm, sounds very much like the reasoning people use now when they talk about how much their father's house appreciated "in the long run" without considering that salaries rose a proportional amount.
Maybe we should just accept that we missed out on a great opportunity to get into the real estate in the past N years.
FALSE. Did we all miss out on a great opportunity to get into the stock of pets.com or other Internet companies with no business model? The real question is what is likely to happen in the next few years according to fundamental economics. The answer is a huge crash. The last guy to buy into the bubble will get hurt the most.
You're saying no one should ever buy a house.
FALSE. While a house is almost always a poor investment, it is a safe time to buy a house for enjoyment when:
a 30-year mortgage + tax + insurance + maintenance is less than 30% of your gross pay and
the loss from interest, tax, insurance, and maintenance is less than rent on an equivalent place and
you plan on staying put for 10 years or more
You failed to factor in emotion. More houses are sold on emotion than will ever be sold based on perceived value. They buy all they can afford plus.
FALSE. Buyer emotion doesn't matter at all to the lenders, not on the way up or on the way down. Most people will borrow more than they can afford, but only if the lender goes along. The whole thing was a party of cheap and easy credit. When the credit machine gets sober again, millions of people are going to be ruined. Foreclosure rates are already going up exponentially.
My wife will divorce me if I don't buy a house.
FALSE. She will divorce you after you do buy a house and go bankrupt trying to pay the mortgage. She won't divorce you if you rent a much nicer place than you can buy, and take her to Paris for a month each spring, which you can do just by avoiding that mortgage.
If she's religious, you could also point out Proverbs 22:7: "The rich rule over the poor, and the borrower is servant to the lender."
I just want to own my own house.
TRUE, most people do and that's fine. Buyers will get their chance when housing costs half as much and they have saved a fortune by renting. House ownership is great - unless you ruin your life paying for it. If you can save even just 10% on the price of a house, you can retire several years earlier than you would otherwise. If you can save 50%, then you can easily take a ten year vacation and still come out ahead.
As reader Sean Olender put it: "Many people have forgotten that the number one restriction on their future freedom to do what they want, when they want, and to go where they want isn't the Iraqis, or Iranians, or North Koreans -- it's their mortgage lender."
What should you do?
If you own, consider selling so you can actually keep some of that funny money that appeared out of thin air. Otherwise, it will be painful to watch it vaporize back into thin air. Investors in mortgage-backed securities subsidized the increase in the price of your house. Now they want their money back, and your challenge is to prevent them from getting it. The only way is to sell before your neighbors do.
If you want to buy, look around and see that house prices are falling. Why hurry to buy into a falling market? Save your cash and buy for much less in the future. Find a nice cheap rental, invest your savings every month, and enjoy the show till then