(Un)Real Estate – part 2 of 2

This is a continuation from Part 1, which generated some controversy as I expected.  If you came here straight, please read that post prior to continuing here.   Points 1 -7 are covered in the previous post.   There are some thought-provoking points in this 2-part series.  Think and be aware before blindly buying into any real estate ‘investment’.

At least, this has a pool to cool off if price falls off a cliff.

  1. “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, the 2002-2007 housing bubble was the biggest bubble in history, ever. Predictions of a “soft landing” were just more manipulation of buyer emotions, to get them to buy even while prices are falling or stagnant.   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.
  2. “The bubble prices were driven by supply and demand.” FALSE. Prices were driven by low interest rates and risky loans, and slowly the bad habits are returning back despite the 2008-09 crisis. Supply is up, and the average family income is either stagnant or falling, so prices are violating the most basic assumptions about supply and demand.
  3. “They aren’t making any more land.” TRUE, but sales volume fell 40-50% in the last recession. It seems they aren’t making any more buyers either…especially when you desperately want to sell.
  4. “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.

Never bet against the bank!

* Owners 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 owning competitive with renting.

* Owners 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 3-5%.

* Owners 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.

* Owners must insure a house, but not most other investments.

* Owners must pay to repair a house, but not a stock or a bond.

  1. “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 mid-western and southern states, 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 anymore 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 a crash.
  2. Great house in a good neighborhood?  RENT it!

    “If you don’t own, you’ll live in a dump in a bad neighborhood.” FALSE. For a 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 downsides to owning anyway, such as being fired and losing your house, or having your interest rate and property taxes adjust upward.  You may worry about being forced to move, but the law says the landlord has to offer you a one year lease at a minimum, and they’ll probably be delighted to offer you a two year lease and give you a discount for that. Other 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 for a year or two. 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.  You can invest these 2 hours to learn a productive new skill (like equity investing) or in your work to move up the corporate ladder to make more money.

  3. “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.
  4. “If and when the market goes south, you can walk away.” FALSE. If you have a single loan with just the house as collateral, it may be a “non-recourse” loan, meaning you could indeed walk and not lose anything other than your house and any equity in it (along with your credit record). But if you refinance or take a “home equity loan”, the new loan is probably a recourse loan, and the bank can get very aggressive, not to mention what the IRS can do. A person who lived through the 1989 housing crash in LA pointed out the following nasty situation that can happen:

* Let’s say you buy a house for $600,000, with a $500,000 mortgage.

* Then the house drops in value to $400,000, you lose your job, or otherwise must move.

* If you can’t make your payments, the bank forecloses on you and nets $350,000 on the sale of your house.

* The bank’s $150,000 loss on the mortgage is “forgiveness of debt” in the eyes of the IRS, and effectively becomes $150,000 of reportable income you must pay tax on. It is true that buyers who put zero or close to zero down are much more likely to walk away. The growing number of new un-invested buyers increases the risk of a horrifying crash in prices rather than a “soft landing”.

We have hardly learnt any lessons from the 2008-09 real estate crash.   Sadly, another crop of buyers will learn the hard way.

[Mr. TFR:  Note that I have largely produced the mail I received with only minor edits for current data.  I see merits in many of the points but I am sure the successful early retiree’s who have achieved financial independence through real estate will find issues with the author’s points, like one commenter did in the previous post.   As always, there are two sides to a coin.   Buyer beware is an important warning that must apply to all].   

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5 comments on “(Un)Real Estate – part 2 of 2”

  1. By ZJ Thorne Reply

    I rent and live with roommates. I could not afford the mega-loan necessary to rent all of this house, nor would I want to. My rent is significantly cheaper than mortgage and taxes would be. I do wish I could afford to rent a 1br or had roommates I liked, but right now I need to focus on building a nest egg and a down payment would ruin that.
    ZJ Thorne recently posted…Net Worth Week 78 – Pushing Through EditionMy Profile

  2. By Jacq Reply

    There is a big difference between renting a house and renting in an apartment complex. Not only did rent go up every year (not with the pace of my raises, which I calculated would eat into my savings /investing money in ~5 years), with the change of complex management I had to follow up with them on paying on time, they deposited the checks late and trying to charge me the late fee. Then there was the day I came home to an eviction notice, for 1 month non payment, because the new woman assigned my rent to another unit, despite my address and account # being on the check. The following month, my bill showed 2 rents, because to get things straight they linked the 2 accounts, so it looked like I was still going to seem to not have paid (someone else’s rent). When this is your business I expect a lot more. It made me feel very insecure, and I’ve chosen to own, closer to the new job. Rent closer to work is at least $500 /month more, because it is also closer to a large metropolitan city, and houses near work can be $400-500k (not in my price range).
    I am happy with my decision for now. I plan to be here for a while and can rent my place if I need to relocate.

  3. By The Money Commando Reply

    As with the first part of this series, I see a lot of major problems with the arguments here, but one that really jumped out at me was this one:

    9. “The bubble prices were driven by supply and demand.” FALSE. Prices were driven by low interest rates and risky loans, and slowly the bad habits are returning back despite the 2008-09 crisis. Supply is up, and the average family income is either stagnant or falling, so prices are violating the most basic assumptions about supply and demand.

    This is incorrect. The price of EVERYTHING is driven by supply and demand. What the author is actually arguing is that the low interest rates and lowered lending standards increased the demand for housing, which caused the price of housing to increase. I agree with that. However, ultimately it WAS supply and demand that drove prices.

    The fact that the author doesn’t even understand this very basic economic principle further validates my belief that he/she has absolutely no idea what he/she is talking about.

    Also, Schiller didn’t say that the housing bubble was the biggest in history. He said it was the biggest in the history of the US. That’s a very different statement.

    • By TFRadmin Reply

      TMC, I knew you would be the first to comment. In this case, the difference between the author’s point and yours isn’t a matter of debate. While ultimately, everything is about Supply & Demand, the underlying factor that caused such a high and artificial demand for housing leading up to the crisis WAS low interest rates and extremely lax lending standards. That is undeniable fact. Prices went up because of this huge surge in housing demand, most of it unjustifiable under reasonable lending standards. And on Schiller’s statement, I think it’s fair to give the benefit of doubt to author – he has been maintaining US-centric basis throughout, so it is likely that he meant only the US when he was referring to history.

      I am more of a guy who likes international real estate (see here), but the author is clearly US-focused. Thanks for your comment!

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