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’.
- “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.
- “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.
- “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.
- “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.
* 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.
- “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.
“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.
- “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.
- “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].
Raman Venkatesh is the founder of Ten Factorial Rocks. Raman is a ‘Gen X’ corporate executive in his mid 40’s. In addition to having a Ph.D. in engineering, he has worked in almost all continents of the world. Ten Factorial Rocks (TFR) was created to chronicle his journey towards retirement while sharing his views on the absurdities and pitfalls along the way. The name was taken from the mathematical function 10! (ten factorial) which is equal to 10 x 9 x 8 x 7 x 6 x 5 x 4 x 3 x 2 x 1 = 3,628,800.