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.
- "There are great tax advantages to owning."
FALSE. It is now far
cheaper to rent a house in the San Francisco Bay Area than it is to own
that same house, even with the deductibility of mortgage interest
figured in. It is possible to rent a good house for $1800/month. That same
house would cost at least $600,000. Assume 6% interest ($3000 per month), $2000
closing costs, and note that a buyer loses $770 more per month buying than
renting. Renting is a loss of course, but buying is a much bigger loss.
Renting:
Monthly Rent: $1,800.00
Buying:
Property Tax: $400.00 ($625 per month at 1.25% before deduction, $400 lost after deduction)
Interest: $1,920.00 ($3000 per month at 6% before deduction, $1920 lost after deduction)
Other Costs: $250.00 (insurance, maintenance, etc)
Total: $2,570.00
Buyers still have to come up with the principal payment as well, just to watch
it wiped out as the value of their house declines. Principal payments over
30 years would average $1667 per month.
This is actually a very conservative estimate of the loss from owning per month.
If you include the likely decline in house prices, as in this rent-vs-own calculator,
you'll see that owning right now is a very poor choice.
Remember that buyers don't 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.
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.
Under current conditions, a renter would be able to live in a house for 30
years, then buy that $600,000 house outright with the saved principal payments
($1667 x 12 x 30), and have an extra $277,200 of saved interest on top of
that: ($770 x 12 x 30). The renter comes out way ahead of the owner, and this
doesn't even count the huge losses the owner will suffer as housing falls year
after year for the next decade or more, just as in Japan.
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.
- "A rental house provides good income."
FALSE. Rental houses provide
very poor income in the Bay Area and certainly cannot cover mortgage payments.
A $1,000,000 house can be rented out for 25K maximum per year after expenses.
The return is therefore 2.5%. If you actually have a million dollars, you can
get 4.5% with no risk and no work by buying a US Treasury Bond.
- "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.
- "House prices don't fall to zero like stock prices, so it's safer to invest
in real estate."
FALSE. House prices do not fall to zero, but the value of your equity
in a house can easily fall to zero, and then way past zero into the red. Even a
fall of only 10% completely wipes out everyone who has only 10% equity in their
house. 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.
- "If you buy, at least you have a house, but if you rent, you end up with
nothing."
FALSE. Renters in this market end up with much more money, while
living in the same quality house as an owner. At the end of 30 years under our
current conditions, a disciplined renter would have enough principal saved to
buy the same house outright and would have an extra $277,200 of accumulated
interest savings, and would have lived in an equivalent house all that time.
Owners frequently end up with nothing because they lose the house to
foreclosure.
- "Prices have been driven by supply and demand."
FALSE.
Supply is increasing rapidly as building continues, and demand is falling as the
population of the Bay Area decreases and the salaries of those who remain
decreases. Prices have been driven by low interest rates and increasingly risky
loans. The dramatic drop in rents and widespread rental vacancies prove that
demand for housing is actually much lower now than a few years ago.
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. In a sane
market, prices should fall 3% to compensate for the extra supply of housing.
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.
- "Nobody is making land."
TRUE, but they are making houses at a record
rate, which is increasing supply dramatically at a time when new houses are not
needed. We have the highest rental vacancy rates since the 1950's.
- "There's an under-supply of housing. That's why prices will rise."
FALSE. There is a large oversupply of housing. To repeat: builders are
making houses at a record rate, which is increasing supply dramatically at a
time when new houses are not needed. The Bay Area has the highest rental vacancy
rates since the 1950's.
- "Population increase will fuel housing price increases."
FALSE.
The Bay Area is losing population the fastest of any area in the US right
now - worse than Buffalo, worse than Detroit. Immigration won't change this
because jobs are emigrating even faster. Rents are falling in part because so
many recent immigrants are leaving, with some going back to China because
opportunities are so much better there.
Nationally, there is going to be a huge glut of housing as old baby-boomers
sell their houses to use the cash for retirement, putting 20% of houses onto
the market for that reason alone. An additional 25% of houses are owned by
speculators, who will soon sell because they are losing money. Birth rates are
declining in all industrialized countries, with the US birth rate barely
replacing the citizens who die.
- "As a renter, you have no opportunity to build equity."
FALSE. Renters
are actually in a better position to build equity because:
- Owners are losing every month on a cash flow basis. The tax deduction does
not come close to making owning competitive with renting.
- 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.
- You must insure a house, but not most other investments.
- You 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
other places, but not in the Bay Area. No one buys with the intention to rent
out in the Bay Area because that's not viable. 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.
It is easy to rent a much nicer house than can be bought with the same monthly
payment right now. Renters live better, not worse. All the best neighborhoods
have rental vacancies. There are downsides to renting, but since there are
thousands of vacant rentals, you can take your pick and be quite happy renting
during the crash.
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.
Renting is temporary, but then, life is temporary.
- "People buy a house for the long term, so things can't crash
quickly."
FALSE. People are now buying houses for the very short term. This
is how they justify interest-only adjustable mortgages to themselves. The
thinking is, "I will own this just long enough to make a profit, maybe a year or
two, so there's no need to get a long term loan at a higher interest rate." The
distinction between the long-term owner and the short-term flipper has gone
away.
- "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 house 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 reader 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.
- "The house down the street sold for 25% over asking, and that proves the
market is still hot."
FALSE.
Realtors(TM) 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 $500,000. He places ads asking $400,000 instead.
(Bait-and-switch is
illegal when selling appliances, 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 on one side: 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.
- "I was lucky that my Realtor(TM) told me to increase my bid by $100,000.
Otherwise I would have lost, because my Realtor(TM) knew about a secret bid
$90,000 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(TM) 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(TM) 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 selling 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.
- "The Bay Area is a special place that will always be expensive."
TRUE,
but it was just as special ten years ago, so that does not account for the
current housing bubble. Even at half of current prices, it will still be
expensive. Many people are confused about the difference between high prices
and increasing prices. Prices are high, but they are not increasing. They are
falling.
- "There's always someone predicting a Bay Area 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%."
FALSE.
Inflation was much higher then, so fixed debt was easier to pay off with
increasing salaries. Now we don't have increasing salaries, just a housing
bubble. House prices and salaries have become disconnected.
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.
- "My dad made money on his house, and it will work for me too."
FALSE.
Your dad bought his house when houses were cheap compared to salaries, maybe 3
or 4 times annual salaries. Go ask him. Things are different now. Here is a
chart of median house price vs median income in Palo Alto:
Year Median House Price Median Income Multiple
1980 148900 24743 6.0
1990 457800 55333 8.3
2000 910000 90377 10.0
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. Another rule of thumb is that a
fair house price is between 100 and 200 times the monthly rent. If a house
rents for $2000 per month, then a fair price is from $200,000 to $400,000.
- "The government will make sure housing prices don't fall, because all the
powerful people in the government have houses and want to keep values
up."
FALSE. There have been many local crashes, and the government can't stop
them. Nor would they even want to; the current Republican administration would
probably be quite happy to see blue states like California, New York, and
Massachusetts crash and burn, and those states are where the worst bubbles are.
- "Look, housing continued to rise after the dot-com 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 people want to sell within 7 years of
moving in, and many have to sell because of 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. Bay Area rents
have fallen 23% in the last 4 years.
- "You have to live somewhere."
TRUE, but that doesn't mean you should
waste your life savings on a poor 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. In fact, it's currently cheaper to live in a nice
hotel in most parts of the US than it is to make mortgage payments in the Bay
Area.
- "Newspaper articles prove prices are going up."
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. Another common occurrence is for the buyer to get a large cash
payment back from the seller. So the house price looks high in the paper, but in
reality the buyer got a huge rebate.
Even though you can in theory go to your county building and get selling
price information, in reality they 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. Please vote
against Warren Slocum in San Mateo County unless he fixes the Redwood City
computers to allow you to save data.
- "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
Anyway, as transaction volumes decline, the first few low sales will have
a large and sudden impact on appraisals.
- "If one house sells for a million dollars, a million houses are worth a
trillion dollars!"
FALSE. If all of those million houses were all on the
market they would sell for far less. Less than 6% of all existing houses were
sold last year. The other 94% are merely assuming they can get the same
prices.
- "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.
- "If you don't buy now, you'll never get another chance."
FALSE. This
argument was also popular more than a century ago in 1889 in Los Angeles, just
before a huge crash. There are always sellers and there are always buyers.
Prices are always corrected when they get beyond what buyers can pay. In fact,
they're being corrected right now.
- "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.
- "Housing will be permanently higher since downpayments are
now obsolete."
FALSE. The first big wave of default will cause downpayments to
suddenly seem like a good idea again.
- "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.
- "Long term rates are still at historic lows!"
TRUE, but irrelevant. Most
new mortgages and refinancings are now short term, and those will definitely be
affected by rising short term rates.
- "The limited land in the Bay Area means prices will always go up."
FALSE.
Japan has a very severe land shortage, but that hasn't stopped prices from
falling for 14 years straight. Prices there are now at the same level they were
23 years ago. If we really had a housing shortage, rents would be going up, but
they're going down instead.
- "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.
- "Housing is an excellent 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 new Bay Area mortgages are adjustable now. 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.
- "Houses always increase in value in the long run."
FALSE. House
values are actually constant. Adjusted for inflation, prices in Holland, 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 produce anything. They
do not 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 - it drained cash from its owners for 100
years of maintenance and taxes. Its price went up about as much as salaries
went up.
- "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 question is what is likely to happen in
the next few years according to fundamental economics. The last guy to buy into
the bubble will get hurt the most.
- "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 own, consider selling so can actually keep some of that funny money that
appeared out of thin air. It would be a pity to watch it vaporize back into
thin air.
If you want to buy, look around and see that house prices have begun to fall.
Why hurry to buy now? Save your cash and buy for much less in the future. Find
a nice cheap rental, sit back, and enjoy the show till then.
SF Bay Area Housing
Crash
