Wednesday, February 9, 2011

Don't buy high and sell low

Alex Stenback has a GREAT post over at Behind the Mortgage, which anyone interested in real estate should -I think- go and read immediately.

Alex hits on something that has perplexed me for a long time, and that is the sort of herd mentality that many people have about real estate.

As far back as eight years ago, it seemed like everyone around me was into buying real estate. At parties and social gatherings, new homes and home projects were a constant topic. If a renter was uncovered in the room it was highly likely that s/he would be overwhelmed with bossy proclamations about how s/he was missing out THE GREATEST OPPORTUNITY EVERRRRRR... because homeownership and real estate was totally where it was at.

I had a friend who bought a small condo off of Excelsior at 38th in St. Louis Park. He got seriously lucky over the whole Excelsior/Grand development, and sold for a tidy profit. I was pleased for him. But then he took the money and invested it into no fewer than ELEVEN different rental properties, all of which he paid top dollar for.

I remember discussing the shift with him and expressing concern that the rents may not be sufficient to cover his loan payments, given the high prices of the properties he was purchasing. He told me that he'd make it work with fat Section-8 rents, and that he wasn't worried, because even if that didn't work out, he'd still realize appreciation on the values and could sell the properties if need be.

Well, a couple of years later, he was in bankruptcy. And, the worst part in my view was that he didn't even have a homestead. After selling his condo, he plowed all the gain into investment property down-payments and then rented an apartment for himself. (Interestingly, it seemed that he didn't care to live in the neighborhoods where he invested, which is why he didn't occupy one of his own units. That set off a red flag of an entirely different nature, which I'll save for a future post.)

At any rate, this friend's situation was particularly dramatic, but there were others who got in over their heads even with their primary residences. You probably know a person or two like that - it seems these days that we all do.

So why did everybody believe they needed to buy? Why were buyers engaging in bidding wars, pushing home prices skyward in their desperation to experience ownership?

I really have no idea, to tell you the truth.

Just like I have no idea why today, when home prices are in the tank and half the houses in my neighborhood could be owned for ONE HALF of the monthly expense of renting around here, many people are still terribly hesitant to buy.

Alex called it a "fear bubble."

And I get that. Some people are scared that prices will continue to fall. But consider this: Unlike with price increases, which theoretically could continue on into oblivion, price decreases do actually have a lower bound. A forty thousand dollar house can only decrease to zero/FREE. (Do you think sellers will start giving homes away for free? I suppose it's technically possible.)

But let's say you find a forty thousand dollar house and its value plummets to zero in the course of four years. That's about $834 in value lost per month.

Which is cheaper than the average rent for a three bedroom unit.

So do you really win by renting?

(And we haven't even gotten into things like mortgage interest deduction, potential rental income in the case of duplexes, etc.)

It's time to pop the "fear bubble."


Anonymous said...

It is an interesting trend. I wonder how much unemployement and job security comes into play with the fear bubble...? Also, there are tighter restrictions in place now from lenders and people may be overstrech on their credit.

It is hard to believe people wouldn't being standing in line to buy up some of the duplexes and 4 plexes on the market for 40-90K. that is a huge opportunity for living mortgage free plus income to boot!

I know I'm very happy to pay a $600 mortage payment vs. an $800+ rent payment. Also, there's the added option of having roommates to help out. I can safely charge $400 rent for a room in my home and cut my mortgage payment down to $200 per month. I like it. :)

Ranty said...

Those are definitely good points.

Clearly it's not a good idea to take on a debt (even so-called "good" mortgage debt) that you know will be difficult to repay. And you're right that banks are stricter these days.

So unemployment is a factor, and lending is a factor.

As for job security though, I would just point out that we all need a place to live no matter what, and I don't think your landlord is going to be any more accommodating than your bank if, all of a sudden, next month you lose your job and cannot pay.

In fact, your landlord typically only has to give you 1-2 months to get out if you stop paying rent. Your bank on the other hand, must give you six months to vacate your homestead (presuming you don't abandon it.)

M. Clinton said...

I had a friend once tell me that the reason that she is not buying a house right now is because she has heard that they are not worth anything right now. She said that she wants to wait until houses are worth something again and then she is going to buy. DOH! These are the same houses now as they will be then. The only difference is that you will have to PAY MORE for them later! Even though this seems obvious to me, I wonder how many out there think like this?