US Housing Crash Continues

What are their arguments?

1. Houses always increase in value in the long run.
   FALSE. House prices cannot increase more than incomes in the long run. This is obvious if you think about it. If house prices go up more than people can afford to pay, buying stops, like it has stopped now.

   For example, prices in the Netherlands are about the same as they were 350 years ago, in terms of how many years of work it takes to buy a house. Warren Buffett and Charles Schwab have both pointed out that houses don't increase in intrinsic value. Unless there's a bubble or a crash, 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, taxes, and insurance - costs that always increase and never go away. The price of the house 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.

2. 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 conservative stocks. The stock market has always been 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.

3. 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, costs that increase forever.
   • 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 similar place to live for much less money. This extra income could be 50% to 200% beyond rent costs forever, and for many is enough to retire right now.

   Either way, owners lose much more money every month than renters and that's assuming prices stop falling! Currently, yearly rents in the San Francisco Bay Area are about 3% of the cost of buying an equivalent house. This means a house is returning about 3%, 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, where the dollar value is guaranteed not to fall. If you don't mind some risk, you may want buy the stocks that make up the market indexes.

   Landlords are loaning a house to their tenants at a 3% interest rate. This is a fantastic deal for renters. When it is possible to borrow a million dollar house for 3% yearly rent at the same time a loan of a million dollars in cash costs 6.5% interest, plus 1% property tax, plus 1% maintenance, something is clearly broken. Renters are enjoying an extreme discount.

   To add insult to "owners", their property is declining in value. Renters do not have to worry about the massive losses owners are experiencing. Here's a great quote from NPR:

   Underwater owner: "We would do it [pay the mortgage] if the equity was there, but in a case where we're already so behind... Imagine that for five years, say, we're gonna pay four grand a month and then we're just gonna be back up at what we bought the house for. We feel like we're throwing away money."

4. There are great tax advantages to owning.
   FALSE. Everyone automatically gets a $9,500 tax deduction, just for breathing. You have to have interest expenses greater than $9,500 to get any advantage from the mortgage interest deduction. And even then, the tax advantage is not significant compared to the large monthly loss from owning.

   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.

5. All real estate is local, so you cannot say anything about the national market.
   FALSE. Lending is global. ALL loans are harder to get. This will drive prices down everywhere.
6. A rental house provides good income.
   FALSE. Rental houses provide very poor income in 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 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.

7. 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.
8. 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.

9. House prices never fall (in my city).
   FALSE. San Francisco house prices dropped 11 percent between 1990 and 1994. Buyers in San Francisco 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.

   Your city may be special, 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, and will not protect it from falling back to what it was.

10. 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 (except in Detroit), 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.
11. We know it will be a soft landing, since it says so in the papers.
    FALSE. Prices are falling off a cliff. No one knows exactly what will happen, but it looks like prices will continue to fall for several years. 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?

12. 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.

13. 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.

    Japan has a severe land shortage, 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.

14. 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 worse problems for owners 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.

15. 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.

16. 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.

17. 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.
18. The MLS proves things are great.
    FALSE. The MLS is a used-house sales tool designed to look "official" so you will believe it and then bid foolishly. It does not include most foreclosures, new houses by builders, houses for sale by owner, and any other case where the agent cannot make a commission. The MLS is not at all credible as a list of what's really out there.

    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, or bank-owned property, or extreme discounts from builders, or many other cases where you could save huge amounts of money. Those cheaper prices are just not in the system, because if you save money, they lose money. Even if some cheaper properties are listed, your agent is not likely to tell you about them if they require more work on his part, or get him a smaller comission.

19. 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.
20. 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.
21. 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.

22. 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.
23. 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 a better house for much less money 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.
24. 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 realtors, 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.

    Here is a good example of a newspaper lying about the crash in prices by using the median: San Francisco Chronicle Headline Lies About Housing Prices

    Finally, note that housing prices per square foot have been falling much longer and by a larger amount than "average house price".

25. 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.

26. Foreclosures destroy neighborhoods, so we should stop foreclosures.
    FALSE. Empty houses destroy neighborhoods. Houses remain empty only because the prices are too high. "Anti-foreclosure" programs just keep prices too high, and keep houses empty. In areas where there are jobs, if prices were allowed to fall enough so that salaries can easily cover the cost of owning, people would move in and take care of the houses. In areas without jobs, the first priority should be jobs.
27. 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."

28. 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."

29. 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".

30. 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.
31. 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.
32. 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.

    If yearly rents are less than 6% of the price of a house, watch out, because house prices are likely to fall.

33. 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.
34. 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?

35. 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.
36. It's unpatriotic to talk about mispriced houses. It might drive down prices.
    FALSE. Lower prices are better for America, especially for new families. Aren't lower food and energy prices better for America? Housing prices are the same: lower is better. Most Americans directly benefit by a decrease in house prices. Only the banks benefit from increased mortgage debt.

    If you own a house, lower prices have very little effect. If you want to sell and buy another house, higher prices mean you'll just have to pay more for the next house, while lower prices mean you will get a discount when you buy. If you want to buy a bigger house, you come out ahead with lower prices.

37. My wife will divorce me if I don't buy a house.
    FALSE. She will divorce you if 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 then take her to Paris for a month each spring, which you can do just by avoiding that suicidal 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."

38. 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.

    Cheap housing is good for us all! High housing costs take away from families' ability to save for retirement, fund their children's education, travel and lead a quality life.

    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, sell now 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 bonds 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. Time is not on your side.

If you can't sell without a loss, it's probably best to just walk away and free yourself from mortgage slavery. It depends on whether your loan was "recourse" or "non-recourse". In the latter case, the deal is simply that you can stop paying the loan and give back the house at any time. It's perfectly legal and moral according to the terms of the mortgage. Now that the Bush administration has temporarily stopped taxing forgiven debt, you can do it without owing anything! But talk to a lawer and accountant first. This service may be useful: http://www.youwalkaway.com/

If you want to buy, look around and see that house prices are falling. Why hurry to buy into a falling market? Time is on your side. Save your cash and buy for much less in the future. The way to win the game is to have cash on hand when others cannot get a loan. You do not want to be bidding your hard-earned savings against people who are bankrupting themselves with debt. It will be time to buy when lenders once again demand a 20% downpayment from everyone and get serious about checking ability to repay. Find a nice cheap rental, invest your savings every month, and enjoy the show till then.