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US Housing Crash Continues

What are their arguments?

1. Houses always increase in value in the long run.
   FALSE. The value of a house is constant. It just sits there. You get shelter, but you have to pay property tax and maintenance and the loss of alternative uses of capital. The price of a house rises with inflation, but 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 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 inflation and 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 saving the money that owners are wasting on mortgages, taxes, and maintenance. Renters are getting paid to wait, both by the monthly savings and by watching the value of their savings increase relative to housing.
   • Owers are losing every month by paying much more in interest than they would pay in 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, and maintenance.
   • 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. 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% rent minus taxes and maintenance, bringing the landlord's return down to 0%.

   Landlords are loaning a house to their tenants at a 3% interest rate, called rent. 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 1.3% property tax, plus 1% maintenance, something is clearly broken. Renters are enjoying an extreme discount at the owner's expense.

   To add insult to "owners", their property is declining in value. Renters are completely protected from 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. Every married couple filing jointly automatically gets a $11,400 tax deduction, just for breathing. You have to have mortgage interest payments greater than $10,900 to get any advantage at all 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 Adjusted Gross Income. Interest is paid in real 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.

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. 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.
7. 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.

   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.

8. 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.
9. 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.

10. 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 15 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.

11. 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. On the other side, if you can get a very long-term lease, say seven years, you will probably find it worthwhile to repair the place to your taste. The average time of owning a house is only seven years anyway.

    It is cheaper to rent a house in a good school district than to buy a house in the same place. In fact, children benefit in several significant ways from living in a rental. Aside from having a choice of school district, kids in a rental benefit from better parks in nicer neighborhoods, more living space, and less stress in their parents' voice -- all because it is still so much cheaper to rent than to own in bubble areas.

    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. Sometimes they will rent to you for free ($0) as long as you keep the place up and pay the utilities.

    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.

12. 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.

13. The house down the street sold for 25% over asking, and that proves the market is still hot.
    FALSE. Realtors lie 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 commission 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 easily raise your offer, but it's awkward to 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.

14. 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.
15. The MLS proves things are great.
    FALSE. The MLS (Multiple Listing Service, a private network of databases controlled by real estate agents) is a used-house sales tool designed to look "official" so you will believe it and then bid foolishly high. That is its purpose.

    All sorts of funny things happen in the MLS. 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 commission.

16. 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 American housing and the dollar 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 realtor is hoping that you are.
17. 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 in the SF Bay Area.
18. 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.
19. Newspaper articles prove prices are not falling in my neighborhood.
    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.

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

20. 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.

21. 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.
22. 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. Don't let them push your buttons.

    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."

23. If you don't own, you're a failure.
    FALSE. Maximizing your savings and escaping the slavery of debt is success. Most people have a hard time understanding this, but they do understand cash. You could show them your bank statements to prove you're way ahead of the game as a renter, but then they would probably just ask you for a loan!

    The use of the status card is another well-known button that realtors push to trick people into making foolish purchases. Don't let them do it.

24. Property in the San Francisco Bay Area is a luxury good, and so will be less affected by economic downturns.
    FALSE. Most San Francisco Bay Area mortgages are 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".

25. 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.
26. 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.
27. 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.
28. 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 as much as the possibly can. The limiting factor is lending, not emotion.
29. 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.

30. 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."

31. My new baby needs a house.
    FALSE. If you're pregnant and desperately want to buy a house for your new child, that's a perfectly normal feeling called "nesting". It is also the leading avoidable cause of financial fatalities! You most definitely do not need a house for a baby. A baby is utterly unaware of whether it lives in a rental or not. Babies also don't need much space.

    Your baby will do better if you're not stressed out about a mortgage. You have five years before school quality becomes an issue, and at that point you can more easily move into the best school district as a renter than as an owner. Avoid debt and save your money so your child has a better start in life.

32. I just want to own my own house.
    TRUE, most people do. There's nothing wrong with that. 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. Great quote from http://healdsburgbubble.blogspot.com/: "People want to buy a house, they want to have someone tell them it is the smartest decision they are making in their lives, and they don't want to hear about any downside risk."

    Housing is the biggest expense in nearly everyone's life, far more expensive than food, gas, energy, even more expensive than education or medicine. To reduce the time you spend working to pay for housing is to increase the time you have for everything else.

    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.

    How can we make lower house prices our official government policy? How can we completely eliminate the mortgage interest deduction which drives up housing costs and discriminates against renters? How can we wipe out Fannie Mae, Freddie Mac, the FHA, and other agencies whose job it is to enslave Americans to mortgage debt?

    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?

Never sign any contract with any realtor! Realtors try to trap you with a contract so that you cannot know what is going on or make independent decisions.

Post on the patrick.net Property Forum to get uncensored feedback about a particular property.

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 government has temporarily stopped taxing forgiven debt, you can do it without owing anything! But talk to a lawyer and accountant first. If you refinanced, you may have given up your non-recourse status.

A long-term rental with a multiple-year lease is a good way to get stability with the economic benefits of renting. Many landlords are desperate, and you'll probably find them quite willing to negotiate a long term lease. Make sure they can't raise the rent much during the lease term, and make sure there is only a small penalty for ending the lease early. Even if you sign a normal 1-year lease, most landlords are happy to keep good tenants as long as possible.

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. All your savings on the price of a house are tax-free earnings! For Californians: buy after the earthquake, not before.

Do not buy anything that wasn't built properly, no matter how cheap it gets. Many foreclosures are houses that weren't built properly, and these houses tend to be foreclosed over and over again. Lots of houses are ugly, but an ugly but well built house is often the best deal.

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. You'll know prices are reasonable when it's cheaper to own than to rent. We're not there yet, not even close. Find a nice cheap rental, invest your savings every month, and enjoy the show till then.  

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Annual income twenty pounds, annual expenditure nineteen six, result happiness. 
Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.
    Charles Dickens, David Copperfield, 1849

From anonymous: The Mexican Dream is to escape from debt peonage. The American Dream is to get into debt peonage.

Lowering interest rates will help the housing and stock market for about as long as peeing your pants will help when you have to go. It will give a warm feeling for a minute.

Everybody hates house-agents because they have everybody at a disadvantage. All other callings have a certain amount of give and take; the house agent simply takes. -- H. G. Wells

Nick Naylor, in Thank You For Smoking: "99% of everything done in the world, good or bad, is done to pay a mortgage. Perhaps the world would be a better place if everyone rented."

They hang the man and flog the woman Who steals the goose from off the Common;
But let the greater criminal loose Who steals the Common from under the goose

From Benjamin Graham, in The Intelligent Investor: "The outright ownership of real estate has long been considered as a sound long-term investment, carrying with it a goodly amount of protection against inflation. Unfortunately, real estate values are also subject to large fluctuations; serious errors can be made in location, price paid, etc.; there are pitfalls in salesmens' wiles."

What the public believes, or can be induced to believe, no matter how wrong, is reality to politicians.

From The Politics of Life by Craig Crawford: "Beware the boss who encourages you to buy a house or new car. Mortgages and car payments enslave you to the paycheck that your boss controls."

From Our Lot by Alyssa Katz: "The secret, he was learning, was to trigger buyers' emotions, specifically women's emotions."

50 Ways To Leave Your Mortgage

You just slip out the back, Jack
Make a new plan, Stan
You don't need to be coy, Roy
Just get yourself free
Hop on the bus, Gus
You don't need to discuss much
Just drop off the key, Lee
And get yourself free

I don't think I'll get married again. I'll just find a woman I don't like and give her a house. -- Lewis Grizzard

Cashtration (n.): The act of buying a house, which renders the subject financially impotent for an indefinite period of time.

The End