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Ten Reasons It's A Terrible Time To Buy An Expensive House
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2015 Jul 11, 12:58pm 939,760 views 470 comments
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"This blog post has already made a lot of terrific points. The one that stood out to me was: "It's better to buy a house at a low price and a high interest rate than otherwise". It's so counterintuitive and yet, so absolutely bang on money. It was almost a Eureka moment for me when I really understood this. Low interest rates means your future is being screwed, but this is the very thing that nearly everyone is taking on and running away with $800K mansions with. Can you say the world is irrational? Nearly everyone advised me buy a house "because interest rates are low"...no sheep, you buy when rates are high and refinance when they get low. It's almost like someone who buys stocks when the markets are riding all time highs and sells them in fear when the market tanks. This is absolutely not how to make money, and all the people who have $800K houses at 3.5% interest rates are thoroughly screwed."
Except, as Mark said, it's 100% false. Housing prices do not move opposite of ...
Did interest rates go as below as 3.5% ever in the history? As a first generation immigrant who has lived in the US for 16 years, I don't have enough context and I haven't really lived through the experiences of various eras.
I can only say this though: Today's rates are tremendously low - made artificially possible by the Fed's prime rate. People have stretched their monthly payment to buy a $800K house that requires a 2 hour one way commute to work. I can logically see if and when rates rise, prices will fall. Maybe the fall won't be as steep as 2009, or maybe the price will just stay flat as interest rates rise very slowly. Whether you bleed in one go or bleed slowly, the bleeding will be there, because I cannot honestly see a $800K-1M house appreciating, or some working family paying upwards of $5K rent for it.
Housing prices do not move opposite of interest rates. History proves this.
If (1) the market is not cheap, and (2) wages do not keep with rates, then rising interest rates will put downside pressure on housing prices. You don't need history to prove this. Common sense is enough.
"If (1) the market is not cheap, and (2) wages do not keep with rates, then rising interest rates will put downside pressure on housing prices. You don't need history to prove this. Common sense is enough."
I'm just saying that it's amazing that common sense has never prevailed for the last 100 years of housing data history. You'd think if something was true, 100 years of data would be enough to show it.
"I can only say this though: Today's rates are tremendously low - made artificially possible by the Fed's prime rate. People have stretched their monthly payment to buy a $800K house that requires a 2 hour one way commute to work. I can logically see if and when rates rise, prices will fall. Maybe the fall won't be as steep as 2009, or maybe the price will just stay flat as interest rates rise very slowly. Whether you bleed in one go or bleed slowly, the bleeding will be there, because I cannot honestly see a $800K-1M house appreciating, or some working family paying upwards of $5K rent for it."
Yes, rates have been very low in the past. The Fed doesn't set prime rate.
Everyone can logically see prices falling when rates rise, because they can't see all the interdependencies at work. Rates don't rise in a vacuum. When rates rise, it's almost always because incomes are rising as well. And the effect of incomes outweighs the effect of rates.
Strategist
2016 Dec 5, 7:33am
Bob makes his own rules.
I've known about it for 40 years since I first starting working with managing rentals for someone else. It's called the 1% rule. I guess these guys are just making it up too.
That gross rent multiplier changes from area to area, and property to property. It can only be used as part of an analysis.
You should know that.
Strategist
2016 Dec 5, 7:37am
In my own place to live I've done very well with renting and banking the difference between the rental amount and cost of owning when owning is really out of line. or buying when it's out of whack the other way then renting when I move on. You can do whatever you want with your money. Sounds like you are one of the people who only asks what the cost per month is.
I look at the "Cap Rates" much better than the GRM. Even the Cap Rates vary with area, but still a better analytical tool than the GRM.
"I can only say this though: Today's rates are tremendously low - made artificially possible by the Fed's prime rate. People have stretched their monthly payment to buy a $800K house that requires a 2 hour one way commute to work. I can logically see if and when rates rise, prices will fall. Maybe the fall won't be as steep as 2009, or maybe the price will just stay flat as interest rates rise very slowly. Whether you bleed in one go or bleed slowly, the bleeding will be there, because I cannot honestly see a $800K-1M house appreciating, or some working family paying upwards of $5K rent for it."
Yes, rates have been very low in the past. The Fed doesn't set prime rate.
Everyone can logically see prices falling when rates rise, because they can't see all the interdependencies at work. Rates don't rise in a vacuum. When rates rise, it's almost always because incomes are rising as well. And the effect of incomes outweighs the effect of rates.
That is totally incorrect. Rates rise because "inflation" rises. True, in a healthy economy, rising inflation would mean people's income rises too. But the US has been printing money for a while now to offset all the junk securities from the 2009 era, and the resulting rising inflation will not necessarily mean rising incomes.
We are due for high inflation and high interest rates, and it remains to be seen if this economy has enough jobs to push people's incomes higher. I hear the minimum wage workers are protesting today on streets for $15/hour...
P.S. 30 year mortgage rates in fact have already jumped by 0.5% - I refinanced at 3.5% just 6 months ago; now that rate is at 4% from the same institution. I will watch closely the summer of 2017 and report the findings on this thread.
That gross rent multiplier changes from area to area, and property to property. It can only be used as part of an analysis.
You should know that.
That's why I said rule of thumb. It's a place to start. Obviously I don't buy properties for investment or make a rentvsbuy call by just looking at the rent vs house prices in the general neighbourhood. But the grm for overall area market lets me have a general idea if I want have a to look or not bother. When I got out of tx (great returns in late 90's then insurance and property taxes went insane) los vegas was a screaming bargain basement. Now I see some other markets that are much better and will start shifting out of vegas.
I look at the "Cap Rates" much better than the GRM. Even the Cap Rates vary with area, but still a better analytical tool than the GRM.
Maybe, maybe not. It depends on whether the books you are looking are truly reflective of actual expenses or cooked up with capital expenditures to puff up numbers for a sale. Almost impossible to verify just going through a P&L. You would have to dig through the actual receipts, even then it can be deceptive.
Cap rates works much better for commercial buildings or apartment complexes than individual houses for rent. I don't do commercial any more. It's not hard to find a rental property manager that's good. It's very hard to find a commercial property manager that's good. I don't know why that should be. Maybe I know a lot more about the right questions to ask rental property managers and how to review their operations.
"That is totally incorrect"
No, it's really not. If money printing were to cause the price of goods to rise, it would be exactly because that printed money reached people's pockets as income. Supply and demand dictates that prices rise when demand outstrips supply. This can only happen when people have money.
"If (1) the market is not cheap, and (2) wages do not keep with rates, then rising interest rates will put downside pressure on housing prices. You don't need history to prove this. Common sense is enough."
I'm just saying that it's amazing that common sense has never prevailed for the last 100 years of housing data history. You'd think if something was true, 100 years of data would be enough to show it.
What a dumb comment. Tell me when during these 100 years conditions (1) and (2) have been satisfied, and interest rates have been rising.
David9
2016 Dec 5, 8:52am
We have too much debt, interest rates won't rise. And house flipping is too large a part of the economy, imo
"What a dumb comment. Tell me when during these 100 years conditions (1) and (2) have been satisfied, and interest rates have been rising"
I think you're missing the point. You are assuming a scenario that doesn't happen.
Supply and demand dictates that prices rise when demand outstrips supply. This can only happen when people have money.
The main driver for house prices besides foreign investors was the downward readjustment of the interest rates so the monthly payments stay the same or don't increase too much. Rates have been artificially extraordinarily low for a while, when the unwinding continues unaffordability will weigh on the market. People don't have 'more' money, their monthly payments have been artificially "deflationed" while the house price itself has been artificially "inflationed".
Laughable - net net people may barely break even, but likely most will have less money after accounting fort the inflation in housing, healthcare, education and childcare. Most have been SHAFTED by ACA premium and deductible increases, those alone may eat their salary "increase".
"Laughable - net net people may barely break even, but likely most will have less money after accounting fort the inflation in housing, healthcare, education and childcare. Most have been SHAFTED by ACA premium and deductible increases, those alone may eat their salary "increase"."
OK fine. Here are real income gains:
Sure looks like real income has gone up quite a bit since 2012
David9
2016 Dec 5, 9:50am
Ask any Realtor about 'cash purchases' it's what they look for. Whatever percentage is reported, I personally would question. IMO, the RE market doesn't even care, currently, about the mortgage customer.
You are assuming a scenario that doesn't happen.
1. So you admit that the conditions that I specified never existed? Here goes your 100 history argument out of the door.
2. Now that we have established 1, we can have a more meaningful discussion - will these conditions exist in the future? Namely, IF rates start rising, is it likely that household incomes will keep with up with them? What effect will it have on housing affordability given it's current level?
joeyjojojunior,
Your graph proves my point. Last time rates were rising, household incomes were keeping with inflation.
"1. So you admit that the conditions that I specified never existed? Here goes your 100 history argument out of the door."
I don't know. I'd have to go back through history and check all the data. But my guess would be that has never happened in the past and will never happen in the future. The 100 year argument is showing you that the idea that when rates rise, prices fall is absolutely incorrect. Which is what the discussion was about.
"2. Now that we have established 1, we can have a more meaningful discussion - will these conditions exist in the future? Namely, IF rates start rising, is it likely that household incomes will keep with up with them? What effect will it have on housing affordability given it's current level?"
You have it exactly backwards. Rates will NOT rise until income rise first. That's my point--your scenario hasn't happened in the past and won't happen in the future. If you disagree with that statement, please give me one reason why rates will rise if incomes are stagnant.
"joeyjojojunior,
Your graph proves my point. Last time rates were rising, household incomes were keeping with inflation."
That's my point too. They ALWAYS do. Your scenario is nonsensical.
You have it exactly backwards. Rates will NOT rise until income rise first. That's my point--your scenario hasn't happened in the past and won't happen in the future. If you disagree with that statement, please give me one reason why rates will rise if incomes are stagnant.
Because rates are first and foremost a reflection of credit risk - or at least they should be. They have been low because the Fed has the banks back, no matter what they do and how much money they will lose in the next crash. The tail risk has been removed, so why not loan out money for less? Still a profit without risk. It remains to be seen if anything changes wrt the Fed under prez Trump, but as long as the credit market believes the central banks have their back rates may stay low. Any sudden risk dislocations or policy changes and watch the rates explode regardless of income.
Very interesting graphs joeyjojojunior. Yes, I did underestimate quite a bit how good the economy is doing - I do agree that incomes have shot up from 2012 (I have personal anecdotal evidence for that if it matters any).
Having said that, I have a few reservations. It remains to be seen how much the income will really rise. Secondly, I personally have been very aggressively courted by RE agents and builder's snake-oil salesmen, who relentlessly tried to convince me that the house price/gross income factor could be stretched to 6 at these low rates. As this blog post points out (and as far as back I remember ever since I have been in the US), the recommended factor was 3.
Now, assume someone making $100K bought a $600K house. If the interest rates were to suddenly rise up to their historical norms (ignore how that happens), that person better be making $200K. Will it happen over the large population? Maybe. I don't think real income will rise; it will more or less be a function of the inflation itself. In a way, buying a $600K house now is hedging against increasing inflation if you have a fear it will increase.
Historically, US inflation is between 2 to 3%. For prices to double at 3%, about 20 years have to pass. So it will take 20 years for the person's income income to rise to $200K and the price to income ratio be more normal. But that again assumes house price will remain the same, which is unlikely. I am betting house price will more than double by that time.
I think in a world where population is declining, high inflation is unlikely. Maybe the interest rates will never rise and stay the same. I don't see rising inflation making people's incomes to go higher, and the size of their comparative debt that much lower. I feel a majority of economic crises around the world are simply happening because populations are declining in the West.
Anyway, my last comment - don't have anything to add more. Thanks for the discussion.
I agree with the statement that interest rates are going to stay very low for very long time.
So if you want to buy a home, be very patient! Don't jump in. Your oportunity will come - 5 years from now.
In the meantime rent cheaply if possibly and forget housing. When the headline of bad economy makes WJ, start tuning in hopefully with lots of saved up cash.
"Having said that, I have a few reservations. It remains to be seen how much the income will really rise. Secondly, I personally have been very aggressively courted by RE agents and builder's snake-oil salesmen, who relentlessly tried to convince me that the house price/gross income factor could be stretched to 6 at these low rates. As this blog post points out (and as far as back I remember ever since I have been in the US), the recommended factor was 3."
I think 3 is a much better guide too. I can't imagine buying at 6--that is ridiculous. I'd also recommend the various buy vs. rent calculators to see how your specific area looks.
"They have been low because the Fed has the banks back, no matter what they do and how much money they will lose in the next crash. The tail risk has been removed, so why not loan out money for less? Still a profit without risk"
Nonsense. There was absolutely tail risk as they banks lost HUGE sums of money. Tail risk was there for IndyMac, Countrywide, Bear Stearns, etc. And it is CERTAINLY there now, as I think every bank owner realizes that the current anti-bank/anti Wall St. sentiment would never allow another bailout.
Nonsense. There was absolutely tail risk as they banks lost HUGE sums of money. Tail risk was there for IndyMac, Countrywide, Bear Stearns, etc. And it is CERTAINLY there now, as I think every bank owner realizes that the current anti-bank/anti Wall St. sentiment would never allow another bailout.
You can't possibly believe yourself. There was ZERO tail risk since the Feds announcement in 2008/2009 to bail out the banks by whatever means possible, print money, buy up debt/MBS and leave the "emergency discount window" open for years. ZERO tail risk, hence the run-up in bank stocks and everything related. Now some tail risk has returned, but nobody believes yet that wall street has lost control over its puppets. Certainly not with the 3 stooges Boosh, Obummer and the Clinton-twins, and even Trump has to prove himself first. Pretty sure that even simply Mnuchin's nomination made the rates retreat a little again. But dislocations may happen all over 2017 which is likely going to be a volatile year, and when big money believes the Fed has lost or is losing control, then they will dump by whatever means necessary and rates may rise drastically.
joeyjojojunior,
You have shown inability to think logically. I have a rule to not waste time arguing with people who write more than they think. Therefore, sayonara to you.
To those who understood my argument - the conditions in the 70's were different than now. Women were moving into the workforce then, which helped increase the household incomes (even if individual wages were not keeping with inflation). In addition, more workers were unionised, had better benefits, and education and healthcare were cheaper relative to incomes.
"You have shown inability to think logically. I have a rule to not waste time arguing with people who write more than they think. Therefore, sayonara to you.
To those who understood my argument - the conditions in the 70's were different than now. Women were moving into the workforce then, which helped increase the household incomes (even if individual wages were not keeping with inflation). In addition, more workers were unionised, had better benefits, and education and healthcare were cheaper relative to incomes."
OK sayonara. But I don't think I'm not logical--I think maybe my argument is not reaching you?
To those who have any inkling that FP might be correct. Of course things were different in the 70s--that's why interest rates went up! My point is that rates won't go up again until we have similar conditions again, eg, less inequality.
"There was ZERO tail risk since the Feds announcement in 2008/2009 to bail out the banks by whatever means possible, print money, buy up debt/MBS and leave the "emergency discount window" open for years. ZERO tail risk, hence the run-up in bank stocks and everything related. Now some tail risk has returned, but nobody believes yet that wall street has lost control over its puppets. Certainly not with the 3 stooges Boosh, Obummer and the Clinton-twins, and even Trump has to prove himself first. Pretty sure that even simply Mnuchin's nomination made the rates retreat a little again. But dislocations may happen all over 2017 which is likely going to be a volatile year, and when big money believes the Fed has lost or is losing control, then they will dump by whatever means necessary and rates may rise drastically."
So, you believe that if there was another Wall St. caused bubble and bust, that the government would bail out the banks and Wall St. again?
So, you believe that if there was another Wall St. caused bubble and bust, that the government would bail out the banks and Wall St. again?
Nobody knows, but the slow rise in rates points to somewhere in between. People are unsure where the economy will go and what the rate of Fed / government bailouts will be going forward. I think the rates are testing the waters right now. If we have a 2008 type dislocation again I would set the chances of another major bailout to at least 50%, Trump being president or not. So far the declining American empire has taken the easy way out each and every time, aiding the slow and constant decline instead of ripping the band-aid off and allowing for a truly organic recovery. I agree there was tail risk until the recession hit and the bailouts were enacted and there is more tail risk now, but it's still relatively low, Wall Street will not cede control that easily.
"Nobody knows, but the slow rise in rates points to somewhere in between"
Fair enough-but I would argue the slow rise in rates is more due to the graph I posted earlier showing rising incomes.
Inflation can be caused by factors other than increased economic activity which leads to wage growth. The causality relation is wage growth => inflation. Not the other way around.
"The causality relation is wage growth => inflation. Not the other way around."
OK--that's what I've asked you several times. What would cause inflation without wage growth AND cause rates to rise? Inflation without wage growth would have to be caused by goods with very inelastic demand curves such as oil and food. But a spike in oil prices would likely bring wage growth at this point with all the oil and natural gas potential in the US. And even if all oil were imported, a spike in prices would push then push the US into recession causing rates to fall, not rise.
I just don't see how you can have inflation with no wage growth. Where is this extra demand coming from if there is no wage growth?
"The causality relation is wage growth => inflation. Not the other way around."
OK--that's what I've asked you several times. What would cause inflation without wage growth AND cause rates to rise?
Once you acknowledge that my original statement:
"If (1) the market is not cheap, and (2) wages do not keep with rates, then rising interest rates will put downside pressure on housing prices."
is accurate and your historical reference does not disprove it, we can move on to discuss the relationship between wages, inflation, and rates.
"Once you acknowledge that my original statement:
"If (1) the market is not cheap, and (2) wages do not keep with rates, then rising interest rates will put downside pressure on housing prices."
is accurate and your historical reference does not disprove it, we can move on to discuss the relationship between wages, inflation, and rates."
OK--I'm not going to play games with you. If you actually want to have a discussion, I'm willing.
Unfortunately, you seem unwilling to do so.
You might as well say--if aliens land on Earth, and destroy all single family housing stock, it will put upside pressure on housing prices.
My comment is actually spot on point. Let's review the discussion. Patrick writes that house prices will fall when interest rates rise, and Mark (and I) replied that historically there is almost no correlation between interest rates and house prices, and the little correlation that does exist is slightly positive (prices rise when rates rise, housing falls when rates fall). You replied with a hypothetical which I then said was basically impossible, and therefore shouldn't be considered when evaluating the future of the housing market.
You replied with a hypothetical which I then said was basically impossible,
No, this is not what you said initially. Only later you tried to change the subject.
My comment was on topic, because it is important to understand that there are several factors that influence house prices. You cannot take just one (in this case interest rates) and consider it in isolation.
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On the other hand, in some poor neighborhoods, prices are now so low that gross rents may exceed 10% of price. Housing is a bargain for buyers there. Prices there could still fall yet more if unemployment rises or interest rates go up, but those neighborhoods have no bubble anymore.
The only true sign of a bottom is a price low enough so that you could rent out the house and make a profit. Then you'll know it's pretty safe to buy for yourself because then rent could cover the mortgage and ownership expenses if necessary, eliminating most of your risk. The basic buying safety rule is to divide annual rent by the purchase price for the house:
annual rent / purchase price = 3% means do not buy, prices are too high
annual rent / purchase price = 6% means borderline
annual rent / purchase price = 9% means ok to buy, prices are reasonable
So for example, it's borderline to pay $200,000 for a house that would cost you $1,000 per month to rent. That's $12,000 per year in rent. If you buy it with a 6% mortgage, that's $12,000 per year in interest instead, so it works out about the same. Owners can pay interest with pre-tax money, but that benefit gets wiped out by the eternal debts of repairs and property tax, equalizing things. It is foolish to pay $400,000 for that same house, because renting it would cost only half as much per year, and renters are completely safe from falling housing prices. Subtract HOA from rent before doing the calculation for condos.
Although there is no way to be sure that rents won't fall, comparing the local employment rate (demand) to the current local supply of available homes for rent or sale (supply) should help you figure out whether a big fall in rents could happen. Checking these factors minimizizes your risk.
The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. Then you get a low price, and you get capital appreciation caused by future interest rate declines. To buy an expensive house at a time of low interest rates and high prices like now is a mistake.
It is far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.
The Fed exists to protect big banks from the free market, at your expense. Banks get to keep any profits they make, but bank losses just get passed on to you as extra cost added on to the price of a house, when the Fed prints up money and buys their bad mortgages. If the Fed did not prevent the free market from working, you would be able to buy a house much more cheaply.
As if that were not enough corruption, Congress authorized vast amounts of TARP bailout cash taken from taxpayers to be loaned directly to the worst-run banks, those that already gambled on mortgages and lost. The Fed and Congress are letting the banks "extend and pretend" that their mortgage loans will get
paid back.
And of course the banks can simply sell millions of bad loans to Fannie and Freddie at full price, putting taxpayers on the hook for the banks' gambling losses. Heads they win, tails you lose.
It is necessary that YOU be forced deeply into debt, and therefore forced into slavery, for the banks to make a profit. If you pay a low price for a house and manage to avoid debt, the banks lose control over you. Unacceptable to them. It's all a filthy battle for control over your labor.
This is why you will never hear the president or anyone else in power say that we need lower house prices. They always talk about "affordability" but what they always mean is debt-slavery.
The simple fact is that the renter - if willing and able to save his money - can buy a house outright in half the time that a conventional buyer can pay off a mortgage. Interest generally accounts for more than half of the cost of a house. The saver/renter not only pays no interest, he also gets interest on his savings, even if just a little. Leveraged housing appreciation, usually presented as the "secret" to wealth, cannot be counted on, and can just as easily work against the buyer. In fact, that leverage is the danger that got current buyers into trouble.
The higher-end housing market is now set up for a huge crash in prices, since there is no more fake paper equity from the sale of a previously overvalued property and because the market for securitized jumbo loans is dead. Without that fake equity, most people don't have the money needed for a down payment on an expensive house. It takes a very long time indeed to save up for a 20% downpayment when you're still making mortgage payments on an underwater house.
It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is kept unfairly high because of the Realtor® lobby's corruption of US legislators. On a $300,000 house, 6% is $18,000 lost even if housing prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.
From The Herald:
"We were all corrupted by the housing boom, to some extent. People talked endlessly about how their houses were earning more than they did, never asking where all this free money was coming from. Well the truth is that it was being stolen from the next generation. Houses price increases don't produce wealth, they merely transfer it from the young to the old - from the coming generation of families who have to burden themselves with colossal debts if they want to own, to the baby boomers who are about to retire and live on the cash they make when they downsize."
House price inflation has been very unfair to new families, especially those with children. It is foolish for them to buy at current high prices, yet government leaders never talk about how lower house prices are good for American families, instead preferring to sacrifice the young and poor to benefit the old and rich, and to make sure bankers have plenty of debt to earn interest on. Your debt is their wealth. Every "affordability" program drives prices higher by pushing buyers deeper into debt. Increased debt is not affordability, it's just pushing the reckoning into the future. To really help Americans, Fannie Mae and Freddie Mac and the FHA should be completely eliminated. Even more important is eliminating the mortgage-interest deduction, which costs the government $400 billion per year in tax revenue. The mortgage interest deduction directly harms all buyers by keeping prices higher than they would otherwise be, costing buyers more in extra purchase cost than they save on taxes. The $8,000 buyer tax credit cost each buyer in Massachusetts an extra $39,000 in purchase price. Subsidies just make the subsidized item more expensive. Buyers should be rioting in the streets, demanding an end to all mortgage subsidies. Canada and Australia have no mortgage-interest deduction for owner-occupied housing. It can be done.
The government pretends to be interested in affordable housing, but now that housing is becoming truly affordable via falling prices, they want to stop it? Their actions speak louder than their words.
Next Page: Eight groups who lie about the housing market »
The Housing Trap
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