patrick.net

Most homeowners have lots of equity in their homes. The average homeowner has about 55% equity in their home. A short-term fluctuation in the value of their home is not likely to be important to them. Even a 25% price decline would leave the average homeowner with 40% equity (and 60% LTV).

Lies, Damn Lies, and Statistics, Part II

DinOR mostly beat me to the punch here (average in Midwesterners owning their homes outright with people who have little-to-ZERO equity, and viola!: 55% "national average" equity rate).

However, I can also add the following:

--This "55%" figure (demos-usa.org/page269.cfm) is an all-time low from 1973, when they first began collecting this data.

--This "55%" figure is based on current home valuations. If prices drop, then guess what? So does the assumed equity.

"by missing out on the 2003-2005 gold bull, you have missed a massive investment opportunity." --Fewlesh

Zephyr knows Real Estate, so that is what he invest in.
"Buy what you Know" --Peter Lynch

For some reason the last paragraph of my above post on flipping/speculation stats got chopped. Should have read:

Statistics on national averages tell me little about what recent homebuyers in my city have been doing. As DinOR pointed out, national averages combine people in the Midwest who have lived in the same house for 50 years with serial condo-Flippers from South Beach.

See “Lies, Damn Lies and Statistics”.

BTW, all of this is recycled, already-posted information, well known to any Patrick.net long-time poster.

I suspect Zephyr is just having a bit of fun with us ;-) .

PIMCO research indicated that 82% of the purchase loans in California in the last year were either I/O or negative-amortization That’s what we expect in the year ahead. Indeed, I would suggest that the downside for home price appreciation (note, being an optimist, I said downside for home price appreciation, not home prices themselves!) is particularly acute right here Paul McCulley of PIMCO announced that in California over 80% of new mortgages over the last year have been exotic creatures – interest only, pay option, and negative amortization concoctions.

Regarding equity of recent buyers, here's some info that caught my attention:

"Recently compiled statistics at Legacy Escrow Service, Inc. reported that 71% of closed purchase transactions by the firm in 2005 were 100% financed."

Legacy services the Puget Sound (West Wa) market (which isn't has hot as here), but what does that suggest for the SF Bay Area? It's pretty easy to imagine it's just as bad (or worse) here.

Zephyr:

Do you happen to have a connection to Zephyr Real Estate on Brannan Street here in San Francisco? Just curious, no need to respond if you don't want to.

@jeffolie,
Thanks for the stat. Here's the link:
blogs.ocregister.com/morningeye/archives/2005/12/the_future_and.html#more

DinOR,
Ah, yes, that's beauty of statistics. ;-)

usatoday.com/money/perfi/housing/2006-01-17-real-estate-usat_x.htm?csp=14

WASHINGTON — As housing prices soared last year, an eye-popping 43% of first-time home buyers purchased their homes with no-money-down loans, according to a study released Tuesday by the National Association of Realtors.

Who are entry-level buyers?
Survey of home buyers reveals:
Median age: 32
Median household income: $57,200
Median down payment: 2%*
Purchased with no money down: 43%
* — on home costing $150,000

Source: National Association of Realtors, 2005 Profile of Home Buyers and Sellers

New thread: Denial is not a river in Egypt

@Linda

OK. Now that I’ve read almost everything on this site, it seems to me that you all have a great distaste for anybody who owns a home and is trying to decide whether to get out now and take the money and run.

Not the case at all, there is this dude I work with that bought a house in $anta Barbara about 10 years ago, paid 2-300K, it's now worth south of 1.5mil. I told him to sell, sell now. His real estate mogul wife doesn't agree, she thinks it is going to go up more. They have a house in templeton also, for what they would gain (tax free I might add) they could pay the templeton house off and have cash in the bank. I do not grok these boomers. I guess when you have had your head in the trough all your life, you expect that the pigs will be slopped forever.

If you think that the market will tank, I do. Sell the house and move to a rental. I've never had a problem renting with my 2 cats (well now only 1 :( ) and my wife has a boston terrier, still no problem. I could see a problem is your dogs could double as draft animals. I would think about what to do with the cash if you sell. I personally have never had much grub to worry about. Education is expensive.

Linda

I understandard your difficult position. Consider what I believe the most likely outcome by the end of 2007. Even though you have plenty of contentment and equity most arround you in recent years have subprime mortgages.

When the subprime owner defaults the following happens:

The first to feel the declines in price are the new sellers. The second ripple is the MEW's (mortgage equity withdrawal, home equity loans, HELOC's, etc) which depresses renovations and major purchases. The foreclosures and REO's come third because the laws give months and months of grace period. Oh, did I mention the defaulting mortgage backed bonds, especially derivatives.

The fear is that the sheer pace of the growth in credit derivatives has outstripped both the scope of the existing regulation and the development of infrastructure to manage exposures in the sector. According to the International Swaps and Derivatives Association, the total notional volume of credit default swaps outstanding had reached $12,430bn by the end of June - a growth rate of 48 per cent in six months. The market had scarcely existed in 2000.

Collapsing mortgage backed bonds and derivatives, plus stock derivatives and a declining economy will overwhelm the Fed. The central bank of Japan in 1990 failed. This is my reason to conclude that all prices will fall in a severely.

Oh, did I mention that the hedge funds use derivatives. Hedge funds account for more than half of the daily volume in the US stock market. Hedge funds can buy or sell the risk of default by a single company or a portfolio of them. Derivatives have been used to create securities that track the credit of hundreds of companies at once, allowing hedge funds to bet either way on the corporate credit market.

the source for this is:

Financial markets: Spread of derivatives reshapes markets
By John Authers Tue Jan 24, 1:00 PM ET

According to the International Swaps and Derivatives Association, the total notional volume of credit default swaps outstanding had reached $12,430bn by the end of June - a growth rate of 48 per cent in six months. The market had scarcely existed in 2000.

That is 12.4 Trillion!

Remember Warren Buffet's warning on OTC derivatives?

@ Bob Cote,

Read closely, I said

They have a house in Templeton also, for what they would gain (tax free I might add) they could pay the templeton house off and have cash in the bank.

Tax free 500K, house in templeton has 250K note.

Priced rentals in Santa Barbara lately? Actually, yes, I just rented a 2/1 victorian flat here for $1950, which I consider a vigourous ass pounding

Yeah the PITI on their current home is low, but come on now these are mid 50's boomer who can take a ton of money off the table for doing squat, the boomer ideal. Dude also has the fat legacy pension from back in the day, you know, back when the boomer hogs were slopped thrice daily.

Surfer-X, based on what Linda wrote it appears she is in a significantly different situation than your friend, mainly:

1. She is living in the house they are considering selling (not a 2nd investment property).
2. No major outstanding debts to pay down (such as your friend's $250K Templeton mortgage).

Different situations, different needs.

So often people today speak of trillions as if they are chicken feed.

Yes, they are used to the Moore's Law for semiconductor. So no problem if the deficit doubles every 18 months.

With 12.4 trillion of trouble, won’t the Fed make a move to prevent such a large exposure?

Greenspan has a very clever plan in place: retirement.

Some derivatives are regulated by the Fed while others are not. In finance, a derivative security is a contract that specifies the rights and obligations between the issuer of the security and the holder to receive or deliver future cash flows (or exchange of other securities or assets) based on some future event.

"As the delinquencies and losses on mortgages flow through to subordinated mortgage- and asset-backed securities, who will be affected? Who buys these securities? The interesting part about these private label subordinate pieces is that for the most part, they’ve ended up in CDOs [collateralized debt obligations] and have been sold outside the U.S. Subordinated pieces are trading at their most expensive levels ever primarily because of the demand from structured deals—CDOs are underwriting the risk in the mortgage market. The lender (buyer of the CDO) is the person in line to lose money. While CDOs often have higher yields for a given rating level, they also usually have higher risk for a given rating level. Because the investors are CDOs, the bonds are outside the banking system, and the regulatory agencies cannot police the market. That has been a frustration for the regulators—they can’t do as much about the situation as they had hoped."

Linda,

there is a simple rule to this. If you sell now, you pocket 300K windfall. Do you think you can save that amount of windfall before you retire with the economy going south? If not, sell now and pocket the money. If not, ride it through.

I am about in the same shoes but I am quite far away from retirement (30+years), and I believe I can save the windfall before I retire. Also, I locked in a tax base which will benefit me for a longer period of time going forward. As you get closer to retirement, pocket the cash whenever you get a chance, don't wait for tomorrow.

Whatever you do, don’t listen to gold bugs until you are financially sophiscated enough to know the difference amongst speculation, hedging and investment.

Honest, very few professionals practically distinguish the three. There are lots of grey areas.

When people tell you that gold is now over 500, ask them what it was in 1980.

I think gold was about $2000 (two thousand dollar!) inflation adjusted. Do your own research.

I won't recommend Linda to get into gold, although I am 40% in gold and silver. The reason is because she is close to retirement and perhaps not mentally prepared for huge swings in metals. I personally believe that gold will go beyond $2000 in a few years, but along the way, there will be huge swings (recently gold went from $540 to 485 within a week), and if you need money to spend, you are not mentally prepared, you should stay out of the game. When it pulls back, it shakes out a lot of weak souls, and you may start to question your own long-term judgement.

The prudent way for Linda to hedge is perhaps through diversification into foreign currencies, at least for part of her portfolio.

Peter P,

Historic Peak Price for Gold: $850 on Jan 21, 1980. In today’s dollars this would be over $2,000. So in real terms gold has lost about 70% of its value since then. Of course that $850 was a price spike and the prevailing price for the last three decades was much lower, but not enough lower to make gold a good place to have been all along. Gold is a speculator's asset, with good moments and bad moments and a lot of boring low return stretches.

Fewlesh,

You said I should look at the macro trends outside of real estate. Good advice. In fact, I spend over two hours each day studying the economic data and trends and have been doing this continuously for about 35 years.

I have been investing in the stock market for more than 30 years. I have put far more money into the stock market than into real estate. I have beat the market by a small margin for most of those 30 years, and by a nice margin in recent years. I have been continuously invested in the stock market for over 30 years with the exception of the period from 1998 through 2003 when I exited the market when the Dow was around 9500 and stayed out until March of 2003 when the Dow was about 7300. I was so convinced that the Dow at 7300 was a buying opportunity that I bought back in with everything I could reasonably muster. I even maxed out my HELOC to buy more stock in 2003. I have made double digit (and seven figure) gains in 2003, in 2004 and in 2005. I am up by about 3% so far this year. That would be about 40% if annualized, but I do not this pace to hold all year.

It is true that gold has performed well in recent years, but not as well as my investments have performed. I expected gold to do well, and it did better than I expected. But I expected stocks and real estate to be better for me. If I had bought gold instead I would have done well - but not as well.

In the long run gold is a piss poor investment. You are lucky if you break even in real terms. In fact gold is really not an investment, it earns nothing. Gold is a pure speculation play. It rises on fear and falls on calm. Over the last 25 years it has not even been a hedge against inflation. It is volatile, as its price is a barometer of fear. And you can make money betting on fear. You can also lose.

I focus my investing attention to real estate, stocks and bonds. They have earnings and capital gains potential. There is a time and place for each. There are definite cycles in each, and I have much experience in working those cycles. There are many other potential investment areas to consider if one desires. However, these three asset classes have been enough for me.

DinOR,

I am sure that most of the equity that people have in their homes is from appreciation, and not from paid in capital.

BTW, the equity percentage is higher in areas where the home prices are higher. Of course, this is logical when one considers that the equity is usually from appreciation in that location or from appreciation in a prior home being brought to the more expensive home. Also, in the luxury home category, about half of all buyers pay 100% cash – no financing. At the other end, first-time buyers generally have very little to put down, given that they had no prior appreciation to work with.

In the hot markets there is a lot of appreciation equity. Of course, much of it is temporary and will validate the old cliché “easy come, easy go” when the cycle heads for the bottom.

DinOR,

While refinancing has been used to extract record levels of cash, the largest single factor affecting the refinancing of mortgages is declining interest rates. People refinance to save money and many decide to take some cash out at the same time. Certainly some are mostly motivated by the cash out, while others merely seek the lower interest rate. Watch the markets for a decade or so and you will see that refinancing is hugely correlated with obtaining a lower interest rate.

HARM,

While flippers do have a disproportionate affect on the market, they are a small percentage of the buyers and owners. There are a ton of legitimate buyers of second homes, and there are enough buyers of rental properties to enable 30% of the population to rent from these landlords. Most are not flippers. Flippers buy and then sell inside a matter of months – often without even getting a tenant. In addition, just consider the math – if the average duration of ownership for a home is seven years, then flippers could only be a tiny percentage of the total. Try the math…

Assume that the world were half flippers and half long-term owners, and all the long-term owners held for 20 years while the flippers continuously bought and held for three months. During a 20 year period the long-term owners would each have owned one home, while the flippers would have each owned (and sold) 80 homes for a total of 81 homes owned. The average duration of ownership would be just under six months (40 years of ownership divided by 81 homes owned). However, the average duration is about seven years.

So you see it is mathematically impossible for the number of flippers to be anything close to half of the market for any length of time. In fact, the math only works using a tiny percentage on a long-term basis, or as is really the case, a modest percentage on a short-term basis.

Soon the flippers will all be gone. Some rich and some flat broke. They (or a new crop) will reappear when the market nears its next cycle peak many years from now. I have been through four real estate cycles during my adult life. The flippers have been there for every peak, doing essentially the same things each cycle.

San Francisco RENTER,

No, I have no affiliation with Zephyr Real Estate or any other real estate entity (nor am I affiliated with the Amtrak Coastal Zephyr or the Zephyr automobile). Zephyr is just a name that sounded fun and does reflect my pattern of posting activity – I am here like the wind for a while and then I am gone for a while. BTW, a Zephyr is a mild wind from the sea – not hot air from the desert… that would be a Santa Ana.

In fact, other than owning rental properties, I have no affiliation with any entity that provides any real estate services or products. I am in the financial services sector and provide capital to other to financial services businesses that have opportunities that exceed their existing capital. We provide off balance sheet capital backing – (for a price).

http://zephyrseconoblog.blogspot.com/

Zephyr, yes I concede that short-term flippers/speculators never constitute anywhere close to an outright majority of all homeowners in any given RE market. However, as you noted, they "do have a disproportionate affect on the market".

Since the percentage of RE turnover in any given year is generally in single digits, they can (and do) constitute a sizeable chunk or even a majority of new buyers during bubble/bull market peaks, as I'm sure you'll agree. Since recent sales (comps) are used to determine median price, appraisal value, tax assessments, etc., it's no stretch to say that flippers can have a large impact on RE prices during such periods.

Interesting long-run take on gold, and some good points. I still wouldn't rule out having a small % in a portfolio as an inflation hedge, though (however you want to calculate "inflation" these days --not about to reopen that can 'o worns ;-) ). As you noted, it's previous peak cooincided (no surprise) with the peak year of double-digit inflation in the U.S., to which thankfully, Volcker put an end.

Posted before I read FogHorn's response --he beat me to the punch!

Dr.Strangelove Says:

"Not trimmed nearly as lean as you, but let me tell you, I feel COMPLETELY LIBERATED! Some books kept for research (job related), one couch, one dresser, computer etc., but really got rid of a lot of that crap, you know…”am I really going to ever wear that friggin’ shirt again? No,”…GONE."

You've inspired me.

I've got to get rid of a lot of sh-t.

I'm going to do it now.

Thanks!

There’s a lot of satisfaction in getting rid of clutter.

Also a lot of grief in having spent so much on useless junk.

Zephyr, I am not super-savvy investor, just a scientist trying to get along and have a decent time. Can you offer some suggestions on the following? I have about 42K in student loan debt from my PhD, it is at 3.75% fixed (Thanks Uncle Sam), I have the cash to pay it off, but to me it seems that I'll never get money this cheap again. As stated prior, not a super-savvy investor. The idea of being completely debt free is appealing but the rate is so low I don't think it makes much sense. Any other super-savvy finance types feel free to comment also. Trolls piss off.

I am not Zephyr, nor am I nearly as sophisticated, but I do not let my wife pay off her student loan.

What is the point of paying off a loan if you are paying quite a bit less than the T-Bill rate?

Peter P, that's what I think, now should I put the money in a safe investment, like T-bills CD etc and use the interest it generates to pay the loan interest?

Peter P, that’s what I think, now should I put the money in a safe investment, like T-bills CD etc and use the interest it generates to pay the loan interest?

That is up to you. The main advantage is liquidity. It is always good to have cash available.

If not, then pay off the loan, your losing money.

I will even give a bit premium to having money on hand. If you need cash for whatever reason, you may not be able to get a loan right away.

surfer-x, is your student loan tax deductible?

Personally I hate owing anyone money, unless I can qualify a good investment a that make sense for me.

I hate owing people money but I love owing banks money if I have enough cash to cover the obligation and the cost of carrying the debt is small or negative. :)

Credit is available only to those who have wants but no needs. When I really need money in the future, no one will be extending credit to me.

I agree this is a personal decision.

Seatledude great words of wisdom!

The most liberating feeling I can relate to is when I left the Army after my enlistment was over at Ft. Bragg, North Carolina back in '89.

I got rid of a lot of shit but kept my big, pimp stereo & Klipsch speakers.

Even after liquidating a bunch of shit from my barracks & locker, my little Ford Tempo was still stacked from floor to ceiling with stuff.

All of my friends that left Ft. Bragg, to either get out of the military after their enlistment was over or move to another military post, gave the old FU two middle finger salute to Uncle Sam.

I flew off the base giving the salute and didn't rest until I hit Oklahoma, some 1,000+ miles later.

Man, what a feeling of liberation, of hard-won freedom!

That GI Bill college fund money sure went a long way on the weekends spent up at Harrahs, Tahoe during my undergrad years at San Jose State.

Damn, those were the days!

Surfer-x,

if I can borrow money and lock down at 3.75%, I will max out the borrowing and convert to non-USD assets, and pay off as USD becomes worthless.

So it really depends on what you are doing with your cash. If you are stashing it away in CD, then pay off your loan. If you are investing, hell no.