patrick.net

Your home purchase breaks even after 5.3 years.

What the heck did I do wrong?

I took the rental 225 Horizon Avenue, Mountain View from Craigslist and got it's lower bound zillow price

Rent: $1750 a month
Zillow: $503,451 lower end

I then plugged it into this calculator:

http://www.dinkytown.com/java/MortgageRentvsBuy.html

with the following assumptions:

And the result is that it would only take me 5.3 years to break even??

That sort of runs counter to a lot of themes here. I guess one assumption that is a little aggressive is the appreciation (3%). If I change it to 1, it becomes 9.9 years - still not exactly a killer.

Thoughts?

Argh - could someone remove my comment from moderation?

Patrickm Says:

> What I have a hard time understanding is,
> who exactly is buying these $600 000
> condos in SF.

Most of the purchases are by scared people who feel they will be “priced out of the market forever” if they don’t buy now… I know a lot of single 30 something gals who decided to jump in and buy (most with little or no money down) in the last year (using loans that will take more than 100% of their take home pay when the low start rate period ends)...

> Someone with an annual income of $200 000?
> Do many in the SF even make $200 000?

An “individual” with an annual income of over $200K is still in the top 1% of the nation (back in 2000 the census reported that a “household” with an income a little over 100K was in the top 5% and a little over $200K put a “household” in the top 1%...

In the past you had to make nearly $200K to buy a $600K condo, but today with a “stated income loan” you don’t even need a job. The market will drop like a rock as soon as the high risk lenders start loosing money and secondary financing and high risk first loans go away.

The number of people that can “save up” a 20% down payment on even an (inexpensive in SF today) $600K condo is very small so it will get a lot harder to sell in the next year. Remember nice 3,000 sf homes were selling for $600K in Burlingame Hills, Laurel Heights and Kentfield less than 10 years ago…

theotherside,

Who are you? A little about yourself might be more civil than just stalking me in every thread. Anyway, such detailed questions about the Bubblizer model are better discussed in my blog. I will say that the model very accurately predicts my own anecdotal experience, having bought my first CA home in 1996 (sold in 2002), and comparing that to the 2006 price of that same home.

If you have questions about the HSBC model, email the authors. I've found them very receptive to questions and very forthcoming with helpful discussion.

For example in our case, I don’t think we are able to afford a place we would like with $110,000 my husband makes.

Do you work? If so, you folks could definitely afford a fairly nice condo in Mountain View...

@RenterinPV,

My pleasure! :-) Actually, that was just a paraphrase of a wonderful antitroll refrain created by someone else (can't recall the original author). The complete quote, which I saved for posterity and re-use-- is this:

It’s a new paradigm, and everybody who doesn’t buy, now, will be priced out forever. Anybody who does buy will be rewarded with a lifetime of riches, as their property will continue its 30% yearly price increase.

This asset bubble is different than all of the others - it will never slow down, or pop. The gains are permanent.

theotherside (The Other)

Your statement is SO conflicted I hardly know where to get started.

Yes. The idea behind studying asset class bubbles is to keep your powder dry until there is a more inviting entry point. In the world of institutional money management this strategy is employed largely to keep your job.

I'm not sure what cloud you've been living in but most economists are calling for 2007 to be a fairly strong year. Even with technology in utter shambles we had but a modest (and shallow) recession. Again unless you sell or finance RE (or rely on MEW to keep current on your no-doc. specuvestments) most of us will hardly notice.

Hint: (There *isn't* a HUGE pool of buyers on the sidelines). RE bear blogs are smallish in nature and with home "ownership" up over 70% we'd love to know where this huge pool is going to come from.

These are all pretty much common knowledge for those that have studied this particular asset bubble for the last 2-5 years. I don't want to speak for others but "I" personally find it very annoying when people that have only recently become aware of the situation (primarily now that it's being covered, as are we in MSM) come here and insist on being given a "free education". Please go back through the archives, read the articles, look at the graphs. That should occupy just about all your free time until about 2009. Seriously, you're THAT far behind the learning curve.

Surfer X,

We FINALLY found a sucker to take you up on your bet! (Give this guy a call QUICK before he changes his mind!)

theotherside Says:

> Here is a deal I am proposing to anyone of you
> guys who is willing to put his/her money where
> his/her mouth is:
> ==> If on January 2009, the median price for a
> single family house is down more that 20% from
> today level in California, I will pay you 3 times your
> premium. If the price is not 20% lower, I keep your
> premium.
> and your premium (anything between $10,000-
> $100,000).

Let’s say we buy an average home West of El Camino in Burlingame or San Mateo (where my Dad owns a bunch of rentals) for $1.5mm putting (your maximum) $100K (6.6%) down.

We can rent the home for about $30K a year ($28,500 after a 5% vacancy/collection loss).

Debt service on $1.4mm will be about $110K a year, property taxes will be about $18K a year and Insurance, mgt. & maint. will be another $5K a year.

Who will cover the ~$100K of negative cash flow per year? Do you have the cash to escrow $1mm for 2 years? (enough to cover the actual 20% + drop + pay me the $300K + pay for the cost of sale)?

If you think prices are going up you don’t need to bet any of us, just go out an buy (don’t forget to post the address of the “investment property” you buy so I can pull the sale price and run the numbers to let the BLOG know what a bad investment you made)…

Person,

Late? Never.

Another "trick" from back in the day was for bond traders to sell "swaps" from the bond desk to brokers like myself. The basic pitch was; "You're INCREASING your yield by 40% AND decreasing your maturity by____!

Well, without so much as being able to find your calculator most of us can quickly figure out that the "mark-up" on the buy side will negate that HUGE 40% increase and it's basically a wash. These guys are under tremendous pressure to move huge blocks of paper so I understand but like my old man used to say "nothing times nothing is still nothing".

FAB,

Additionally isn't it something of an idle threat given there's a pretty strong consensus that most markets already peaked in OCT 2005?

Person,

In a nutshell....yes! When you get into the shorter maturities the mark-ups begin to evaporate and the broker is lucky to get a 1/4 point. Even w/that small a mark-up the net to the client (investor) is basically a wash out, BUT "you've decreased your volatility AND increased your credit quality yada yada". It's basically a "churn" scripted to look good but people at the bond desk need to eat too. MB's of late are operating on that same basic model to generate fees.

The difference is that they are peddling their wares to an unsuspecting public most commonly with no financial background.

From the LA Times today:

“800 employees nationwide who were laid off when Ownit Mortgage Solutions Inc. announced that it was closing its doors immediately — and had no money to pay its employees.”

“Ownit's demise is an example of wider troubles among independent sub-prime lenders, which, unlike more diversified banking companies, depend heavily on Wall Street for loans and services. "This is going to end badly" for the industry, Dallas predicted.”

It looks like 2007 is off to a great start. It will be interesting to see how many $1,000 per sf condos in SF sell when Borrowers actual have to come up with a down payment and qualify for a loan (vs. last year when you could Borrow all the money IO and “state” (aka “lie about”) your income…

FAB

You're wasting bits on "theotherside". (S)he apparently doesn't quite get the whole net present value thing.

The funny thing is, many of us here are anything but "perpetual real estate skeptics". Both FAB and I have often stated our appreciation for the Bay Area and belief that it rightfully commands a premium in real-estate value. We and many others here have many times described our criteria for when we'll buy.

Before asking us to repeat detailed calculations and defend the results, "theotherside" could do us the courtesy of reading through past threads and not asking the same old tired questions.

Maybe I'm just getting tired, but I've grown very impatient with these types of provocateurs. Here's your answers, in short, "theotherside":

1. Yes I'm going to buy, and I'm already banking on that so I don't need your "bet".
2. No I won't take your bet because you are not a credible counter party. I don't even know who you are. You won't even enlighten us as to yourself so we can better view your fount of knowledge.
3. I feel quite good about all this, despite the royal pain-in-the-ass renting represents to me and my family. During this 2 year respite, we've managed to earn about 13.5% after tax return on our cashed-out-equity. And as an added prize we finally got to purge ourselves of that 40% of crap we kept moving house to house which no one wanted or needed. Hell, even if prices didn't correct, we'd be able to buy a much smaller house than the 4Ksqft monster we sold, and save a bunch of $$ right there.

Randy H,

Ditto. Now if you're a paying client, then I have all the time in the world to address your issues. We come here for advanced debate on the degree and direction of the market correction. Not to grapple with the existence of one. (Isn't there some kind of "Flat Earth Society" these guys can join?)

OT but NGEO had a great special on the 1974 Xenia, OH twisters and man was that scary! They went into detail as how Dr. Fujito gleaned through the data to give us the warning systems we have today. Really neat stuff.

FAB,

Isn't that hysterical? (I mean provided you didn't work at Ownit). It's all momentum. If momentum so much as slows the whole thing de-rails! With Nardelli out at Home Despot it will be intersting to see how the new CEO's relationship w/the employees develops. Did you get a load of his severence pay? Fire ME!

Have we studied asset bubbles?

Here's just some samplers from references I've read over the past 2 years: There are more formulae, datasets, and statistics therein than you can shake a troll-paw at--

1. The Baby Boom: Predictability in House Prices and Interest Rates
Robert F. Martin* November 2005
*The author is an economist in the Division of International Finance, Board of Governors of the Federal Reserve System.

Abstract: This paper explores the baby boom's impact on U.S. house prices and interest rates in the post-war 20th century and beyond. Using a simple Lucas asset pricing model, I quantitatively account for the increase in real house prices, the path of real interest rates, and the timing of low-frequency fluctuations in real house prices. The model predicts that the primary force underlying the evolution of real house prices is the systematic and predictable changes in the working age population driven by the baby boom. The model is calibrated to U.S. data and tested on international data. One surprising success of the model is its ability to predict the boom and bust in Japanese real estate markets around 1974 and 1990.

His conclusion: (alpha .05) Real House prices will fall over the next 50 years, due to a 30% drop in related economic consumption, ending up at roughly 1993 real-prices by 2050. This model predicted Japanese house price action within an error of .05; slightly under predicting the top top and bottom both.

Conclusion. This paper has shown that a simple model which takes as given the demographic time series for the United States is capable of replicating many of the features of U.S. post-war data. I have shown that the demographic impulse implied by the baby boom is a likely driver of both interest rates and house prices and that both of these prices are likely to be influenced for some time to come as the baby boomers slowly retire and eventually die off.
The most important idea to take away from this paper is that while many factors may affect the price of housing — changes in ability to build Glaeser et al. (2005)), tax changes (Gervais (2002)), improvements in financial markets (Lamont and Stein (1999)), or changes to monetary policy Ahearne et al. (2005)) — if these factors are to explain the post-war house price experience, the price movements implied by the factor must be correlated with the timing of the impulses implied by the demographic model. I do not, however, mean to imply that these other forces are unimportant.
For example, Glaeser et al. offer a political economy rationale for the increasing level of building regulation observed in the United States. They argue that as home owners become a powerful political bloc they enact
regulations intended to protect the value of their investment. But who is this politically powerful cohort? — the baby boomers. If it is the baby boomers, then it is also not surprising that the timing of the regulations
32 correspond to the price impulse implied by the baby boom.

2. FEDERAL RESERVE BANK OF SAN FRANCISCO
WORKING PAPER SERIES

This paper was produced under the auspices for the Center for Pacific Basin Studies within the Economic Research Department of the Federal Reserve Bank of San Francisco.

Asset Price Declines and Real Estate Market Illiquidity:
Evidence from Japanese Land Values
John Krainer, Federal Reserve Bank of San Francisco
Mark M. Spiegel, Federal Reserve Bank of San Francisco
Nobuyoshi Yamori, Nagoya University, Nagoya, Japan
January 2005; Working Paper 2004-16
http://www.frbsf.org/publications/economics/papers/2004/wp04-16bk.pdf

Abstract

We develop an overlapping generations model of the real estate market in which search frictions and a debt overhang combine to generate price persistence and illiquidity. Illiquidity stems from heterogeneity in agent real estate valuations. The variance of agent valuations determines how quickly prices adjust following a shock to fundamentals. We examine the predictions of the model by studying price depreciation in Japanese land
values subsequent to the 1990 stock market crash. Commercial land values fell much more quickly than residential land values. As we would posit that the variance of buyer valuations would be greater for residential real estate than for commercial real estate, this model matches the Japanese experience.

OO said:
"What do you guys think of the rivermark condo fire?"

That was exactly what came to my mind last night when I heard about the news. And this morning on the news, there was another condo fire in Boston.

http://news.bostonherald.com/localRegional/view.bg?articleid=175110

His conclusion: (alpha .05) Real House prices will fall over the next 50 years, due to a 30% drop in related economic consumption, ending up at roughly 1993 real-prices by 2050. This model predicted Japanese house price action within an error of .05; slightly under predicting the top top and bottom both.

Someone better tell Bap33 to stop railing against the illegal immigrants if we want to keep housing prices up!

DinOR said:

"I’ve never heard of any fund that demanded the shareholder sit tight for the full 5,6 or 7 years or get hit with a full redemption fee? Are you sure you aren’t thinking of perhaps some of the older fixed annuities?"

It's rare, but there are some funds that do this. The fees are usually lower, 2-3%, and the terms are shorter, 2-3 years. I just did a little query, and found this gem: DCRIX has a 30 year term and 2% fee.

Harry Dent drew similar projections as far back as the late 90's. Let's see, declining population...... declining home values? Wow, what a revelation!

He also accurately predicited that MEW would become non-existent by 2010. Mind you, all of this WITHOUT the debacle we are now facing!

theotherside:

Are you saying that if the January 09 median California home sale price is down by more than 20% versus the January 07 median CA home sale price, in real terms, you'll give me 300% of my money? And if it's less than 20%, you keep my money?

What do we use to adjust for inflation? I suggest the 3-month t-bill.

We will need to adjust for counterparty risk. I know of some hedge fund managers that will definitely take you up on that offer. How long will it take for you to come up with $300 million for the escrow account?

Thanks Randy. I particularly enjoyed this key insight:

Sellers facing heterogeneous buyers have
the incentive to price their houses higher, essentially “fishing” for high-valuation buyers. This is particularly true when they are saddled with a debt overhang.

The morale of the story: when it comes time for you to buy, don't be hooked on a house. Fish with lowballs for the owners without debt overhang.

Mt.ViewRenter,

O.K ya' GOT me! I stand corrected. (kidding)

Looks like a REIT and given they just got underway they may have structured it that way to turn away smaller investors and create a more long term investment strategy. It can be difficult to manage something illiquid like RE and have to deal w/constant redemptions (they add to overall expense ratios too).

We are putting together a smaller REIT but decided to have annual redemption windows instead.

One of the big misunderstandings about back loaded funds was that they were a way to compensate planners/brokers for bringing on smaller clients and still be somewhat compensated. When managed money had entry thresholds of 1 mil (later 250k) smaller investors were either left at the bank or placed in individual bonds. Without some form of compensation where was the motivation to keep the client updated on their holdings? Unlike RE sales there was (and is) ongoing service to the client. "You bought it, YOU name it" is the NAR's motto.

theotherside:

Oh oops, just re-read your post. The bet is only up to 100k. Not worth my time. Why don't you put your money where your mouth is?

From the reference list of your Paper Randy:

http://web.mit.edu/jcstein/www/housing.pdf

In its most general form, the
proposition is that when buyers finance the purchase of assets by borrowing, this can lead the prices of these
assets to become more sensitive to exogenous changes in fundamentals. ...
That is, over some regions, a fall in asset prices can actually lead to reduced asset demands, because
it impairs the ability of potential buyers to borrow against the assets–this is the key amplifying effect.

This was written in 1999. How many speculators in the Bay Area have borrowed against their paper gains to buy an "investment property"? This is the amplifying effect that the authors identified before this bubble even began blowing.

The other MIT paper that "The Other" cited a couple threads back suggested that investment purchases can perhaps explain why "it's different this time". Flat prices can remove the paper wealth gains which was in turn responsible for the rising prices.

DinOR,

There are a number of other funds too. But like the previous example mentioned, I think these funds usually have some sector-specific liquidity issues.

I never really understood the exact workings of the back load. When does the broker actually get paid, and how much do they pay him?

We had one REIT investment where they allowed quarterly redemptions only up to the amount of cash they had available. Thought that was an interesting gotcha since management alone determined the redemption price and the avaiable cash flow.

theotherside :

What you are asking us to do is similar to buying a deep out of the money put option. I do that very rarely, and with money I can afford to loose. In general I consider such way out of the money options pure gambling.

The thing is I am fine if the median does not drop by 20% in Jan 09. If that drop happens by 2010 or happens to be "only" nominal 10% by Jan 2009, I will still be fine.

Predicting the long term direction is much easier than predicting exact amount and length. And you may not agree, but the general direction for the housing prices is downwards.

The funny thing about these trolls is that if you've been reading this blog long enough, it's just the same crap over and over again. Some poor sap - either a homedebtor and/or realtor (tm) who probably just got wind of the "bubble" recently freaks out. (S)he finds this site, does a cursory read of one or two threads, and then comes out guns-a-blazin' with the usual litany of RE bull "talking points." The same arguments get rehashed over and over again - of course, they don't bother to look at previous discussions that have answered their "questions" many many times over. I bet if we culled over old threads, this story would be repeated at least a couple of dozen times. In the end, the poor soul fades away.

Maybe we should be less harsh on them so they'd be more willing to stick around and contribute constructively to the discussion after they've shot their wad...

The other thing I've noticed is that after a relatively troll-free period a couple months back, there's been a clear pickup in activity of late. Reasons? Perhaps more MSM bubble stories, perhaps increased generalized panic?

MtViewRenter,

Ahh, the age old question. Do want low expenses or daily liquidity? Or both? A lot of the Sr. Floating Rate funds had a qtrly. redemption window simply b/c there was no active secondary market (but had a higher yld.)

I don't happen to think there's anything inherently wrong w/a smaller REIT offering qtrly. windows or having redemption based on cash flow. The bottom line is either we have the faith to have given this guy/gal the $'s to manage or we don't. Why tie his/her hands when it comes to making you money? Just let them do what they do best.

I realize most of this is r a l l y dry for non-securities folks but the "pecker waving" on broker forms is just more than I can take!

Really? And how LONG exactly have been a member of "that" gated community? Yawn.

I agree Skibum. Maybe we should have a FAQ type list ready to throw at the trolls.

But being lenient doesn't always work. I have tried hard being fair to patrickm. Bu that person just keeps going in circles. First, renters have nothing, then RE always appreciates, then it's just a roof over my head. The unwillingness to engage in logical arguments casts a clear doubt on their motivations.

BTW SP saw right through patrickm's first post. Maybe we need Surfer-X back in these times of increased troll activity. It will save us a lot of time.

skibum,

I hear ya' and I've tried being generous only to take a "knee to the groin" later w/all the standard "none of this matters b/c you're all justabunchoff@ckinglosersanyway!" The minute some (not negative) MSM article hits print, everything you've shared in earnest is swept aside, their bravado renewed!

I never took Psych. 101 but isn't this called "rescuer's syndrome" or something like that?

I never took Psych. 101 but isn’t this called “rescuer’s syndrome” or something like that?

Actually, I think it's called being a RE bull f%cktard.

RC,

Yeah, uh it was just one of those moments where you're looking for the "un-submit" button! (I think I'm a few months older!)

FAB's link was funny but I didn't see Blanche (the douchebag) Evan's latest "Make Money in ANY RE Market" offering in there! Evidently it didn't meet the criteria as "flipping" wasn't mentioned in the title.

theotherside:

What do we use to adjust for inflation? I suggest the 3-month t-bill.

MtViewRenter,

You'll notice TOS specifically said NOMINAL price drop of at least 20%, not real, because even he knows that's a sucker bet. Hell, if we're talking REAL, then I'd even go to 30%.

skibum,

LOL! I'm going to the judges and they say...... they will accept that answer!

I thought it was when you picked someone up from the gutter, brushed them off, gave them a meal and a roof over their head and then "somehow" they wind up resenting you b/c they realize they may not have done that for someone else and can never repay you?

DinOR,

I agree with your point about trusting the manager to do their job. Most of our due diligence is about figuring out whether or not you believe management will do the right thing in bad times. Even if they have an impeccable reputation and brilliant track record, there're still ample opportunities for them to just take your money and run, especially when the going gets tough.

Back on topic. For the record, I would hate to own a house because of all the work involved in maintaining the place, but would love to own due to some weird nesting instincts. Of course, I can't afford a detached house w/o using some kind of voodoo loan, so I'm fence-sitting.

HARM:

He said "nominal"? Bah, must have missed that part. Yeah, nominal is a sucker bet.

(Note to self, stop skimming posts)

MtViewRenter,

Well I'm sure when you say "take the money and run" you're alluding to style drift or consolidating the fund and not outright fraud, right?

You may or may not believe this but there was a time when I actually enjoyed being a homeowner! I looked forward to some projects on the weekends b/c they were not all that mentally challenging and a welcome change. THAT is when homes were homes! Now that we all know they are investments first, and shelter a distant second...... the "pressure" is on! It no longer was about what vision YOU might want to pursue, it became about what's "hot" and what increases your resale value. Hence the koi pond rage.