Despite the fact that house prices crashed, wiped out millions of loanowners, and wiped out the illusory equity of an entire generation, people persist in believing owner-occupied housing is a good investment. Most people believe house prices appreciate 5% to 10% or more each year and by simply owning real estate they can become wealthy. It doesn’t work that way. Over the long term, house values increase with wage inflation as buyers bid up prices with their increasing incomes. An amortizing loan is a forced savings account — assuming the owner doesn’t refinance or HELOC this money out and piss it away — so houses can serve as a retirement savings vehicle, but only if the owner is disciplined. The false belief that rapid appreciation of a highly leveraged asset can create wealth prompts speculation. This speculation is what drives home prices up to unsustainable heights that inevitably lead to a very painful crash.
Sam Ro | Feb. 7, 2013, 7:25 AM
Robert Shiller, the Yale economist who nailed the housing bubble before it burst, was on Bloomberg Television with Trish Regan and Adam Johnson on Wednesday afternoon to discuss the U.S. housing market.
As usual, Shiller was reluctant to declare that home prices had bottomed. He explained that the housing market is a speculative one and that there’s no telling, which way prices would go tomorrow. He also explained that there wasn’t much reason to believe that home prices would appreciate back to levels seen during the last cycle.
Regan followed up with a question that got Shiller perked up.
“Then why buy a home?” she asked. “People trap their savings in a home. They’re running an opportunity cost of not having that money liquid to earn a better return in the market. Why do it?”
This woman’s question reveals much about how twisted people have gotten about housing. Her underlying assumption is that without the investment component, there would be no other reason to own a home. The false belief in investment returns is certainly the only justification for overpaying for a house, but it’s not the only reason to own a home. There are valid emotional and consumptive reasons to own. If Americans purged themselves of the delusions about financial returns, prices would fall to stable levels of incomes and rents.
“Absolutely!” Shiller exclaimed. “Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing.
Most people when the consider buying real estate completely ignore these realities. When it’s owner-occupied, they pay the maintenance as a lifestyle expense and fail to realize this cost of ownership weighs against the returns on their property (renters don’t pay for big maintenance items). The quality of the structure deteriorates over time and becomes dated. The owner must replace the roof, refresh the landscaping, update the kitchens and baths. This big-ticket items are also ignored. Further, owners tend to over-improve their properties changing them to suit their tastes. Such improvements add far less in value than they cost. That isn’t to say all such improvements are foolish. People can consume whatever they choose, but it invalidates the investment reasoning they used to justify the purchase in the first place.
So, new ones are better.”
Perhaps, but not in California. New homes have onerous Mello Roos fees which generally negate any savings from lower maintenance costs.
These were some of the issues Shiller addressed in his classic book, Irrational Exuberance.
“So, why was it considered an investment? That was a fad. That was an idea that took hold in the early 2000′s. And I don’t expect it to come back. Not with the same force.
It probably will come back in California. Rising prices stoke fears of kool aid intoxication. People want to believe. It’s like a lottery. Believing your home will go up dramatically in value provides hope for the future. There’s nothing wrong with hope, but it makes for a poor financial plan. Many people fail to save in other ways because they falsely believe the house will do all the saving for them. This costs them dearly in their retirement as the must suffer a loss of entitlement or work longer because they foolishly believed the house would provide for them. Rather than face these consequences, the federal reserve is currently reflating the bubble ensuring the moral hazard of a lack of savings due to the false belief in housing riches will persist for another generation.
So people might just decide, “Yeah, I’ll diversify my portfolio. I’ll live in a rental.” That is a very sensible thing for many people to do.”
Whenever Shevy works with a client, he prepares cost of ownership reports for each property someone wants to bid on. These reports compare the cost of ownership to the cost of a comparable rental so people can evaluate for themselves whether renting or owning makes more sense for them.
Another common mistake people make when considering a home an investment is to ignore the additional costs of ownership versus renting. If an owner is spending $1,000 a month or more owning, this quickly negates the long-term lump sum they receive when they sell. Most also fail to consider transaction costs at both ends of the deal as well. This can be 10% of the price or more, and it often represents a huge portion of the gross profit on the deal.
Adam Johnson also noted that this was in line with Shiller’s assessment that real U.S. home price appreciation from 1890 to 1990 was just about 0 percent. This is explained by the falling costs of construction and labor.
For people who can’t wrap there heads around this, Shiller offers an analogy.
“If you think investing in housing is such a great idea, why not invest in cars?” he asked. “Buy a car, mothball it, and sell it in 20 years. Obviously not a good idea because people won’t want our cars. It’s the same with our houses. So, they’re not really an investment vehicle.” …
Are cars really like houses? During the crash, houses depreciated like cars, but ordinarily they don’t. People will find the same value in houses twenty years from now that they do today. Technology doesn’t make houses obsolete like it does with cars. Houses don’t need to be replaced, simply remodeled.
A better way to view this is to look at the behavior of private equity hedge funds. If houses were truly a good investment, hedge funds would be buying at every price point in every market like owner-occupants do. They’re not. Instead, hedge funds are only buying properties at the lowest price points in the most beaten down markets because those are the only investments that make sense. Owner occupants bid prices of houses up to levels that don’t make investment sense, mostly out of a desire for consumption, but increasingly out of a mistaken idea that it really is a good investment.
Wells Fargo recoups their HELOC losses
I recently reported that Lenders will target near-equity squatters for future foreclosures. Today’s featured property is an example of what I’m talking about.
The former owner only refinanced one time with a $722,400 first mortgage, but he also took out a $200,000 HELOC. With prices down, Wells Fargo, which owned both loans, was in no hurry to foreclose. However, with prices up lately, this squatter was near the surface, so Wells Fargo foreclosed on him. If they get their asking price, they will recover all their lost HELOC money. Expect to see more foreclosures like this one as underwater squatters reach the surface.
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Proprietary OC Housing News home purchase analysis
$949,900 …….. Asking Price
$700,000 ………. Purchase Price
12/12/2003 ………. Purchase Date
$249,900 ………. Gross Gain (Loss)
($75,992) ………… Commissions and Costs at 8%
$173,908 ………. Net Gain (Loss)
35.7% ………. Gross Percent Change
24.8% ………. Net Percent Change
3.3% ………… Annual Appreciation
Cost of Home Ownership
$949,900 …….. Asking Price
$189,980 ………… 20% Down Conventional
4.11% …………. Mortgage Interest Rate
30 ……………… Number of Years
$759,920 …….. Mortgage
$183,370 ………. Income Requirement
$3,676 ………… Monthly Mortgage Payment
$823 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$237 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$4,737 ………. Monthly Cash Outlays
($856) ………. Tax Savings
($1,074) ………. Equity Hidden in Payment
$275 ………….. Lost Income to Down Payment
$257 ………….. Maintenance and Replacement Reserves
$3,340 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$10,999 ………… Furnishing and Move In at 1% + $1,500
$10,999 ………… Closing Costs at 1% + $1,500
$7,599 ………… Interest Points
$189,980 ………… Down Payment
$219,577 ………. Total Cash Costs
$51,100 ………. Emergency Cash Reserves
$270,677 ………. Total Savings Needed