Feb242012

With prices at 10-year lows and falling, renting is back in style in 2012

When the housing market nears the bottom, despair dominates. Prices have fallen for five straight years and hover at 10-year lows, and real estate is out of favor as an investment class. Evidence of the market’s despair crops up in articles extolling the virtues of renting. Articles about renting were common from 1994 to 1996, and at the time, renting was a good idea; prices had been falling, and there was little reason to believe they would be going up soon, just like today. However, in the big picture, people who bought in 1994 to 1996 were rewarded. They suffered for the first year or two of ownership, but when prices bottomed in 1997, the contrarians who bought early found themselves back in the black.

People who buy today are buying early, but five years from now, will they regret it? Perhaps, but if they are locking in a cost of ownership lower than competing rentals, I doubt they will be upset by the rocky road ahead. Everyone wants to buy at the bottom tick of the market. However, nobody can be certain when that is. The people who do buy at the bottom do so by luck, and at the time they purchased, they bought in a declining market, probably for cashflow savings reasons. Many will chose to wait until the bottom is apparent in the rear view mirror. They will likely face a higher cost of ownership on a monthly payment basis because they are paying a higher price, and they may also be paying a higher interest rate. Many were fooled by the bear rally of 2009-2010. They will be more cautious next time.

Home prices at lowest point in more than 10 years

By Chris Isidore @CNNMoney February 22, 2012: 11:48 AM ET

chart-home-sales.top.gif

NEW YORK (CNNMoney) — Home prices fell to their lowest point in more than a decade in January, which helped to lift the pace of home sales, according to a report from an industry trade group.

The National Association of Realtors reported that the median home price in January fell 2% from December to $154,700. That’s the lowest price reading since November 2001, before the run-up in home prices that became known as the housing bubble.

The median price is the point at which half of homes are sold for a higher price, and half are sold at a lower price. (Multi-million dollar foreclosures)

Serving as a drag on existing home prices is a large inventory of homes in foreclosure. Distressed home sales, which includes homes in foreclosure and so-called short sales in which the home is sold for less than what is owed on the mortgage, made up 35% of sales in January.

“Prices will continue to fall through the first half of 2012 due to the high share of distressed sales,” said Stuart Hoffman, chief economist with PNC Financial. “The recent agreement between the big mortgage servicers, state attorneys general and the Obama administration will also result in more homes going to foreclosure over the next few months, adding to downward pressure on prices.” …

Prices are near the bottom. It is cheaper to own than to rent in many markets, and historically this spurs demand. Of course, with so many with bad credit, demand will not be robust, and therefore prices will continue to fall, probably not catastrophically, but with choppy ups and downs as the market headwinds blow and subside.

New American Dream is renting to get rich

By Lou Carlozo

Wed Feb 15, 2012 12:05pm EST

(Reuters) – Rich Arzaga owns a luxury home in San Ramon, California, but he’s not betting on it as an investment.

The founder and CEO of Cornerstone Wealth Management, who bought the 5,000 sq. ft. property in 2005 for $1.8 million and has spent $500,000 improving it, considers the abode a wonderful place for his family. But ask him to rate his home — or any home, for that matter — as a financial investment, and Arzaga balks.

“It’s the American Dream to own a home, but whoever said that didn’t do the analysis on it,” says Arzaga, knowing he’s taking a contrarian stance to conventional wisdom.

If he bought a home in 2005, he obviously didn’t do an analysis on it either. He sunk $2.3M into a property worth far less today. I hope he enjoyed the consumptive value because he certainly is paying a high price for the property.

Examining 250 properties around the U.S., and going through close to 40 client files to project the financial impact of owning real estate versus liquidating it, Arzaga, an adjunct professor in personal finance at the University of California at Berkeley, found that, “100 percent of the time it was better to rent, rather than own.”

That’s right: 100 percent.

In 2005 I would agree with him. There were no houses anywhere that made sense to own in 2005. Today with prices 50% yo 70% lower in some markets and interest rates down from 6.5% to under 4%, owning makes sense again.

The reason is simple. While a home is the main repository of wealth for many Americans, it comes with numerous hefty expenses. The carrying costs – what’s needed to hold and maintain the asset – range from property taxes and home insurance to emergency repairs and renovations. In a rental situation, the landlord covers those costs, leaving the occupant free to invest revenue in other areas.

Even people who were making money on appreciation during the bubble weren’t making near what they probably thought they were making when the high carrying costs and transaction costs were factored in.

“I don’t have the emotions a lot of people do surrounding real estate,” Arzaga says. “I have steely eyes for how investing in real estate works, and I’d better be a prudent investor for my clients.”

The guy who is nearly a million dollars underwater has a steely eye for how real estate works? ~~ giggles to self ~~

Owning a dream home, he says, creates a drain on other financial priorities, causing homeowners “not to meet their financial goals. They were going to fail.”

Even though conventional wisdom today says borrowers can afford a 31% debt-to-income ratio, when you look at the after-tax impact of that decision, over 50% of a borrower’s take-home pay is going to pay the mortgage. That doesn’t leave much for consumption and saving. Without HELOC supplementation, such high debt-to-income ratios are debilitating.

Some real estate experts thought there was some truth to Arzaga’s argument, albeit with several conditions.

“To state that owning a home is or isn’t a good investment is too simplistic,” says Jeffrey Rogers, president and COO of Integra Realty Resources.

When you read this “expert” was the president of a real estate company, was your first reaction that what he says is complete bullshit? That was my first reaction.

“It depends. In times of relatively higher rents, low home values, and low interest rates, it makes sense to own a home. But in a reverse market, it wouldn’t be economically feasible. Over time, those who purchase in down or flat markets with low interest rates come out ahead.”

His statement wasn’t as bad as I thought it would be. However, buying in a low interest rate environment doesn’t mean you will profit on appreciation. Rising interest rates will hurt appreciation moving forward.

“Our lifetimes are a long time, and when we look over the long term, real estate and other investments tend to have a positive return,” says Jed Kolko, chief economist at Trulia.com, a real estate search and research website. “But when it comes to real estate, changing your mind is expensive. There are a lot of costs involved in buying, selling and moving. If you move every two years, it’s probably a bad investment for you. It also depends on your job market. If you’re in a one-company town and the company goes down, there goes your job and there goes your home value.”

Greg McBride, a senior analyst at Bankrate.com, agrees with one point of Arzaga’s. “Home ownership is not so much a creator of wealth as a store of wealth,” he says. “The promise of home ownership is that over the long haul, it can rebate many or perhaps all of your costs, unlike rent, which doesn’t rebate a dime.”

He is correct that home ownership historically has been a store of wealth going up roughly with inflation. However, the idea that it can rebate your costs is a fantasy.

The trouble, he says, is that many Americans want a home so badly, they neglect other ways to grow wealth and financial security.

“You have the other financial bases covered: emergency savings, retirement savings, paying off debt, saving for the education of your children,” McBride says. “There’s no sense in buying a home if it’s going to deplete your emergency or retirement savings.

Unfortunately, during the housing bubble most people came to believe owning a house was the only retirement savings they needed. The house was going to provide them a steady income through double-digit yearly appreciation and endless HELOC money.

McBride crunched the numbers in a pre-bubble era (2004) for a home purchased at $200,000 by a buyer in the 27 percent marginal tax bracket. Factoring in a 30-year mortgage, $1,200 in annual home insurance, closing costs of $5,500 and maintenance costs of $100 a month, along with property taxes, he calculated that it would take a selling price, 10 years later, of $395,404 just to break even. His conclusion gave Arzaga’s view credence: “Homeownership may not be the moneymaker you think it is.” (See the full chart at link.reuters.com/hej66s)

Then there’s the emergency fund, a must for when a home requires unexpected repair work.

“As far as emergency savings is concerned, six months of a cushion is adequate,” McBride says. “But only 24 percent of people have that kind of cushion, and about 65 percent own homes.”

So while home ownership may sound glamorous, you need a lot of money to make it work, without much guarantee of positive returns in a post-bubble era. Indeed, Arzaga cites himself as an example of how home ownership doesn’t pay off. His residence is today worth $1.5 million, about 17 percent less than what he paid.

That’s $800,000 less than he has into the property.

So why not sell? For Arzaga, it’s a lifestyle choice, and one that he doesn’t regret, since his big money-making investments are elsewhere.

I hope he is making money elsewhere because this white elephant is eating a huge hole in his balance sheet.