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You’ll lose money if you buy a house? Which house?

This is my column for this week from the Arizona Republic (permanent link):

 
You’ll lose money if you buy a house? Which house?

Jim Cramer, a clownish buffoon who screams for a living on cable TV, went on the Today show last week and said, “Don’t you dare buy a home now. You will lose money.”

The clownish buffoons in the National Association of Realtors have no faith in your ability to discount hyperbole, so they denounced Cramer’s remarks as “misleading, inaccurate, and inappropriate.”

Ya think?

A steady mantra of the NAR during the housing downturn has been to insist that all real estate is local. My friend and fellow real estate weblogger Dan Green (TheMortgageReports.com) amends that obvious truth by pointing out that all real estate news is granular — national trends say nothing about local markets, and lower overall prices in the Phoenix area are consistently belied by steady appreciation in high-demand neighborhoods. And not all bad news is bad: 2007 is the worst year in real estate since 2002 — but 2002 was a very good year.

Here’s the real truth: All real estate is particular. You’ll lose money if you buy? Nonsense. The right rental home will pay for itself no matter happens to home values.

Don’t buy a home? Which home? A few weeks ago I was in a trashed house that was listed at $200,000 below market. We estimated that it need $50,000 to bring it back to turn-key condition, with a four-month span of time between purchase and resale. Even allowing for errors in our estimates, the house would net out to between 200% and 300% cash-on-cash return in one third of a year. Do that three times and $50,000 capital becomes as much as half-a-million dollars in a year’s time.

All real estate is particular: Which buyer? Which seller? Which house? Which ownership strategy? Which anticipated return? If you’re looking for a residence you intend to occupy for less than three years — rent. You’ll almost certainly lose money buying now. But there is a ton of money to be made in particular real estate transactions right now — provided you have sense enough to turn off the television.

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16 comments

16 Comments so far

  1. Cindy Jones October 5th, 2007 12:27 pm

    I recently expressed similar sentiments myself. Depending on your semantics we have had a lot of house buyers in our market in the last 4 years and not as many homebuyers. There is a difference in how you look, finance and buy depending on whether you are going to make it a long term place to live or whether you want to make $$$$ and walk-away.

  2. Allen Butler October 5th, 2007 4:44 pm

    I absolutely agree. If you intend to live in a home for 5-7 years, you’ll be fine. Buy the damn house already!
    Allen

  3. Robert Kerr October 5th, 2007 6:30 pm

    Even allowing for errors in our estimates, the house would net out to between 200% and 300% cash-on-cash return in one third of a year.

    200% to 300% in 4 mos?! That’s a sure winner.

    Congratulations on your purchase. You did buy it, didn’t you?

  4. Scoot October 5th, 2007 7:15 pm

    I happen to agree with you, but I try to get people to think long term. If you put money down on a house and stay in it for 5 years, how could you not come out ahead? The prices in my market are going UP not down, in a time when few people can get a loan. I wrote a post about this yesterday and the stats are saying we’re making an extra 20K this year as apposed to last year, but having to wait an extra 23 days to sell the listing. Everyone has been talking about how prices are going down, but I don’t see it.

  5. Brian Brady October 5th, 2007 7:26 pm

    “Congratulations on your purchase. You did buy it, didn’t you?”

    You know? We’re damned if we do and we’re damned if we don’t.

    If a broker promotes a great real estate investment, he’s called a pollyanna. If he snaps it up before letting the public know about it, he’s criticized for “front running” the customer.

    Brokers can’t buy every deal, all the time. In fact, customers will get smoking deals as brokerages turn their excess capital towards their businesses. Eeals like Greg cites are attainable; you just have to look for them or hire a broker to look for them. (You also need to know how to remodel or run a project)

    So, I ask the few non-licensees…Would you care to see more investment opportunities or less from your real estate broker? If it’s less, change the channel. if it’s more, tune in at the same time tomorrow.

  6. Robert Kerr October 5th, 2007 9:55 pm

    The write-up reads like a lead in to a future: “and so we bought it.”

    I think he signed the PSA, he’s just waiting for the sale to go through before telling us.

    That’s one hell of a deal; much better than anything I’ve been able to find.

  7. Daniel Butterfield October 5th, 2007 10:04 pm

    Greg,
    I could not have said it better myself. As the Chief Manager of a small real estate hedge fund I am focused on Phoenix as a fantastic market for residential real estate investment. However, like you indicated, which house? which neighborhood? what buy price?. Real Estate has always been only as profitable as your original buy price and of course your exit strategy. Thanks for taking the time to compose a well written article, take care.

    Daniel

  8. Dometri Companies October 5th, 2007 10:10 pm

    Buying Real Estate in Phoenix is INSANE?!?…

    Buying Real Estate in Phoenix is INSANE?!?…

  9. Paul Francis October 6th, 2007 3:25 am

    You make your money when you buy! Hello!!?? There is a reason why it is called a buyers market. In your sample above, if an IRR % was used it would be much higher then 200 to 300% for a cash on cash return. IMO, IRR is an even more important valuation when comparing alternative investments.

    Highest and Best Use, Right?

  10. Daniel Butterfield October 6th, 2007 7:43 am

    Related to Paul’s comment, I am not sure IRR is as important when evaluating real estate investments because you are leveraging other debt during your purchase. I don’t disagree with Paul, but I have found that during most of our purchases (concerning the Dometri Companies Real Estate Hedge Fund) we look at other aspects of the transaction like cash flow, ltv and exit strategy. We lastly look at IRR only because IRR is misleading for us. We purchase most of our investments with no money down, I know now a days that sounds like a cliche but while purchasing our real estate, we focus on making sure the total amount invested into project is below 80-90% LTV and financed at 105 – 110% so there is an operating budget. One could say that is dangerous but also remember that we are a short term hedge fund and we successfully exit our investment within 6-12 months which includes our profit. If we were to calculate our IRR in most cases it would be astronomical and unrealistic especially to the Real Estate Hedge Fund investors which is why we stay away from it all together.

  11. Dometri Companies October 6th, 2007 7:51 am

    IRR (Internal Rate of Return) and Real Estate…

    IRR (Internal Rate of Return) and Real Estate…

  12. Jeff Brown October 6th, 2007 9:27 am

    IRR is fine – as an indicator of what each investment will do – especially if you’re doing it after tax, which is the only sane approach.

    That said – (and as our newest contributor will certainly concur) ‘bringing forward’ the annual after tax tax flows to the close date of the exit sale, using a market after tax, and obtainable rate of return – will enable you to compare apples to apples with near absolute confidence.

    This will result in: Money in – sale – money out – after tax return.

    It used to be called, (yeah, I know Sean, in the old days) FMRR, or Financial Management Rate of Return. My son knows the new term for it, as I’ve forgotten it.

    The reason you go through this process is is because IRR is flawed. The annual after tax cash flows for each year in a five year investment are not getting the 12.4% after tax IRR your analysis produced. (If they are, you’re dealing with the guy with the crooked nose on the corner.) 🙂

    Therefore you must take those cash flows and apply the market rate you would actually receive (after tax) and bring them forward to the sale date – adding them into the final year’s (after sale) proceeds. The ultimate result of this will be a lowered after tax return when compared to your IRR.

    The real benefit however, will be twofold.

    1. You’ll be able to compare real estate vs stocks – or whatever else you wish. The most common comparison is – buy the apartments or the strip center. Something like that.

    2. You’ll actually KNOW your real return.

  13. Paul Francis October 6th, 2007 3:52 pm

    I certainly don’t suggest using IRR for all real estate investments, just the potential real estate investment that Greg is mentioning above which I assume has zero cash flow and will require a cash outflow before selling.

    The key phrases are four months time and $50,000 in cash for repairs. Simple to explain to a single family home investor without getting complicated.

  14. Jeff Brown October 6th, 2007 4:03 pm

    Couldn’t agree more Paul.

  15. Deb October 7th, 2007 9:34 am

    I was with you until you said if a person is looking for a residence and will hold it for three years or less they will almost “certainly” lose money – again, real estate markets are PARTICULAR. Not sure how you can make that blanket statement . . .

    And as far as time to hold an investment -even an investment you might live in, which is a benefit that other investments don’t offer – your crystal ball can’t predict all of the variables that will affect market trends.

    As I said, I was with you on the notion of “particular” as applied to real estate . . .

  16. […] There is no question that I am one of the more dour of the Bloodhound gang; if we were the “seven dwarfs” I’m laying decent odds that I get tagged with the “Grumpy” moniker.  And while I may, on occasion, revel in astonishment at the self-inflicted pain that the industry has kindly laid at our feet via the past 5 years of transgressions; I am in no way a fan of the current havoc buffeting our industry.  I don’t like seeing people losing their jobs, their homes, their future plans – it’s not a pretty sight.  But one thing I do like, is honest, important inspection of real estate and mortgage; and Greg Swann’s recent post on “You’ll Lose Money if You Buy a House?  Which House?” reminded me of why I blog and what I believe we should all strive to achieve in one form or another through our blogging: cutting through the sound bites to get to the truth. I believe that cavalier shibboleths are the primary cause of Realtor-focused ire on behalf of the disgruntled public.  We’ve heard for too long that “Now is a great time to buy,” “Rates are dropping,” “It’s a buyer’s market,” and more that unfortunately to the everyday Joe just ring of hollow greed on the part of the real estate professional.   And why do they ring of greed?  It’s in the numbers stupid!  It rings of greed because the main stream media is showing them graphs and charts and year-over-year figures that show real estate, as a whole, is a losing investment right now.  They’re saturated with it.  6 months ago ask someone what the Case-Shiller Home Price Index was and you’d probably get a blank stare; ask today and you’ll probably hear about what the index is doing for that person’s MSA.  This data dump has created a problem for real estate professionals. […]