This is my column for this week from the Arizona Republic (permanent link).
As a matter of eating crow, I will attest that I publicly denied that housing prices could ever behave like securities prices, falling far below their fundamental value. The market has proved me wrong. We’re writing contracts on REO properties where the purchase price is well below the replacement cost. I read a listing for a potential rental property in a not-awful neighborhood that is selling for $49,500. We anticipate prices like that in premium rental neighborhoods when the Ameridream/Nehemiah calliope grinds to a halt. A house in Detroit was listed last week for one dollar. This bust behavior is just as irrational as the boon behavior — and it is a choice opportunity for people who are not irrational. Nevertheless, I was wrong. The real estate industry told buyers that homes were an investment just like securities — and damned if they didn’t believe us.
What went wrong in the real estate market? We told homeowners to treat their homes like securities investments — and they did…
If you were to turn back the clock on the Phoenix real estate market by four years — that would be just about right.
Judging by prices for bread-and-butter homes, it’s just as if the last four years didn’t happen. The average stucco and tile suburban dream home sold in July of 2008 for almost the same price you would have paid for it in July of 2004.
A lot has happened since then, of course. The 1,400 square foot single family home you could have had back then for $150,000 soared to $250,000 by December of 2005. That seemed like $100,000 in free money, and, regrettably, many people borrowed against that paper equity in their homes. Even if they did not, it has proved difficult to eradicate that entirely imaginary $100,000 from list prices.
The real estate market got hammered good and hard by two very bad ideas. The first is that homeownership is an unlimited good, that everyone should own a home regardless of their circumstances. Governments — and the National Association of Realtors — came up with program after program to induce more and more people to buy homes — regardless of their income, regardless of their credit, regardless of their debt load.
At the same time, lenders threw away all of their old, time-tested, flinty-eyed ideas about thrift, declaring that real estate investment was just like securities investment, the leveraged path to assured wealth.
By the old rules, a homeowner or rental property investor had worked and saved for years to accumulate a down payment. That down-payment was more than enough to cover the foreseeable losses of a foreclosure action, so the loan was secured by the property. Buyers and investors didn’t abandon homes when the market went down, dumping the investment like a declining stock in the face of a margin call.
The market is what it is, but it would be a boon for all of us if we could turn back the clock on those four years and play the game over — by the old rules.
Technorati Tags: arizona, arizona real estate, investment, phoenix, phoenix real estate, real estate, real estate marketing
Brian Brady says:
“We told homeowners to treat their homes like securities investments — and they did…”
I remember when you told me this 2 months ago and my world became much more clear.
August 16, 2008 — 11:29 am
Greg Swann says:
>> “We told homeowners to treat their homes like securities investments — and they did…”
> I remember when you told me this 2 months ago and my world became much more clear.
Look at this web site. I’m previewing potential getaway homes for an out-of-town buyer. I built an engenu site of 17 of them, just to show off what I’m seeing.
The prize, so far: 3/2, play pool, on a golf course, custom tile work — $110,000. It’s in Buckeye, but that’s not horrible for a second home.
Just amazing…
August 16, 2008 — 12:15 pm
Robert Kerr says:
One of your better posts, Greg, IMO, and I agree with 99% of it.
Yes, treating homes like securities *is* how we got into this mess. I’d love to strangle some of the financial geniuses out there that encouraged gullible people to do that.
On the surface, the whole “put all that dead equity in your home to work for you” was specious. It had the natural allure of easy money. And, if the pitchman glossed over the innate risk of debt and leverage, and the investment vehicles had the *illusion* of guaranteed returns like, say, investment grade life, well, one could get wealthy the way PT Barnum did. There really is one born every minute; maybe more.
Where I disagree, the remaining 1%, is: I don’t think your Phoenix-area prices have yet fallen below their “fundamental value,” whatever it is (replacement cost, I presume?) you’re using to judge that.
In this particular credit market, the only fundamental that matters is: “can buyers afford to buy with conventional financing?”
Your market’s median price is still ~10% too high.
August 16, 2008 — 7:08 pm
Laura says:
The only resistance to turning the clocks back 4 years would be from all the fat cats who made their millions and walked away unscathed.
August 16, 2008 — 8:28 pm
Sean Purcell says:
Greg,
Another great post. I agree with your conclusion, although I don’t think it was because people treated their homes like securities investments but rather because they didn’t!
Proper investments have a long term view and a strong equity presence (often 50%). Plus, the position is marked to the market daily. Homeowners were ill advised by agents and lenders into short term views. I would suggest that homeownership is an unlimited good… but not always suitable. Just as in the securities industry, if the investment is not appropriate to your current financial situation you should not be investing. As you clearly said, this is where the lenders dropped the ball BIG TIME.
Thought provoking post. Your comment on values got me thinking about an idea I am off to explore right now. Thanks!
@Robert
Taking equity out is not a problem if it is reinvested appropriately and if you have the reserves. Again, this gets down to suitability. The generalization that “putting dead equity to work” is specious is simply… specious.
August 16, 2008 — 9:23 pm
Thomas Johnson says:
If you put “dead equity” to work, you better be able to handle the margin call.
None of my clients have Ben Bernanke shoveling money at them to keep them in business.
August 16, 2008 — 11:52 pm
Denver, CO says:
The problem is with the schools. You should graduate from high school or college with more than just a piece of paper. Home equity is no different than paper profits in the stock market — it’s not worth anything until it’s cashed in. You would never borrow against your paper stock profits. If the schools taught finance as they should, people would have known. Do we need courses on Calculus (I took it twice and still don’t know what it is) or real estate? I say that we need courses on real estate and personal finance a lot more than the bunk making up the current curriculum in schools. A house is the biggest financial event in the lives of most people, and the schools do absolutely nothing to prepare their students for it. It’s downright sinful.
August 17, 2008 — 7:24 am
Sean Purcell says:
If you put “dead equity” to work, you better be able to handle the margin call
Exactly the type of advice clients should be given. Suitability is everything. Well said.
August 17, 2008 — 7:31 am
Robert Kerr says:
RE: “Taking equity out is not a problem if it is reinvested appropriately and if you have the reserves.”
Allow me to rewrite that for you: “Taking equity out is not a problem if it is reinvested such that investment gains exceed finance costs + lost equity gain.”
That’s the only time it makes sense. Anything else is a losing proposition. A lot of people are losing significant amounts of money in the markets these days, now that the Dow’s not doing 15% per year, but -15% per year, money that was otherwise safe and sound in their homes.
August 17, 2008 — 8:19 pm
Robert Kerr says:
RE: “Home equity is no different than paper profits in the stock market — it’s not worth anything until it’s cashed in. You would never borrow against your paper stock profits. If the schools taught finance as they should, people would have known.”
Exactly. EXACTLY! You don’t “cash in” by taking a loan against equity. You “cash in” by selling. A lot of smart people forgot that.
August 17, 2008 — 8:23 pm
Sean Purcell says:
You don’t “cash in” by taking a loan against equity. You “cash in” by selling.
Again, a broad generalization. You lock-in a return by selling. This removes any possibility of greater return and makes sense when the potential for loss outweighs the gain on an individuals risk aversion scale. Cashing in is what you do with chips at a casino. In an appreciating market you should avoid locking-in and make use of leverage by taking a loan out against equity, assuming the returns outweigh the costs.
Debt financing is more financially sound than equity financing. In a depreciating market this advice still holds true if, as Thomas Johnson put it, you can make the margin call – which in real estate means do you have the legs (and the appropriate financing) to wait out the correction. Either way, what should be taught in school, if you really want to help, is how to assess the true cost of money. Most people believe that money in a home has a return (which is, of course, false) and that it is somehow immune from inflationary loss while sitting and earning nothing.
BTW, in the formula: reinvested such that investment gains exceed finance costs + lost equity gain… what exactly is “lost equity gain?”
August 18, 2008 — 9:17 am
Louis Cammarosano says:
Nice one Greg.
Taking an interest only mortgage out on a home is akin to buying securities on margin.
August 18, 2008 — 12:06 pm
Sean Purcell says:
Louis,
Taking an interest only mortgage out on a home is akin to buying securities on margin
EXACTLY! That is exactly how one buys securities and should buy homes… assuming the investment is suitable. You are making my point for me.
August 18, 2008 — 12:15 pm
Greg Swann says:
> Taking an interest only mortgage out on a home is akin to buying securities on margin.
Indeed. But it always depends on the context. Imagine a trashed REO that should sell turn-key for $150,000. If I can buy it for $50,000 with $10,000 down and a one-year interest-only balloon, put $20,000 into it and sell it fast at $140,000, I’m way ahead of the game.
It’s important to learn the lessons of history — provided we learn the right lessons. In this example, hard money at 18% would be a stone bargain — even better if I could get the whole $70,000 with nothing down. I’m paying six months debt service at the worst — $6,300 — probably a lot less. My closing costs could run higher than that.
August 18, 2008 — 12:19 pm
Al G. says:
People should treat it more as a long term investment, and not a get rich quick scheme. Luckly, I’ve held on for long term and planned that way, and not tried to buy and flip.
I recommended this on my blog at Have Someone Else Pay Your Mortage and reference this blog as good information.
Thanks!
August 18, 2008 — 12:45 pm
Louis Cammarosano says:
Sean
“assuming the investment is suitable”
There is the rub.
Buying securities or homes on margin during a bubble run up in hind sight is not a suitable investment!
August 18, 2008 — 1:03 pm
Sean Purcell says:
Al,
People should treat it more as a long term investment, and not a get rich quick scheme.
I try to avoid telling people how they should do things, but I will say this: Real Estate is often a great long term investment. Also, Real Estate is often a great short term investment. I have bought and sold real estate for close to 20 years. Great money maker. Some of the real estate I sold I wish I had held. Great money makers.
August 18, 2008 — 1:10 pm
Sean Purcell says:
Louis,
I agree, although it is not the bubble so much as the time frame within which the investor is working.
August 18, 2008 — 1:24 pm
louis cammarosano says:
the question is will todays real estate correction
Leave us with the housing equivalents cmgi and sun microsystems?
Homes like their stock counterparts that never return to their peak valuations
August 18, 2008 — 8:52 pm
Poconos Real Estate says:
Just hold on if you can. I have a few vacation properties that I was hoping to sell last year, but it just does not make sense. I will now have to wait and sell them in the next 2-3 years.
August 20, 2008 — 12:16 pm
Sue says:
Good discussion. I actually tried to pull an equity line to purchase another property but hit a brick wall because the money was in a coop. Given the turn in the market, this ended up being a good thing for me. Guess someone was watching out!
November 27, 2008 — 6:39 pm