US Realestate scenarios...

[sunnysideup]

I copied this over from Bangalore realestate forum so more eyes can look into
this.

Can the finance gurus comment on this.




The following is an FAQ on US property bubble. The parallels to India (including the terminology) is quit amazing! Of course, this talks about only one side - the crash
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[QUOTE]
That house prices will continue to fall? Real estate related businesses disagree, because they don't make money if buyers do not buy. These businesses have a large financial interest in misleading the public about the foolishness of buying a house now.

1. Buyers' agents get nothing if there is no sale, so they want their clients to buy no matter how bad the deal is, the exact opposite of the buyer's best interest. Agents take $100 billion each year in commissions from buyers. Agents claim the seller pays the commission, but always fail to mention that the seller gets that money from the buyer.

There are good buyer's agents who really believe they are helping the buyer, but they often in denial about their conflict of interests.

2. Mortgage brokers take a percentage of the loan, so they want buyers to take out the biggest loan possible.

3. Banks get origination fees but sell most mortgages, so they do not care about the potential bankruptcy of borrowers, and will lend far beyond what buyers can afford. Banks sell most loans to Fannie Mae or Freddie Mac. The conversion of low-quality housing debt into "high" quality Fannie Mae debt with the implicit backing of the federal government is the main support for the housing bubble. That is ending as Fannie Mae shrinks.

Even for the "jumbo" loans that banks cannot sell to Fannie Mae and Freddie Mac, they have a motive to lend beyond what buyers can afford. Banks designate interest as "income" whether they receive it or not. As long as borrowers do not actually default, additional interest owed is counted as bank income, and banks can claim higher "earnings". That is going to end when those borrowers cannot even make the principal payments.

4. Appraisers are hired by mortgage brokers and banks, so they are going to give the appraisals that brokers and banks want to see, not the truth.

5. Newspapers earn money from advertising placed by realtors, so papers are pressured to publish the realtors' unrealistic forecasts.

Worse, realtors have a near-monopoly on sale price information, and newspaper reporters never ask realtors hard questions like "how do we know you're not lying about those prices?" The result is an endless stream of stories which quote David Lereah of the NAR saying it's a good time to buy, as if there were some news in hearing salesmen say that you should give them your money. To be optimistic about this market takes a real estate "professional". Everyone else speaks the truth too clearly.

As one reader writes: "The advertiser-paid media continues to interview commission-based salesmen who try to cover up the crash and hope to bring a few more young suckers into massive debt for houses that are falling in value."

6. Owners themselves do not want to believe they are going to lose huge amounts of money.

What are their arguments?

1. "Renting is just throwing money away."
FALSE, renting is now much cheaper per month than owning. If you don't rent, you either
* Have a mortgage, in which case you are throwing away money on interest, tax, insurance, maintenance.
* Own outright, in which case you are throwing away the extra income you could get by converting your house to cash, investing in bonds, and renting a place to live. This extra income could be 50% to 200% beyond rent costs, and for many is enough to retire right now.
Either way, owners LOSE much more money every month than renters. Currently, yearly rents in the Bay Area are about 2% of the cost of buying an equivalent house. This means a house is returning about 2%, and it is a bad investment. Pretty much any other investment is better. If you don't like risk, put your money in US Treasuries at 5%.

In effect, landlords are loaning the purchase price of a house to their tenants at a 2% interest rate. This is a fantastic deal for renters. When it is possible to borrow a million dollar house for 2% yearly rent at the same time a loan of a million dollars in cash costs 6% interest, plus 1% property tax, plus 2% maintenance, something is clearly broken. I would think every rational businessman would take the extreme discount renters are enjoying.
2. "There are great tax advantages to owning."
FALSE. The tax advantage is not significant compared to the large monthly loss from owning. For example, it is far cheaper to rent in the San Francisco Bay Area than it is to own that same house, even with the deductibility of mortgage interest figured in. It is possible to rent a good house for $1800/month. That same house would cost about $700,000. Assume 6% interest, and we can see that a buyer loses at least $4,936 per month by buying. Renting is a loss of course, but buying is a much bigger loss.

Renting:
Rent: $1,800
----------------------
Monthly Loss: $1,800

Buying:
Property Tax: $486 ($729 per month at 1.25% before deduction, $486 lost after deduction.)
Interest: $2,333 ($3500 per month at 6% before deduction, $2333 lost after deduction.)
Other Costs: $450 (Insurance, maintenance, long commute, etc.)
Principal loss: $1,667 (Modest 3% yearly loss on $700,000. Reality will be much worse.)
----------------------
Monthly Loss: $4,936

This is a very conservative estimate of the loss from owning per month. If you include a realistic decline in house prices, as in this rent-vs-own calculator, you'll see that owning right now is a very poor choice. Here's a more optimistic calculator which ignores price changes entirely. House value losses will stop eventually, but it could take 5 or 10 years to bottom out.

Remember that buyers do not deduct interest from income tax; they deduct interest from taxable income. Interest is paid in real pre-tax dollars that buyers suffered to earn. That money is really entirely gone, even if the buyer didn't pay income tax on those dollars before spending them on mortgage interest. Of course the creeping AMT will eliminate the mortgage interest deduction soon anyway. Ah, you didn't know that there are limits to the mortgage interest deduction and that more and more people are hitting that limit every year?

Buyers do not get interest back at tax time. If a buyer gets an income tax refund, that's just because he overpaid his taxes, giving the government an interest-free loan. The rest of us are grateful.

If you don't own a house but want to live in one, your choice is to rent a house or rent money to buy a house. To rent money is to take out a loan. A mortgage is a money-rental agreement. House renters take no risk at all, but money-renting owners take on the huge risk of falling house prices, as well as all the costs of repairs, insurance, property taxes, etc. Since you can rent a house for 2% of its price, but have to pay 6% to borrow the equivalent amount of money, it is much cheaper to rent the house than to rent the money.

Then there's earthquake insurance. It's really expensive, so most people just skip it and risk everything on the chance that no earthquake will happen.

3. "A rental house provides good income."
FALSE. Rental houses provide very poor income in the Bay Area and certainly cannot cover mortgage payments. In the best case, a $1,000,000 house can be rented out for at most $25,000 per year after expenses like property tax and repairs. The return is therefore 2.5% with no liquidity and a huge risk of loss.

If the owner were to sell that rental house for a million dollars, he could get about 5% with no risk, no work, and no state income tax by buying a US Treasury Bond. And the money would be liquid and secure.

That said, there are many parts of the US where it does make sense to buy because mortgage payments are less than rents in those areas. They are generally rural areas away from the coasts, and have not seen the same bubble that the coasts have.

4. "Impending regulation changes to allow 40 and 50 year mortgages will fix everything."
FALSE. 40 and 50 year mortgages will probably not be paid back, since a large number of borrowers will die before 40 or 50 years are up. This makes these loans a bad idea from the lender's point of view. It also doesn't make sense from the borrower's point of view, since almost of their payment will go to interest for most of the life of the loan. This makes it almost the same as renting - except that it's 2 or 3 times more expensive!

5. "OK, owning is a loss in monthly cash flow, but appreciation will make up for it."
FALSE. Appreciation is negative. Prices are going down in most places, which just adds insult to the monthly injury of crushing mortgage payments.

6. "House prices never fall."
FALSE. San Francisco house prices dropped 11 percent between 1990 and 1994. Buyers in SF in 1990 did not break even in dollar amounts until about 1998. So those buyers effectively loaned their money to the sellers for 8 years at no interest, losing all the while to inflation. With inflation, 1990 buyers truly broke even only about the year 2000, ten years after buying.

Los Angeles' average house plummeted 21 percent from 1991 to 1995, and of course there have been many similar crashes all around the US. The worst may have been after the oil bust in the 1980's, when Colorado condos lost 90% of the value they had at their peak.

7. "House prices don't fall to zero like stock prices, so it's safer to invest in real estate."
FALSE. It's true that house prices do not fall to zero, but your equity in a house can easily fall to zero, and then way past zero into the red. Even a fall of only 5% completely wipes out everyone who has only 10% equity in their house because realtors will take 5%. This means that house price crashes are actually worse than stock crashes. Most people have most of their money in their house, and that money is highly leveraged.

8. "We know it will be a soft landing, since it says so in the papers."
FALSE. Prices could fall off a cliff. No one knows exactly what will happen, but the risk of a sudden crash in prices is severe. As Yale professor Robert Shiller has pointed out, this housing bubble is the biggest bubble in history, ever. Predictions of a "soft landing" are just more manipulation of buyer emotions, to get them to buy even while prices are falling.

Most newspaper articles on housing are not news at all. They are advertisements that are disguised to look like news. They quote heavily from people like realtors, whose income depends on separating you from your money. Their purpose is not to inform, but rather to get you to buy.

9. "The bubble prices were driven by supply and demand."
FALSE. Prices were driven by low interest rates and risky loans. Supply is up, and the average family income fell 2.3% from 2001 to 2004, so prices are violating the most basic assumptions about supply and demand.


10. "They aren't making any more land."
TRUE, but sales volume has fallen 40% in the last year alone. It seems they aren't making any more buyers, either.

11. "As a renter, you have no opportunity to build equity."
FALSE. Equity is just money. Renters are actually in a better position to build equity through investing in anything but housing.
* Owers are losing every month by paying much more for interest than they would pay for rent. The tax deduction does not come close to making owing competitive with renting.
* Owers are losing principal in a leveraged way as prices decline. A 14% decline completely wipes out all the equity of "owners" who actually own only 20% of their house. Remember that the agents will take 5%.
* Owers must pay taxes simply to own a house. That is not true of stocks, bonds, or any other asset that can build equity. Only houses are such a guaranteed drain on cash.
* Owers must insure a house, but not most other investments.
* Owers must pay to repair a house, but not a stock or a bond.

12. "If you rent you are a buyer. You are just buying it for someone else."
FALSE. It may be true that rent covers mortgage payments in some places like South Dakota, but not in any of the markets that have shot up in the last few years. Rents are much less than mortgages in most places now. No landlord buys with the intention to rent out in California because that's not profitable. The owner is generously subsidizing the renter, a wonderful thing for renters during this crash.

13. "If you don't own, you'll live in a dump in a bad neighborhood."
FALSE. For the any given monthly payment, you can rent a much better house than you can buy. Renters live better, not worse. There are downsides to renting, such as being told to move at the end of your lease, or having your rent raised, but since there are thousands of vacant rentals, you can take your pick and be quite happy renting during the crash. There are similar downsides to owning anyway, such as being fired and losing your house, or having your interest rate and property taxes adjust upward.

You may worry about being forced to move, but the law says the landlord has to offer you a one year lease at a minimum, and they'll probably be delighted to offer you a two year lease and give you a discount for that. Other people want the mobility that renting affords. Renters can usually get out of a lease and move anywhere they want within one month, with no real estate commission.

It is much easier and cheaper to rent a house in a good school district than to buy a house in the same place.

A fun trick to rent a good house cheap: go to an open house, take the real estate agent aside, and ask if the owner is interested in renting the place out. Often, desperate sellers will be happy to get a little rental cash coming in and give you a great deal for a year or two.

The biggest upside is hardly ever mentioned: renters can choose a short commute by living very close to work or to the train line. An extra two hours every day of free time not wasted commuting is the best bonus you can ever get.

14. "Owners can change their houses to suit their tastes."
FALSE. Even single family detached housing is often restricted by CC&Rs and House Owner's Associations (HOAs). Imagine having to get the approval of some picky neighbor on the "Architectural Review Board" every time you want to change the color of your trim. Yet that's how most houses are sold these days.

In California, the HOA can and will foreclose on your house without a judicial hearing. They can fine you $100/day for leaving your garage door open, and then take your house away if you refuse to pay. There's a good HOA blog here.

15. "If and when the market goes south, you can walk away."
FALSE. If you have a single loan with just the house as collateral, it may be a "non-recourse" loan, meaning you could indeed walk and not lose anything other than your house and any equity in it (along with your credit record). But if you refinance or take a "home equity loan", the new loan is probably a recourse loan, and the bank can get very aggressive, not to mention what the IRS can do. A reader who lived through the 1989 housing crash in LA pointed out the following nasty situation that can happen:
* Let's say you buy a house for $600,000, with a $500,000 mortgage.
* Then the house drops in value to $400,000, you lose your job, or otherwise must move.
* If you can't make your payments, the bank forecloses on you and nets $350,000 on the sale of your house.
* The bank's $150,000 loss on the mortgage is "forgiveness of debt" in the eyes of the IRS, and effectively becomes $150,000 of reportable income you must pay tax on.

It is true that buyers who put zero down and have nothing invested in the house are much more likely to walk away. The large number of new uninvested buyers increases the risk of a horrifying crash in prices rather than a "soft landing".

[Desi_by_Nature]

couple of comments

Buyers' agents get nothing if there is no sale, so they want their clients to buy no matter how bad the deal is, the exact opposite of the buyer's best interest.

True. It is true for seller's agents as well. Mortgage brokers too. None of these in their sane selfish business mind will ever tell you that this is not a good time to buy or sell.
If you're a buyer and are getting a good interest rate and plan to stick with the house for 5 or more years then generally speaking anytime is a good time to buy.
If you're a seller desperate to sell and if you can sell it for a price that makes financial sense - then sell it.
In either case you'll waste time and money by waiting.

Worse, realtors have a near-monopoly on sale price information

may be true for India but not in the US. In India there is usually a black money element in most transactions so yeah even if the records were public, they would be meaningless. In the US all sale records are public. Most cities/counties have sales info on their websites.

"There are great tax advantages to owning."

Cannot be deemed as FALSE. could be TRUE as well. Say if your mortgage interest deductions actually push you into a lower tax bracket, wouldn't that be a great tax advantage of owning?

"A rental house provides good income."

again not necessarily FALSE. Bay Area is a bad example because prices there are inflated anyway. Surely you'll almost never recoup your mortgage payments by rental income. But come to a more saner and stable market like the midwest and you'll see that renting your house can actually make good sense depending on the market conditions.

Renters are actually in a better position to build equity through investing in anything but housing.


Man! then i guess 70% of the US population is stupid. And by the way any idea what might that "anything" be?

5. "OK, owning is a loss in monthly cash flow, but appreciation will make up for it."
FALSE. Appreciation is negative. Prices are going down in most places, which just adds insult to the monthly injury of crushing mortgage payments.

I guess the author forgt to mention that the world is coming to an end. The world economy is now in a self destruction mode. We're all gonne be eaten up by zombies next week.

[nand]

The analysis conviniently forgets that when you buy a house for 700K you can also sell it later for 900K or whatever, and the gains are tax free!! That is not figured in to the calculation. Secondly, fine in bay area it may or may not make sense but in texas for 250K you can buy a nice house. And there is something about owning your own house, and doing it up the way you want.

Renting makes sense in some cases. But nearly always buying a primary home makes sense esp. if outlook is long term ~5yrs.

[vijay]

some truth in what the OP says, I have heard of the term " House Poor" very often amongst whites
Living in an apartment sucks (renters typically live in aps), they are small and have no privacy,try raising kids in apts. Living in a house is a huge upgrade in lifestyle and comfort. Of course if one could rent a house that would be just as good assuming your rent is much less than the mortgage for that same house

[kalpesh145]

some truth in what the OP says, I have heard of the term " House Poor" very often amongst whites

Vijay,
Just wanted to make a comment on your term amongst whites --> "House Poor"

Y'day I read in SJ mercury news about poverty in US.
32 million poor (20K annual income for family of 4) , 16 million extreme poor (10K annual income for family of 4). Among those 16 million, 10 million white. So, I think they have more to worry than buying v/s renting IMO. I found this article quite shocking, as didn't expect situation this bad here.

http://www.mercurynews.com/mld/mercurynews/news/nation/16781121.htm

[money_in_my_mind]

Vijay,
Just wanted to make a comment on your term amongst whites --> "House Poor"

Y'day I read in SJ mercury news about poverty in US.
32 million poor (20K annual income for family of 4) , 16 million extreme poor (10K annual income for family of 4). Among those 16 million, 10 million white. So, I think they have more to worry than buying v/s renting IMO. I found this article quite shocking, as didn't expect situation this bad here.

http://www.mercurynews.com/mld/mercurynews/news/nation/16781121.htm[/quote]

Looks like Bush's policy worked to perfection. Corporates benefitted while poor working class got poorer :mad: .

"...the share of national income going to corporate profits has dwarfed the amount going to wages and salaries. That helps explain why the median household income for working-age families, adjusted for inflation, has fallen for five straight years."