Driving to a meeting today, I tuned into a show called House Calls on a local FM talk radio station. The show centers on real estate investing and taking calls (massively prescreened) from the public. Whenever I’m in the car on a Saturday morning driving with the gorgeous California sun, I usually tune into this station to see what the media and the public are saying about the housing market. I’ve listened to this show for a very long time. And I can tell you that last year they were cheerleading Southern California housing like you wouldn’t believe. Any caller mentioning the word “bubble” was painted as a tinfoil hat wearing bubblelista. Fast forward one year to summer 2007 and they are giving the advice of investing out of state for cash flow properties. Sounds like the strategy I’ve been purporting since the beginning but why mince words, these are the experts.
One call however summed up the psychology of current sellers. A woman called up and the conversation went as follows:
“We purchased a wonderful condo in Orange County in 2001. Last year, homes in the same area were selling for $749,000 and quickly. These were horrible condos in bad condition. We have our place on the market for $779,000 since November and we’ve had no visitors. What gives? We have granite countertops and removed the popcorn on the ceiling. We were wondering what we could do. It seems the days on market (DOM) is hurting our negotiations and giving buyers the upper-hand. We were thinking of taking the home off the market for a few months and relisting it. What do you suggest?”
I’ll get to the advice offered to this women later but let us analyze what is going on here. First, we have the belief that peak prices will come back. Her belief that somehow her home is worth what a buyer was willing to pay last year is massively incorrect. The actual value of the home is whatever a buyer is willing to pay, today. And buyers aren’t willing to pay Pollyanna prices simply because she removed remnant 70s popcorn from her ceiling. You would think that this Trump wannabe would quickly take a survey of the market and ask herself the following questions:
1. Am I not marketing the property correctly?
2. Could it be that the price is too high for the current market?
3. What can I do to make it sell given the current market sentiment?
These questions don’t matter because the ultimate answer is something she does not want to hear. Lower the damn price! It isn’t the granite tops or the green Behr paint you added, it is the fact that the market has drastically changed. Sellers are no longer in the bargaining chair. In addition, many sellers last year were able to squeeze into the party by buying with risky subprime loans. The subprime market is now toast. Banks are becoming stricter on their lending standards. Need we point out that inventory is growing therefore giving buyers more choice?
The second point of contention is overvaluing basic remodeling jobs. It is the case in other states that sellers actually need to replace a roof/carpet, install ceramic tiling, and work on the garden simply to move the home. Not only that, the seller usually under prices these updates so the house can sell. In California, as demonstrated by this seller, they believe that adding granite countertops and doing a basic cosmetic update has made their home worth hundreds of thousand more. Can we say delusional? The great thing about the market once fraudulent credit is removed, no one will buy this place and that will be her outcome. The home will not sell until she reconciles her cognitive dissonance regarding missing the bus in selling the home. Sorry, the lights are out on this party.
Then we get shady tactics that once worked before. She is obviously on the up about relisting her home. Somehow, these yesteryear tactics are pointless in a market brimming with REOs and soon to be added foreclosures. The bank won’t hesitate to cut prices. To them the home is a liability on their accounting books. They will drop prices until market interest is stirred up. This seller? Well they are pining for the days of 2006 as if it were a lost high school love interest. Keep in mind for the last 7 years, sellers only competed with themselves. They had a monopoly on the market. Now REOs and foreclosures are rapidly growing and their market share is increasing. Result? A competitive market driving prices down.
Equity Out of Your Bubble Home to Other States
So what was the advice given to this aspiring seller? Get this. Tap out your equity and invest elsewhere! So let me get this straight, we are in a national housing bubble and you want this person to lock in her overpriced asset and invest elsewhere? In effect, this will make her the buyer of her own home. Say she taps out $100,000 in equity from her house, she has essentially created a pseudo American Express agreement with her home for 10 years. And get this, she will need to pay that $100,000 completely back. It amazes me how so many people in the mainstream media see HELOC or home loans as your money. All you are doing is creating a relatively affordable loan against your biggest asset. Financially retarded in a declining real estate market.
I’m all for investing in real estate. But not at the cost of locking you into an overpriced asset and pulling a 2nd for leverage. Doesn’t make sense. Equity is only yours when escrow closes and you have a cashier’s check in your hand. Maybe they should wait for a year and save up to see how things are in 2008 and try to sell their home again. At that point, they’ll realize that they should have cut and sold in 2007 because some greater fool is still out there. I’m not sure about next year.
The advice is typical for those in the real estate industry. Keep doing things that churn commission cuts. You refinance, the broker gets a cut. You sell, an agent makes money. You buy out of state, you make a loan executive and an agent money. But wait out the market. Ahhh, the silver lining. If you wait, which in investing is prudent at times, you will make yourself money but others may suffer. If you want to buy, go ahead. No one is stopping you. Heck we have enablers everywhere. Give this seller a call for her $779,000 condo. You might be able to get her to chip in a few bucks for closing cost.
Horrible financial advice under the guise of investing. Sorry folks, if you want true investing knowledge purchase a few books and educate yourself. It’ll cost you $30 bucks on Amazon or even free at your local library but you’ll save tens of thousands in the long run. Don’t fall for the mainstream debt trap. Debt is not wealth. Slavery is not freedom. And removing popcorn does not cost $779,000.
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20 Comments:
Touché, good Doctor.
Why do home-sellers refuse to cut prices? Denial, anger and guilt.
Dr HousingBubble,
I have heard the radio show you mentioned in the article. I can't stand that show. It's just one big commercial. The callers are retards that want to be the next Donald Trump. Like you mentioned, I have never heard them say "maybe you should wait and not get over-leveraged".
I guess they have to generate commissions to pay for the radio time.
I live in Glen Park neighborhood of San Francisco. In 1982, I brought my house for $115K; it was on the market for $130K. The seller gladly accepted my bid, as I was the first bidder in six (6) months.
Now homes in my neighborhood are selling north of $600K, and the few sellers are receiving bids over asking. We are close to shopping, public transportation, restaurants, a wilderness park within blocks of my house, etc.
I usually walk or take public transportation whenever I go somewhere!
Maybe the answer is location, location, location.
Darrell's End Times said...
"I live in Glen Park neighborhood of San Francisco. In 1982, I brought my house for $115K; it was on the market for $130K. The seller gladly accepted my bid, as I was the first bidder in six (6) months.
Now homes in my neighborhood are selling north of $600K..."
Here's the thing. That same $115K invested in the S&P 500 instead of a house would be worth something like $1,477K today. (S&P 500 for Jan 1982 = $110.90; for Jan.2007 = $1,424.16.) And that doesn't include the dividends the portfolio would have been kicking out over time.
And, too, was $115k the true cost? That is, was there a loan? What was the interest cost?
Maybe location, location, location still can't make residential real-estate such a great investment except in anomalous markets over short periods of time. That is, for flippers, during a run up like we've seen over the past six or seven years.
Doc., is this reasoning right? I'm new at this.
@dog-walker and darrell's end times:
Dog-walker, that point about the S&P is absolutely priceless. At the same time, consider that the stock market can be flat for a decade or more. But--and this is a big but--you'd have needed some serious intestinal fortitude to buy stocks in 1982, just like you would have in 2003. Hell, if you had locked in a 16%/year 10-year CD, you'd still have time to hit up the Dot-Bomb Mania.
The thing is, though, that most people don't understand personal finance at all. They don't even know what an index fund is, so how can they be expected to realize one would earn almost 50% more than homes? On the otherhand everyone needs a roof. Anyone with a pulse and a down payment can buy a house, and everyone needs a home, but most first-time buyers are illiterate about other places to put money.
In a way, it really is not that different from Tulipmania. Most people don't understand investment vehicles like stocks or bonds or metals, but like tulips, everyone knows what a house is and what you do with one! Now imagine that someone is telling you they made 100% flipping their house! You need to live somewhere and you like money, right? Is this exciting or what! Hell, this worked for Donald "Bankrupt Again!" Trump, it'll work for us too! Hey, is that Alan G-Span with the 1.25% champagne? Party On, Dudes!
At 6% a year, real estate is not bad, but it's not so much an "investment" as a safe-haven for wealth that, if you are renting it, can generate cash-flow. Otherwise it is basically an inflation-protected savings account unless you can call a top and "Flip Dat".
@Dr. HoBub:
Do you have any recommended books from Amazon? I think that The Intelligent Investor should probably be required reading in high schools--even though i'm not a big fundamentals guy advice like "You cannot be half an investor and half a speculator" is priceless and would have prevented this mess--but where is a serious guide to real estate?
Anon said:
Like you mentioned, I have never heard them say "maybe you should wait and not get over-leveraged".
As Dr Bubble has pointed out repeatedly, many people figured they were financial geniuses by watching their home equity rise, when it had nothing to do with anything besides favorable market conditions that rose all boats. As the old saying goes, "even a blind mouse occasionally finds the cheese".
Famous failed flipper Casey Serin was seduced by early success when his condo sold for $60k more than he paid. Who WOULDN'T say, "Boy, that was great! May I have another please?" after being flush with their early success?
Many investment dabblers did just that, and hence a self-perpetuating real estate market frenzy was born, off and running.
By 2004-2005 the smart money had pulled out of the game. Foolish money was getting in deeper and deeper, using leverage to get into as many properties as they could manage. The lenders/agents were all too happy to allow buyers to create their mini-empires, as there's EZ money to be made in conducting transactions (just like when selling and buying stocks).
Here we are in 2007, and some people are learning that leverage is a double-edged sword: it's a powerful tool to wield in an "up" market, but has some nasty backlash when the market turns! That depreciation gets amplifed on the downside just as strongly as the appreciation does on the way up!
@@@@
BTW, I love it when people speak of "their" equity, or "their" home. Sorry, but equity is never YOURS until the day you sell, and have the money in hand! Also, the home is never truly "yours" until the day you pay for it free and clear, and burn the mortgage! Before then, you're simply renting MONEY from the bank to buy the home.
Over-pay on a home initially, and you'll find that flagging home values means you're not building ANY equity at all. You cannot build equity in a depreciating asset, as the equity is the first component to evaporate.
Also good to remember that a HELOC is NOT your equity, or putting YOUR equity to work for you, etc, it's simply a LOAN that is secured by the house title. As stated, you have to pay back every filthy penny when you sell. If you've borrowed more than the house is currently worth, then bring a checkbook to the closing table, as in all cases you're going to be paying the loan back to the bank.
Adam Smith nailed it right on the head: The smart money exits first.
Bear cave: The best way to understand this whole mess is to understand the underlying motivation of the human mind.
This is a great book that explains how our minds work.
Why We Do What We Do: Understanding Self-Motivation
by Edward L. Deci, Richard Flaste
I wonder if she ever even checked out the "horrible condos for $749,000" claim.
What gets me is that she said she bought the condo in 2001. She could drop the price by $100K and still make much more on the sale than she deserves to. But I guess she is entitled.
Pure greed.
Has the thought that the majority of homes now built are virtually worthless in light of escalating energy costs and shortages?
How much is a home worth if a person cannot afford the gas to drive to it daily? How much is a home worth when the energy costs to heat and cool it are prohibitive?
Best bet is possible recycle the components of the home
I have been hearing a lot of similar stories recently. Two friends of mine own houses/investment properties, one in Sacramento and one in Florida. Neither of them are willing to sell in today's market (they'd be "giving their houses away" when they are "worth so much more"), so both friends are holding on to their houses because they are sure that "next year the market is going to turn around." My advice to them is to cut their losses now, but they are convinced that the current environment is only temporary. After all, their realtors tell them: "Real estate always goes UP!"
@anon 3:54,
Merci
@ukhousingbubble,
We simply need the final two steps from the theory, bargaining and acceptance. That’ll come once folks realize the summer bounce is not coming.
@anon 1:07,
Amazing show. Anytime a seller starts going negative on real estate these two folks jump in like a group intervention. “Okay sir, what is your QUESTION???” However when we get a housing cheerleader they drool and let the caller have carte blanche on pumping real estate up. Can’t ask a leopard to change its skin but they try to sound unbiased with their advice when they are sprung on real estate. Obviously I have a bias too – that is I believe California real estate is massively overpriced.
@darrell’s end times,
There are places in Virginia and Ohio that are close to restaurants, wilderness, and public transportation and for a lot less than $600,000. Location does matter. Yet the bubble has been inflated with easy and irresponsible credit. Require a 20% down-payment and many places over $500,000 will go down quickly. In addition, rental rates are much lower than the actual carrying cost.
@dog-walker,
Excellent point. We are talking 25 years ago. The overall rate of return was a whopping 6.31% compounded annually. Not exactly fantastic. And that is historically about average. However, in the last 7 years we have seen annual increases of 20%, nearly 3 times the historical average.
@bear cave,
You should read Manias, Panics, and Crashes by Charles Kindleberger if you have not done so. Excellent book giving you a historical nuts and bolts of bubbles. Not a light read but definitely worth it. The Millionaire Real Estate Investor by Gary Keller is a solid read on smart real estate investing. He talks about buying property below market value. Assessing a properties true rate of return. Of course they are pumping real estate so some things are biased but definitely a good read on some technical aspects of becoming a real estate investor. A few books by John T. Reed are also good. You can also read Automatic Wealth by Michael Masterson, not exactly a real estate book per se but good wealth building book including using a balanced approach that does include rental property. As in anything in life, don’t put all your eggs in one basket.
@ adam,
Levearge cuts both ways like you say. Again, we have this mentality that home equity equals money. Yet drawing on a HELOC, you are simply getting a relatively affordable credit card, nothing more. Equity isn’t realized until you sell and have a cashier’s check in your hand.
@socalwatcher,
Excellent recommendation. I’d also recommend Blink by Malcolm Gladwell. Interesting view of the American psyche and snap judgments.
@bryce beattie,
I’m sure they’re your typical standard cookie-cutter condos. Assembly line style design. So her argument is even weaker because the fact that similar units sell for a lot less. Obviously granite countertops are not worth $50,000. Now solid gold countertops…
@starve the beast,
Gordon Gekko say you?
@jake,
No one cares about the nuts and bolts especially this seller. Do you see her sitting down worrying about a 20% increase in her utilities? She’s too busy counting her hundreds of thousands of imaginary profits to look at anything else.
@anon 3:59,
They may have bought at a good time and are cash-flowing. If that is the case, they shouldn’t sell. Buy low sell high right? If folks took the time to analyze the biggest purchase of their life, maybe this mess would have been avoided. But a common theme in all these messages is human nature and greed go hand and hand. Nothing wrong with turning a profit so long that it isn’t built on fraudulent credit and a financially irresponsible government encouraging risky behavior.
Hi, I'm closing on a new condo near Tampa next month, when I start my new job. I put $50K down on it two years ago, and will be mortgaging about $240K fixed for 30 years. The builder doesn't want to cut the price, or help with the closing. It's a beautiful place and I plan to live there for at least five years. Should I walk and lose the down payment, and look for a "bargain" next year or sooner, or will I be OK in five years if I want to sell??? Thanks for any advice!!
@anon 7:03,
Florida is ground zero for this housing debacle. Too much inventory. In my opinion, the market has a long way to go down. Here is my perspective; no one has a crystal ball. But if you asked me if prices would be the same or less in summer of 2008 I would say yes. This isn't some gut response. This is based on the fact that Tampa is way overbuilt and rates are massively resetting (Florida has a large number of ARMs). REOs and Foreclosures (read good deals) are starting to hit the market in significant numbers.
My suggestion is wait it out and buy in the dead of winter if need be (best time to buy property folks, this applies to all states). I would start saving up, rent in the area you plan to buy, and if all is well in 2008, drop the cash into a place.
anon 7:03-
Are you sure you are out the full down payment if you walk? Since it sounds like new construction and you put the money up two years ago you probably are, but be sure to double check the contract. There may be a liquidated damages clause that specifies an amount you owe if you breach. It could be the down payment, but it could be something less - perhaps a % of the purchase price.
How much did you put down $50,000? Why would you give a builder interest free money in that amount for 2 years? Did you check what that stuff sells there lately, maybe you are in the hole 70-80k already if you close on the deal right now... Man, do your homework before throwing money around like this. 2 years ago was the hight of the shyster market in Tampa...get yourself a lawyer and try to get your money back if your builder doesen't work with you..
Tampa guy,
Check out this article about condo buyers who bought on spec and are now looking for ways to back out:
http://tinyurl.com/2hfdha
It's a two-page article, so be sure to read page 2.
I'm in the market for a home in The DC area, which saw the same big runups over the early part of the decade that Socal saw.
Sellers here have yet to realize just how bad the market is, compared to their two year old expectations.
I recently made an offer on a house that originally listed in December 06 at $629k, and dropped to just over $500k in early May. My offer was another $70k lower, and I considered it generous for the comps in the nieghborhood. The tax asessment is $319k. The seller would not even counter. His agent mentioned that the seller had, "significant expenses to cover, along with a generous 9% commission." I hope that goes well for the both of them.
Now I'm looking, none too closely, at a rehab-flip that ran out of money, 13 blocks from the home metioned above. The bank owns it, listed 9 days ago for $399k, dropped 4 days ago to $339k, and dropped yesterday to $329k. It assesses at $469k.
It's a mighty enticing deal, right next to a bazillion dollar condo development (right downtown), and across from an older (less than five years) loft style condo building. Great 'hood, great location, great price.
Another one, zoned commercial, l2 blocks away from the first and listed at Christmas at $500k, just dropped for the third time. Cuts of $70k, 50K, and 50k bring it to $330k. It assesses at $466k-- My wife is interested now.
But I'll wait, thank you. There are still a few bidding wars going on (on very particular homes), and this just encourages the rest of the sellers to hug even more tightly to their crazy expectations. Something's gotta give, and when it does, I'll get us a house.
It'll still lose money against inflation over the term I'm in it (10-15 years), but it'll be my love and my hobby. And by then, it'll be paid for.
I was a seller who came off the marke a month ago.
I was willing to lower my price if the places I wanted to buy would lowe theirs by the same amount, or else I couldn't afford to move.
So, it's not about greed or being unrealistic in my case, I got on the market, offer prices came down, but I couldn't reduce if the other sellers didn't reduce. When their prices start coming down, I'll get back on and I know my selling price will be lower still.
You make it sound like we are all greedy, unrealistic jerks, well some are.
The other reason I came off the market was that the only places that were coming down in price were REO's which were mostly in bad shape --and I had to compete with them.
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