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Residential Real Estate is Dead Money for the Next Decade
Every few weeks I get a warm and fuzzy feeling when I see my old house for sale in the Wall Street Journal. I’m sure you’ve seen it. It’s the 8,000 square foot, four bedroom, seven bathroom white elephant perched on a mountain peak, with a dramatic waterfall pouring into a marble swimming pool, an elevator, and panoramic 360 degree views of the San Francisco Bay Area.
I picked it up for a song from the Sultan of Brunei in 1998, when crude crashed to $8/ barrel, and he was dumping properties to meet a cash flow crisis. The actor, Steve McQueen, had owned the property once, and the local teenagers used to park out front and make out, taking in the stunning view of the Golden Gate Bridge and shimmering city lights. The parties! Oh, the parties!
But one day in 2005, my gardener, José, mentioned that he had just obtained a $500,000 loan to buy a new place in which to house his seven kids, along with a home equity loan to cover the first year’s mortgage payments. How would he make the next year’s payments? The broker said the value of the house would go up, and he could then increase his home equity loan to cover that too.
I knew I had to sell my home immediately, hitting the bid for a tidy $12 million, along with the rest of my real estate holdings around the Fog City and Lake Tahoe. At the closing, I couldn’t help but notice that my broker, Olivia, was drunk with greed, with 360,000 dollar bills dancing in front of her eyes. Regretfully, I had to let José go. I have been renting ever since. The last price I saw for my former “Xanadu” was $7 million, and I know that a cash offer well below that would talk. I could also lease it for $19,500 a month, which wouldn’t even cover the taxes and the maintenance.
I’m not a person who normally wishes ill on people, but really, what were these buyers thinking? When people urge me to buy it back, I lie down and take a nap, and when I wake up, the feeling has refreshingly gone away. If you strip away the industry fig leaves, and ignore the paid apologists, the excesses in this sector are truly of Biblical proportions. “Official,” shadow, and bank inventories, and another 1.5 million imminent option arm induced foreclosures, probably mean there is five years worth of supply out there. The demographic pressure of 80 million retiring and downsizing baby boomers easily adds another five years. A capital constrained Fannie Mae is taking down 75% of the new mortgages in the secondary market, the FHA is taking almost all of the rest, and there is no way the socialization of the mortgage market can continue indefinitely. The market for jumbo loans no longer exists.
Residential real estate is at best a push, and worst case will drop by half again if the “W” recession pans out. This is why banks, already choking on foreclosed properties, will only lend if you hold a gun to their head. They know there are more big hits to their capital coming their way in the form of tsunamis of more bad loans .
Only buy a home if your wife is nagging you about living in that cardboard box under the freeway overpass. But expect to put up your first born child as collateral, and bring in your entire extended family in as cosigners, if you want to get a bank loan. I heard that Olivia lost her commission and everything else in the stock market crash and committed suicide. I never found out what happened to José. And no, I won’t be uttering the word “rosebud” on my deathbed.
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I bought the worst house in the best area (Berkeley Hills Ca.) in 98
Sold in 07 and tripled the purchase price.
Now I own my home outright and will wait to pick up some rentals when a bottom is more apparent.
I have factored a drop in value to the new homestead but I have moved to a more stable region with less inventory to cut through in the next ten years.
I just lucked into the cycle that allowed for massive inflation in home prices
aka cheep money from the fed with unmatched income increases and unemployment due to offshore economics.
Well guys I can tell you my very good friend philosophical approach to real estate investing up in Vancouver Canada.
He bought 2 condos in a VERY desiderable part of downtown (Yaletown), young "hip" couples and usually with good stable decent paying jobs wants to live there, a very good night scene, business district....no need for a car, you can walk to work if you you are employed downtown and these are usually the best jobs in the city.
He did buy with your "typical" Canadian mortgage terms (20% down).
The rents cover the mortgage payments and then some.
He admits he is a bit underwater with one of the properties but he could not care less.
His approach is that in 25 years these 2 properties will be well paid off and he will have a nice stream of cash monthly from rents. He is actually considering a third buy taking advantage of the dip in prices.
One is his tenants lost his job and had to move out, he did find an other couple immediately....people actually lined up to look at the apartment, he can afford to be disgustingly choosey if he wants to.
Again, his point is the appeal of the location, even if you pay a bit more for the purchase...it's all well spent if you analyze the place from all angles.
People that made a similar investment buying in less expensive areas of Greater Vancouver are more underwater and with more trouble finding new tenants.
Another individual I know bought several properties (on the cheap and with a lot of leverage) in some crappy WA towns like Bremerton, Centralia, Richland and so on, places with a shitty job environment overly dependant on retail and other minimum wage jobs or sometime relying entirely on one of 2 big companies (if one moves it takes down the entire place)
Well this guy is one the verge of declaring bankrupcy, half of his properties are empty and/or with tenants far behind with rent payment.
One of these Vancouver Yaletown condo I mentioned before was bought for $310,000 and it is being rented for $1800 monthly.
So, assuming it was bought cash, before taxes (circa $1000 per year) that property yield about 7% per year....find me any stock or bond investment that can steadily generate that kind of yield basically risk free...no danger to be inflated away, no casino, company imploding, accounting frauds, equity dilution issuing more stocks, etc...And if in the long run you get value appreciation it's all gravy. People forgot what investing is, mainly, all about....cash flow, earnings (in your pocket as dividends when it comes to stock investing). Asset price appreciation should be secondary.
So as the wisest line for real estate says: Location, Location, Location.
Dollars to doughnuts your buddy isn't yielding 7%. Maybe when the unit is occupied and he isn't having to make repairs it is? And wait until deferred maint. kicks in (25 years?!)
Your example is not a sound one. But many inexperienced Real Esate investors have looked at a deal like this and thought so.
Good example: depressed market, depressed rents. you are out on the street looking for multi family properties - the more units you can afford, the better.
Any property you look at gets 30-50% knocked off actual rents (not projected!). Then you subtract PITI. Now you have a "net rents" number you can count on. You use that number to figure what your "cash on cash" return is. And guess what - you'll still be yielding less then expected.
Over the long haul, you look for rents to move up, and if the building appreciates, it's gravy. If it doesn't, no matter, you have income stream.
I am a small fry in Southern California - 44 units. All bought between 1995 and 2000. We weren't thinking about appreciation back in those days, just cash flow. And the banks were giving shit away. I wouldn't look at a building in the early days unless it was still returning at least 20% cash on cash - after a 50% vacancy and expense. And they were out there.
If I only knew then...Oh well. Anyway, my coulda, woulda, shoulda, buddies and I are hoping that those days will return - or at least get close. This is the way to get rich in Real Estate - long term. APPRECIATION IS GRAVY - look for CASH FLOW!
And when you are considering rental property, location doesn't mean shit. On the contrary, location costs money. What you want is a blue coller bread and butter area of town. Stable and clean. The return on investment is usually better, and surprisingly, this type of area/tenant pays better then your more upscale locale. Canadians! just effin around - we'll probably be moving there after TSHTF.
Anonymous
Money talks
At the moment my friend collects $200 a month (on each condo) on top of his mortgage payments (he did not buy cash).
People line up to live in that part of town...individuals without money problems or expats where their company pick up the tab.
You say: "Over the long haul, you look for rents to move up, and if the building appreciates, it's gravy. If it doesn't, no matter, you have income stream"
We totally agree on that..that is my friend point.
As far as maintenance, a condo doesn't need much in the first place and my friend does all he can by himself (painting plumbing, etc...).
He knows already that every 25-30 years he has to pay for his share of external building renovation...but considering the time period is not that much.
Location is very important, you do not know what you are talking about...."bread and butter blue collar part of town" do not exist anymore or, better, they are becoming increasingly rare up to the point of extintion.
We are increasingly moving towards a model of society where you will have the vast majority of people struggling to pay their bills Vs. the superrich and the "creative" (mostly useless) or management class.....6 figures jobs for marketing types, financial types and so on.....and that part of Vancouver downtown attract precisely that kind of people....50% vacancy rate?? Are you kidding?? Not in that part of town buddy (Vancouver has the advantage of having a very strong inflow of immigrants every year...and they are not pennyless illegal Latinos like down in Cali but folks from all around the world bringing cash)
You said: "APPRECIATION IS GRAVY - look for CASH FLOW"
That is exactly, again, my (and my friend) point.
Within 30 years he will have 3 condo (or more) well paid off and yielding a juicy cash flow...this is his retirement....and it is more secure than your average 401K.
"This is why banks, already choking on foreclosed properties, will only lend if you hold a gun to their head. They know there are more big hits to their capital coming their way in the form of tsunamis of more bad loans"
Thats why I used FHA (AKA USA) to purchase my house this week. I only had to put 3.5% down and then once you count the upfront Mortgage Insurance Fee of 1.75% that they are nice enough to roll into the balance of my loan I technically only had to put 1.75% down on my home. Add in transaction costs and I am underwater day one! Good thing our government learns from mistakes! Can't wait to see what happens with Health Care.
As far as hyperinflation and real estate go, you don't buy real estate to achieve massive price increase for a hyper-inflated house that you can't sell. The relationship of hyper inflation and real estate is that instead of buying a $5 million dollar loaf of bread, you pay off your mortgage.
Real estate you live in is fine. I have a place, myself. Stupid Trump-like palaces bought with leverage and a dream that a Greater Fool will make you rich are dumb. Even if you sell the place for a profit.
Here is a "bottom line" for you - If, after factoring in a HEALTHY vacancy/expense factor AND PITI, you are getting the "cash on cash" return that satisfies your needs - go ahead and buy.
If you are looking at Real Estate to owner occupy, look at it as a DOMICILE ONLY. Because if your timing isn't right, bend over.
Follow these rules and you will know whether Real Estate is a good investment, or not. I am referring to rental property only.
TGIF
Native San Franciscan, own a few properties in the area. Beware, MadHedgie--reversals of fortune are commonplace. I bet the Sultan of Brunei has recovered nicely. God doesnt favor condescending pricks. You, sir--are a renter. Persona non grata.
Watch your back. Karma is a bitch-and your overdrawn at Banco Karma.
Indeed.
"God doesnt favor condescending pricks."
Looks like you're SOL, then, karma-boy.
madhedgefundtrader is still a liar......can he deny that this article is about him?
http://www.lawfuel.com/show-release.asp?ID=3686
MHFT uses ALLEGORIES to get his points across.
Sorta like Jesus did back in the day, but without all that religiony stuff like heaven and hell.
Woah, you just sunk my Battleship.
Is this article some sort of parody? Seriously...
the best real estate deals are much farther east, but you need an 'army' of agents, a lot of advertising, and the interest is a bitch
Does it make sense to pay at least $2000 per month to rent a house for 10years without any tax deductions??? That's about $200,000 NPV. That's a real out of pocket cost unless you live with your parents. Not so much fun.
Generally, "owning" the equivalent mortgage will run you about $3,000/mth. In addition:
1) Exit anytime you like
2) Don't pay a sales commission to exit
3) Don't pay land or other real estate taxes
4) Don't pay maintenance
Renting is by far the more economically beneficial option to the dweller, still. Only when house prices capitulate another 50% will these dynamics start to come back into line.
If you want to study it further, go and analyse Canada, the UK, and especialy, Australia.
The trick with Real Estate is you have to make your money at the point of purchase that means distressed for pennies on the dollar or forget about it.
+1000000
Amortize the 30 year. Look at where your payments go for 10 years. Interest, baybee!! Thus, got to keep inflation down in real estate; lots of home owners to feed off of. Fuckers.
madhedgefundtrader,
Your only partially right. You idiots in California, Nevada, Arizona, Michigan, New York and Florida are dead in the water for a long time to come. But you should be! The level of stupidity that the buyers, the mortgage industry, our Government and Wall Street demonstrated in these States is mind boggling.
So, madhedgefundtrader, it appears you got lucky. Real Estate in most other parts of the US will continue to do just fine and will prove to be a solid reliable source of profits for the Real Estate professionals in those areas.
P.S.
California is the only State I know of where a fu#%ing gardener can get a $500,000.00 loan. You are getting what you deserve. It's just a shame that the stupidity of a few, in a few States, is causing the rest of the Nation, and in some respects the world, such pain.
Now I would have agreed with you if you would have titled your post "Commercial Real Estate" is dead money for the next decade.
....another texan with california envy
Hey anonymous. You understand clearly why some people hate wall street because of his attitude? I understand why Wall Street questions the intelligence of people like you. Unfortunately a fool and his money are soon parted. There can never be enough laws and supervision to prevent this from happenning. I got out of the Nasdaq around nazdaq 4000 when it was clear that gardeners, busboys, and yes even my mom was speculating in the nasdaq. I couldn't believe she was buying intel and thinking that she could judge the success or failure of a potential new chip. She was just spouting what was in the newspapers. I couldn't get my mom out and it's too late now. Granted I got out a little early, but you are the one with the bad attitude Mr. Anonymous. You wish to blame people who see the situation correctly and make money from it as somehow responsible for it. It's easy to be cynical and perhaps the truth hurts from Mr. Hedgie, but gardeners have no business buying a $500,000 house. I make $250,000 per year and I won't buy a $500,000 house. Now maybe if that $2,000,0000 house that's been on the market for 9 months is willing to drop to $500,000 then I will consider it providing they pay the points. Hehehehe.
having spent the last year of my life restoring an abandoned farm and clearing land, running fencelines,creating and building gravity powered water systems for animals as well as human consumption, tinkering with permaculture concepts, expanding garden space, controlling erosion and being at the mercy of nature the entire time, i found farming to be anything but easy. true self-sufficiency would be, as you guys on this blog might say, a six sigma event for most ZH posters.
¿Qué estaba pensando José?
ORO PUTAS!!!
Waterfallsparkles, I thought I read historically real estate just keeps up with inflation when property taxes are factored in and that it is people that made money in the real estate bubbles that give the view that it is such a great investment when in reality it isnt long term. Of course you will have some exceptions like worthless beachfront/swampland from the mid 1900's going way up in value eventually but that is not the norm.
Yes, I think you are right that Real Estate just keeps up with inflation. But, what you fail to realize in my opinion is that the appreciation on your home of say 5% as an example is on the value of your home an not on your initial investment.
Example if you buy a home for $200,000 and you put 10% down your capital invested is $20,000. If your home appreciates 5% you have $10,000. more in value which is a 50% return on your capital. You also have tax deductions of the Interest and Property taxes you have paid which would increase your return. What you have left is what you would have had to pay to Rent somewhere else. A $200,000. would rent for 10% of its value at $1,666. per month. So effectivly break even on the Rent vs Owning but you have made a 50% return on your original investment.
Do not forget that the appreciation has a cumulative effect. So the following year you would make 5% on $210,000. which would increase the return on your Money for that year and each year thereafter.
A $200K house would rent for $1,666/mo? Really? What market? What idiot would rent a $200K house for that rent when he could buy it with 10% down for less on a 30 yr. fixed?
Nice article.
California seems to go boom and bust a lot more than other Eastern states. Also, the Multi Million Dollar properties tend to lose more value in a downturn than the "Average" priced home.
I believe Real Estate is the best investment available. It is stable and you can either live in it or rent it an get a stable return. There also is a limited quanity of Real Estate Available. I think Will Rogers said it best "buy Real Estate young Man they aren't making any more of it".
The majority of Wealth in America has been made thru Real Estate and not thru the Stock Market. With Real Estate there is no one to Short your home or devalue it overnight.
In Maryland you rarely see huge drops in Real Estate Values. Prior to the last year Baltimore County only went down 1% for one year out of a 30 year period. All of the other 29 years Real Estate Values increased 4 to 5 % a year sometimes more.
It is hard to base what has happened with any historical significance because from about 2001 to 2007 Real Estate was going up over 10% sometimes 15% a year. The correction in Real Estate has only reversed about half of the gains and in Maryland not even half of the gains, maybe 15%.
So, all in all I will stick with Real Estate. Now is the "PERFECT" time to buy (maybe not a Multi Million Dollar Home) an averaged priced home as you are getting the best of both worlds. EXTREMELY low Mortgage Rates and substancially lower home prices.
The absolute best Real Estate to buy in my opinion would be a very small Farm. It would be very easy to be self sufficient.
I have much experience with real estate.....
.....the only true point you make is the last one about the farm.
Avoid everything else like the plague.
I live in SE Tennessee. Most of the small farmers and ranchers have 2nd and 3rd jobs, around here.
It takes about 1.5 acres to feed a person for a year. We've got 8 acres, but I would not begin to spend money on the equipment and fertilizer to sustain it. Cheaper to go to the grocer, and better quality.
What real estate to own? Your home (debt-free) with some land so that you have a clear field of vision if you ever have to shoot a hostile trespasser. But you better damn well make sure that you can make a living where that home is, and always buy what you are sure you can sell quickly if you have to.
And as the saying goes, it's your land and you can piss on it.
Baltimore real estate never went down before b/c it never had an unsupported boom before. Want to see what that looks like? Look at the early 90s California. Prices went ALL THE WAY BACK DOWN.
A 15% off sale isn't a good time to buy when there's a 75% off going-out-of-business sale around the corner.
"The correction in Real Estate has only reversed about half of the gains and in Maryland not even half of the gains, maybe 15%."
Expect more losses then.
Maryland is close to Washington DC, plus we have the Social Security Administration in Baltimore County.
I do not expect more losses in value.
We have the DIA, CIA, Fed and all the money that the Treasury can print using those very fine Italian presses. Rome was sacked only after the empire collapsed.
Small self sufficient farm = Peasant. Unless you have the capital to be completely self sufficient with solar panels, wind turbines, and such; but then your investment is really in renewable energy, not farmland.
Or if you have capital buy a bigger farm and save the remaining capital until food prices sky rocket and there's a need for more farms. Use it to employ laborers.
I could go into real estate prices but I think that's been covered enough here.
Edit: Be careful you don't buy in the next Detroit. There will be more Phoenix?
I'm going to go out on a limb here and guess you are less than 30 years old. Correct?
63. Never sold a property without making at least 100% profit from purchase price. Remember that with Real Estate you have leverage. I bought a few investment property's with as little as 15% total cash outlay. Government had in the 80's FHA Investor Loans with 15% Down and you could finance your closing costs. If you look at the real return based on my cash out lay my return was spetacular.
Example $100,000. property $15,000 outlay. Rental of property over aprox 10 years covers Mortgage and other expenses. Sale at $200,000 10 years later is a gain of 1,333% profit on your original $15,000. investment. You have to remember that the return is on your principal investment and the profit is on the value of the property. So, it is leverage at its greatest.
Think about it you are leveraging your money 85 to 1. Plus, you get income to support your costs to hold the investment. Stocks cannot do that.
Even with the downturn most of my properties are stll at Double or Triples from where I bought them. How many People can say that about their Stocks?
madhedgefundtrader,
You certainly have a lot of influence if you can meet with Leon Panetta one on one. Props to you.
Second, I was just reading about residential real estate from Martin Armstrong yesterday.
http://economicedge.blogspot.com/
See the last chart of his latest article. He predicts based on cycles that 2007 was the top for residential real estate, the down turn will last until 2012, an upturn into 2015, and then persistently down into 2033. This confirms your own thoughts on the matter.
thomas j.
Hey Thomas,
Do you think putting your picture on the $2.00 bill was some sort of Federal Reserve joke?
Personally, yes. But the Club is afraid of thomas j. Why do you think they stopped printing the note? They don't want people to be reminded of him and what he advocated. Jackson on the 20 is also a joke (why honor the man that shut down the 2nd US Central Bank?).
thomas j.
I think they did it as a slap in the face to Andrew Jackson. I'm sure it was intended that way, rather than as an honor.