Will the Housing Market Drop out of the Race? Quick Media, Tell me how to Think! 3 Important Tips Buying in a Crashing Housing Market.
Last week, the media was beating the final march song echoing the sentiment that Senator Clinton was down and out. In fact, early on March 4th, before any results were coming in, the media was heaping up a serving of speculation of which party elders were going to tell the candidate the bad news about stepping aside. Forget the fact that these were states that she had 20-point leads only a few weeks ago and after all the delegates are counted, the race pretty much remains the same aside from knee jerk perceptions. Welcome to fanatical speculation governed by all the talking heads on cable news. Not only does this psychological delirium play out with the 24-hour news stations but you also see this with the cable business stations that seem more like mouthpieces of companies. They reflect more a conversation around a water cooler except everyone is wearing a tailored suit. If you were to spam the internet with penny stocks that way you would have the SEC on your back but since they pump up so-called quality stocks, it is deemed as respectable business journalism. Even as the housing market is crashing, you’d be hard pressed to find anyone given much airtime talking about this and what got us here. After all, it would be bad for business.
The importance of looking at how utterly wrong the media is should give you a sense of why this historical bubble was missed. It should also give you insight into where many Americans get their “knowledge” and really will help you understand how a large part of the nation was bamboozled into buying into the housing Ponzi Scheme. A NEA report mentions that only 57 percent of Americans read any book in the past year. Yet overall, the homeownership of the nation is approximately 70 percent. I’ll let that fact seep in a bit. Now, if someone isn’t reading then where are they getting their knowledge from? Certainly you don’t have to read a book to purchase a home but how are you going to know about historical bubbles such as the 1920s real estate bubble? Now I would like to think that everyone and their pets is using alternative media such as blogs or books to dig deeper into what is being espoused by the media but more and more I’m convinced that sometimes, the media is the only source of information for many. It also gives us insight into manias, panics and how mob mentality works especially when it relates to real estate.
Now you would think that with every poll telling us the economy is the number one issue, many folks would be tuning into things that would help us understand this. Yet it seems many are relying on the media once again to tell them how to think and how to operate their lives. And let me be clear here on what a “crash” is in regards to housing. California as a state has already seen a year-over-year 21.9% median price decline in January of 2008. If we want to quantify this further, let us say the following:
10 percent decline: Correction
20 percent decline: Severe Correction
30 percent decline: Crash
40 percent decline: Severe Crash
Now since we are already seeing homes dropping by 40+ percent, I think it is safe to say many places are now crashing. How often do you hear the media saying housing is crashing? All you ever here is housing is “correcting” or “subprime” woes continue. This is a neat trick since they don’t define their terms, housing can be down 50 percent in certain areas and they can still call it a correction. Maybe the Great Depression in modern journalism would be called a prolonged recession.
Now with that said, many still seem keen on purchasing a home in this current market. In fact, many intelligent people are wiggling on the fence getting ready to purchase homes. Now I’ll make this clear, someone can be a brilliant medical doctor or scientist but have no clue on how real estate operates especially in a banana republic monetary system. In fact, given how our current Federal Reserve is handling this mess I don’t think they even know how to handle it. Not everyone is an expert in every niche not even purported experts:
“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency. We will continue to monitor this situation closely.” – Ben Bernanke, March, 2007
Good job monitoring the situation. In one year, they are now talking about bailouts, right downs, slashing rates, and running around with their underwear on the outside. I wouldn’t lay all the blame with Ben Bernanke given that Alan Greenspan was the one who championed adjustable rate mortgages and dropped rates to fuel this bubble:
“He said [Alan Greenspan] a Fed study suggested many homeowners could have saved tens of thousands of dollars in the last decade if they had ARMs. Those savings would not have been realized, however, had interest rates shot up.
“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,” Greenspan said.” -February 2004
Common sense would tell you that a 500 square foot Real Home of Genius is not worth $500,000. No need for a doctorate in economics here.
Given that we are seeing that the option ARM problem is already encroaching into the current subprime problems, we may have a few more years before we hit any sort of bottom. There simply isn’t a rush to purchase in places like California were even a 21.9% median price drop still has us in very unaffordable price ranges. Yet you want to buy so what are a few tips you should adhere to?
3 Tips for Buying Real Estate in Crashing Markets
#1 – Never Offer Market Value
Remember the condo bidding wars? Remember the phase one listservs? Those days have gone the way of the Dodo bird. Inventory is soaring and so are distressed properties. In early 2007, you would be hard pressed to find a large number of short sales here in California. Now, take a look at the numbers:
Total Southern California Inventory: 147,852
Total Short Sales: 16,945
Short Sale Percentage of Total Market: 11.4%
The fact of the matter in a swiftly declining housing market, the going rate is whatever someone is willing to offer. After all, if you are using recent comps these won’t reflect future deprecation that may occur. Keep in mind a large portion of the price was based on the idea that appreciation was going to be built into the home. Things radically change when you are faced with potential depreciation. This is another factor that spurred the housing market on. Even if owning required you to allocated twice the monthly expense compared to renting, the idea was that you would soon sell and make up the difference. Now, you need to factor in the potential liability of holding a depreciating asset and also look at comparable rental properties to base your price. Distressed properties offer a better opportunity for you to negotiate. After all, many would be sellers still don’t realize that yesteryear prices are not coming back for many years. Remember that time is on your side.
#2 – Don’t Fall in Love with a Home
Whatever you do, don’t fall in love with a home. This seduction is another reason we got into this housing bubble. Folks started upgrading their homes as if they were remodeling an old vintage car. When it came time to sell, they had a hard time accepting anything less because they invested so much emotion into the home. This is not the time to get emotional and purchase a home simply because you are gaga for the clear glass shower and French doors. Let us run a hypothetical buyer’s budget to get a better perspective:
Gross Annual Salary: $80,000
Monthly Net Take Home: $3,869 (10% to 401k single filing in California)
| Item | Per month allocation |
| Housing | $2,220* |
| Gas | $250 |
| Auto | $350 |
| Utilities | $125 |
| Food | $400 |
| Revolving Debt | $100 |
| Entertainment | $300 |
| Misc. | $124 |
*We’ll use the one-third ratio of gross monthly pay for our max limit
Now I know many people in California spend 50 to 60 percent of their income on housing but we’ll simply revert to conservative old standards using the one-third ratio as a cap for how much we should spend on housing. If you look at the above budget, I did not exaggerate any of the above items and given the cost of energy and fuel, many of these things can be much higher. Given that, we are looking at a monthly payment of $2,220 as our monthly max. We are also putting in 10% to our 401k and not being like many who are now tapping into their retirement accounts.
So what can we get for a $2,220 PITI monthly home payment? Not much at current price levels:
$300,000 @ 6.25 plus taxes and insurance 5% down: ~$2,100
$400,000 @ 6.25 plus taxes and insurance 5% down: ~$2,800
So it looks like we are aiming for a $300,000 home with $15,000 down. After tax benefits, if we can find a home in this price range we are set to go. The tax benefit will most likely come after you file your taxes assuming you don’t ramp up your exemptions so you will still be paying the PITI from your monthly nut.
#3 – Get the Right Financing
I know we all want to listen to the sage advice of Alan Greenspan but I’m going to go against his advice and recommend you go with a 30-year conventional mortgage. By the time they update all their systems this month, you’ll be able to get a $729,500 jumbo mortgage through government implicitly supported financing so long as you have the income to back it up. If you can find a place within the budget guideline and have solid financing, then you may decide to go ahead and purchase. This point is the most important. After all, financing is what got us into this mess in the first place.
My personal view is housing has a long way to correct in California but if you are gung-ho about purchasing a home, please do it the right way based on the numbers and not talking head inspiration.
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28 Responses to “Will the Housing Market Drop out of the Race? Quick Media, Tell me how to Think! 3 Important Tips Buying in a Crashing Housing Market.”
I heard on NPR the guy from HUD or some such place. He said it was great for regular people like firemen, the fuzz, nurses and teachers can get a jumbo loan for almost 3/4 of a million bucks. What a blessing that you can have a $700,000 mortgage. The property tax on the house would be about a thousand a month. Where do I sign? What’s principle and interest? The article talks about emotion, its all about the math.
I can’t remember seeing any discussion on buying a house in a housing bubble type blog. It’s almost refreshing. I’m thinking it would take ALOT of research to figure out the right price for a particular market. And there would have to be a willingness to risk offending people by offering well below the wish/list price. Adding in a comment to the effect of “I’m pricing in the losses you will see in the next year(s) in my offer” could get the seller thinking.
Regarding the idea of not falling in love with a house, I’ve had first hand experience of how RE agents will guide you into this. A while back I went house hunting and looked at around 30 places. The agent was encouraging me to only keep track of the best house so at the end of the search I’d have my choice. A simple trick that builds commitment to buy that house since I’d forgotten the rest. Instead I kept track of 5 houses, any of which could be the best depending on criteria (location, ask price, lot, building, etc) This meant if I couldn’t reach an agreement on my top pick, I’d move onto my second through fifth choices.
As my name suggests, I live abroad, but I am pretty sure that you can’t feed yourself and certainly not a family on just $400 per month. Even one car filled once a week will cost $400 per month in California. Utilities at $125? What? No a/c? No hot water? No sewer? Entertainment? $300 per month for beer, pizza, movies, ballgame, and …oh, yeah, a vacation. What about life and medical insurance? Emergency reserves? Clothing? Dental? Eyeglasses? etc.
I think it is unreasonable and unwise for someone earning $80k a year to buy a $300k house. It’s imprudent. The PITI should be reduced by about 400 per month for starters. What can you buy 1700$ per month? Maybe something around 250-260 tops. And that is still a stretch.
but, hey, this is America. If you can’t afford it you can always borrow more. right? right? hello? anyone there?
Well, I would quibble with you over some terms.
Market value equals sales price, which is what a willing buyer actually paid for a house. It is what the house is actually worth, what someone was willing to pay.
Fair market value is a guestimate at best of what a house will sell for, based on comparable sales and listings, and may be high or low within a range of say 15%. It is almost never equal to list price, since every owner fervently believes that his house is worth more than it really is. This is particularly true of owner-occupiers, most of whom refuse to negotiate on the sales price.
As a Realtor who works primarily with repossessed homes, I perform market analyses and write price opinions every day. My clients include Fannie Mae, Freddie Mac, Opition One, MGIC, among other. They very seldom list a house at the price I recommend, but usually much higher. Then when it doesn’t sell, they lower the list price until it does. The final sales price, or market value, is usually within 5% of my original recommendation, so my price opinions are pretty accurate.
I work for the seller. My job is to market, advertise and show a house. But all I can realistically do is attract a buyer, present an offer to the seller and try to negotiate a deal. That is not as easy as it may seem, but I do well enough.
If, however, I were to represent a buyer–that is, if a buyer came to me and signed an exclusive buyer’s representation contract–I would counsel him on the purchase of a house. I would ask what his specific requirements are–school district, square footage, number of bedrooms, etc. Then search for houses that met those specific requirements. For each I would prepare a subdivision history, which would include ever sale and listing going back five years, and a list of comparable sales and listings in the neighborhood. I would estimate the fair market value of each prospect and recommend what the buyer should offer.
My advice is very simple really. You do your research and arrive at a price you are willing to pay for a house. Then make that offer. The seller will either accept it, which is the best case since you get the house you want at the price you were willing to pay; negotiate, in which case you would have to decide whether you are willing to pay a little more; or reject it, in which case you go on to the next house.
You buy a house to live in it. Thus, your primary concern should be looking for a house in a well-established neighborhood with good schools. Those houses are more expensive than others, because they are the most likely to appreciate in value. But that is the price you pay for investing in value.
Most people think of their house as an asset. It is not. An asset produces income, the house you live in does not. It is a capital savings account with liabilities (taxes, utilities, maintenance, insurance). Over the long run, investing in value will give you a return. Speculating on presumed appreciation in a poor neighborhood will guarantee you a loss.
One should never take out a home equity loan, borrow on your savings. You’ll only end up paying more money in interest than what you used the loan to buy with is worth. That is the road to ruin.
And one should never purchase real estate without representation by a licensed agent who’s looking out for your interests. You’ll only end up being taken advantage of. That is a fool’s game.
I don’t do speculation. I only do value investing. Real estate, even in a down market, is one of the best investments around, but only if you do your research and know what you’re doing.
The real culprit- stated income loans.Even borrowers with poor credit were able to use stated income loans.
I don’t know. I live here in southern CA and I think the figures are very realistic for a single person (not for a family of four).
The gas cost will easily fill a car once a week. If it’s a compact car, it should come in significantly less than $400. If it’s a Hummer …. well good luck with that one. The utilities cost is low for utilities on a whole house (it’s probably doable on a condo though).
It does leave out some categories, such as clothes. The insurance won’t be a big cost IF the person has most of their medical insurance cost covered by their employer (if they are earning that much they probably do).
it is a unbelievable situation & attitude that has overtaken Americans that they can just have whatever they want – it is now BEGINNING to play out and this is only the beginning. Housing in CA has be OBNOXIOUSLY overpriced for 15 years – Who the hell would want to live there??!
Vegas is another overpriced mess now with homes going for 45% LESS than 14 months ago and DROPPING! It lead the nation on appreciation and is leading is DOWN as well. Prices NEED to come down 35% so things can stabilize – workers earning 40K cannot BUY a home for 300K – it is ridiculous and downright idiotic. Americans need to learn BASIC MATH SKILLS and stop trying to pretend they are all rich moviestars. The lessons is coming and it WILL be learned – most will not make it at all…..
$400 a month for food? Try $800 for a family of 4 here in eastern MA. We cook about 6 nights a week, eat leftovers, clip coupons, etc etc. However, our small apartment lacks sufficient freezer/fridge/closet space to take advantage of buying in bulk or good sales.
I am waiting for 450,000$ homes to drop to 220,000$. Then I will start looking.
I’m basing all my house shopping on 2001 prices. You can already start seeing these prices in places like Moreno Valley. However, this will take another 2 years to materialize… fortunately I can wait, and I already have my down payment. %20 percent, so about $30,000.
Right on Expat. 50% of America makes less than 50K, so based on traditional mortgage ratios of 3-3.5 times yearly income, most americans are looking at 150 -175 K as an affordable home, to still maintain paying taxes, insurances, utilities, a vehicle, health insurance and a once in a while ballgame with a beer and dog with the son.
I saw this mess coming in the late 90’s when I was making a six figure income and watching the home upgrade madness all around. I used to think that 260K was a hell of an expensive home making 100K +. How I pine for the good ol’ days. House buying will not return until house prices fall to the traditional income to payment norms, or when investors can earn 5-8% buying and renting. Given the craphole the dollar is falling into, it is only a matter of time before the ten year rates (what mortgages are based off) rise in response to investor demand. Imagine the horrendous crash in housing if interest rates were to rise simultaneously with the credit crunch? Housing prices would be back to the historical mean in about two weeks.
Well, I’m convinced. I’ll just keep renting, maybe for another three years, depending on the market. I had -intended- to buy a house this summer, and I was emotionally invested in that. (I’d owned my homes before moving to SoCal and to me, renting feels less ‘grown up’–not logical, but a real feeling.)
Hey GawainsGhost,
A little more quibbling over terms. A house is an asset, because it has value. Companies can list office furniture as assets on their balance sheets because it has value. A house is, for the most part, not an investment because investments are supposed to produce income. If you buy it to live in it, it’s an asset not an investment. Short version, you’re getting the two terms (asset and investment) backwards.
Family of four in los angeles = 250 a week in groceries
Filled up my car last night = 59 dollars for a vw jetta! So gas is 240 a month plus car payment of 230 a month
not to mention 1800 a month for daycare for two kids so mom and dad can go work all day
And should I mention student loan payments?
So even with two good salaries I would balk at a mortgage payment over 2000. I guess we’ll be in our rent controlled apartment forever….:o(
Or am I too frugal?
Nice work again Dr.
these numbers are a nice starting point, but here in SoCal with the flashy lifestyle, I think it would be hard to find a person making 80k/year with only $100/month revolving debt…present company excluded.
Had an interesting conversation with a friend/RE agent this week. She DOES have ‘buyers’ for some of her listings, but in her words, NO ONE is qualifying for financing at current asking prices. Evidently, she said, the only ones that can qualify are those smart enough to wait it out.
You’re crazy to buy ANY property now or take on any debt at all. Housing prices are in freefall. The economy is teetering. In six months we could be in the worst
recession since 1929. I met a woman today who, unsolicited, suggested I buy her house. Seems she has been having a larger, nicer one built for her but has not yet sold her existing one. When I told her I didn’t need a house she replied, “Buy it for your children”. I started to reply but she blurted out still smiling ‘ or are you afraid of going bankrupt like me’. I was speechless! I’ve got to hand it to this middle aged Chinese American woman her jolly demeanor given her apparent circumstances was remarkable but it also reminded me of a saying I heard as a child. Show me a man who doesn’t have a penny to their name and can keep a smile on their face and I’ll show you a grinning idiot!”
Well, if you want to quibble, I’ll tell you how I define terms.
The real money is making money. Which is to say, if your money is not working for you, making money, you don’t have any. In that sense, equity is not money; it is capital, which may be converted into money but only when it’s invested in an asset that makes money.
An asset generates income. A libiality generates expenses. In that sense, the house you live in is not an asset. It is a capital savings account with liabilities. It may have value, because it can be sold to recover the equity or capital you stored in it, but that value is never more than what a buyer is willing to pay for the house minus expenses. The expenses associated with ownership (taxes, utilities, insurance, maintenance) are often greater than the equity recovered, especially if you only live in the house for a few years. But as a general rule, and I will be the first to admit that these are extraordinary times, you only lose money in real estate if you are forced to sell. This is why you buy a house to live in; it’s a long term investment. If you’re only in the market for the short term, renting is more financially sensible.
Prices go up and prices go down. However, over the long run, a house in an established neighborhood with good schools will appreciate in value such that the equity built and recovered at sale exceeds the expenses of ownership. At that time, it can be said that the capital was converted into money, because then it made money, but not before.
In my mind, there is only income, savings and expenses. You live below your means, minimize expenses, maximize savings, and invest in income-generating properties, be they stocks, bonds, funds, rental houses, or commercial buildings. That is the only way to grow wealth.
See The Millionaire Mind, by Thomas J. Stanley, particularly the chapters on buying a house, in this regard.
800 dollars a month for groceris in MA amazing! This family of 3 spends less than 200 dollars a month (not including eating out which we dont do much) Grant you we do alot of shopping at Costco
Funny you’re debating ‘asset’ vs ‘investment’. I posted the definition of ‘asset’ over at HP, today. Not sure a house is an asset for many, nowadays.
Definition: ASSET
1. useful or valuable quality, person, or thing; an advantage or resource: proved herself an asset to the company.
2. A valuable item that is owned.
3. A spy working in his or her own country and controlled by the enemy.
4.assets
Accounting The entries on a balance sheet showing all properties, both tangible and intangible, and claims against others that may be applied to cover the liabilities of a person or business. Assets can include cash, stock, inventories, property rights, and goodwill.
The entire property owned by a person, especially a bankrupt, that can be used to settle debts.
Gael, this is what market fundamentals are all about – the local income must correspond to the local housing prices. Overall, the housing crash will stabilize this, some areas will be more severe than others. Economic conditions will always vary, live within your means. Soon enough, the prices will come down low enough in your area, much so that rental cost will be close to mortgage costs- so no, you’ll not rent forever!
GawainsGhost,
While you may like to have your own personal definitions for words, I’ve found it best to use the commonly accepted ones.
http://www.investorwords.com/273/asset.html
http://www.investorwords.com/2599/investment.html
An investment is an asset that is designed to generate income. A house is designed to give you a place to live and thus is an asset, not an investment. If you buy a house to rent it, then it is an investment. I am myself a homeowner as I have chosen this method of dealing with the expense of providing shelter for myself and family.
Your definition of liabilities is only partially correct. Some expenses are generated by liabilities (ie. interest on loans) but most are generated by activity to generate revenue (ie wages).
I do agree with living below your means to invest in income generating assets (bond, stocks, rental properties) instead of spending on non-income generating assets (TVs, fancy cars, clothes).
Well, you can define terms any way you want, as long as you want to live in Wonderland.
`When I use a word,’ Humpty Dumpty said, in rather a scornful tone, `it means just what I choose it to mean — neither more nor less.’
`The question is,’ said Alice, `whether you can make words mean so many different things.’
`The question is,’ said Humpty Dumpty, `which is to be master — that’s all.’
I choose to use definitions of words that work. My definiton of an asset is something that generates income. My definition of a liability is something that generates expenses. My definition of money is something that makes money.
You may choose to be the master and define these words in whatever way you want. And all the king’s horses and all the king’s men won’t be able to put you back together again.
My realized income was over $75,000 last year, and my living expenses weren’t even $25,000. My net worth is $10,000,000.
What do you have to show for definitions of words? Nothing but broken egg shells.
Ha too funny,
Let me guess, as a realtor you define property as something that always goes up in value!
As someone with a net worth over $10M, you have nothing better to do than make up definitions for words that already have definitions?
You may want to take some of that excess income you have and buy a dictionary.
What do I have to show for my definitions of words? The ability to communicate accurately with other people knowledgeable in the field. I’m not making this stuff up. Try FASB and GAAP.
Too much fun.
If you followed the rules you laid out, any time would be good to buy.
Great fact comparing the amount of books read by adults to homeownership by the way.
Oh ya my net worth is $57000000000000000000000.33. And my dad can beat up your dad. How do you like them apples? Realtors….Classic
One of the reasons I am a cash, versus paper-tiger, millionaire is that I don’t fall for Gawain-style rhetoric, like “real estate always goes up,” “real estate is always a good investment because they’re not making any more of it,” etc.
$10 million of “market equity” (even if it’s not made up market equity as I suspect it is in this case) means nothing, as tens of millions of deluded Americans will eventually discover as they try to cash out their housing “wealth” only to discover that all the next greater fools have already left the scene of the crime.
Historically, real estate appreciates at a rate only slightly above the inflation rate, meaning that in real terms over the long term, RE is a crappy investment in the overall scheme of things. Just ask “millionaire” Carlton Sheets…or his bankruptcy attorney.
One last jab for me
Net worth $10,000,000
Net income $75,000
Rate of return after taxes: 0.75%
Must have all his money in a chequing account. Way to invest.
Cash management at that level is no joke. My dad was executor on his good friend’s estate and they were war refugees who came to the u.s. who both worked hard at professional jobs, no children, and they squirreled money away just everywhere for fifty straight years. You only want to keep 100k in a single bank (the FDIC insured limit, obviously) so you really have to stay on top of the statements and when the CDs are maturing, etc. 10mil… that’s 100 bank accounts. I realize there are banks that handle this for you, but I’m assuming the added fees would leave your gains in the negative after inflation if you went that route. On the upside, not a problem I ever expect to have.
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