(c) copyright View from Silicon Valley, 2005. All rights
reserved.
With all the pontificating and bloviating over the housing market,
let's review and summarize some of the "strategy" being employed for Silicon Valley housing:
Strategy v0.0: Just buy the house and flip it.
The market is going up so fast it doesn't matter what you pay, there will be a greater price (fool?) available tomorrow.
In our view, this is the same as no strategy, hence the version number...
Strategy v0.3: Buy the house even though the rent will never cover
the cost to finance, let alone to maintain. Paying $1M+ easily justifies a -$20K, or worse, negative chase flow since
the price will "inevitably" go up $100K or more this year(*). A repeat of the last two years' ~18% appreciation just fattens the profits. At this point in the
market cycle, we equate this strategy to clicking your heels three times while closing your eyes and wishing (hence the version
number...)
Strategy v0.5: The "investor" decides to make improvements.
There is now a reality show ("Property Ladder" on The Learning Channel, **), showing "investors" doing their own deals. The highlight of the first episode was finding the
seller was also his own real estate agent. He "countered" ten of the seventeen offers received with
prices higher than his original asking price. (I guess this is not actually illegal. Just another manifestation
of a "free market"...) On camera, he admitted to the bait-and-switch pricing plan and he indeed got a sucker (err,
buyer) to pony up $700K+ against his $630K published asking price. He supposedly cleared $81.5K "before fees."
(No disclosure was given on his net or if he paid for his parents' two trips from Boston to Santa Monica to give him
free labor...)
At least, this is the first half of a strategy that might
work in markets that aren't forever going straight up. (The other half is making sure you can afford to keep owning
it if it doesn't sell right away. A big part of the "drama" on the "Property Ladder" episode was his escalating
cost for every month gone by without the improvements completed.) Half a strategy, hence the version number...
As an aside, the ease of financing these flips is
exemplified by a new mortgage "product" advertised locally: A "six-month fixed rate" interest-only loan up to $650,000
at 1.99% with a pre-payment penalty. The short lock and pre-payment penalty scream "flipper loan." "Investors" borrow up to $650K for only $1,078 per month then, presumably, covering
the pre-pay penalty from the flipper's profits (assuming there is a profit).
Strategy v1.0: As described in previousmissives, this is an "investor" looking for a "renter" who wants to become the "buyer." We couldn't help
but marvel at brazenly asking an above-market rent ($4,000 is ~$1,200/month above the market rate) in exchange for
an option to buy the house. This "investor" explained he didn't want to flip the property now, even though he was confident
of clearing at least $200K, since waiting a year would lower the tax hit. (The real goal was likely to roll
the sale into a 1031 exchange and dodge taxes completely.) This is the first "strategy" which even attempts
to account for cash flow and has an exit plan, hence the version number.
Alas, strategy v1.0 seems
to be struggling. A couple weeks ago, $4,000 was lowered to $3,500 per month, a broker was employed and, "Our tenant needs to have good credit, can afford to buy a home in Cupertino, and
have outstanding references." When you can finance a $1.2M house, who needs references?
This "investor" later expressed "astonishment" for our "bad acts" of using his
e-mail after he realized we were publishing parts of the correspondence. (And here we were thinking this was a
"free market"...) I offered to publish a rebuttal but all I got was another copy of the Craigslist ad. Subsequent e-mails asked how do you guarantee a renter really gets to buy the house? Or why someone
who already qualified for a $1.2M house would want to wait another year? (Maybe because they thought
pricing might go down??)
Possibly in response to such questions, the "investor" last week lowered the rent to
$2,488 and added, "We will lock in a price (for early-mid next year) for the home before you sign
the lease option-- and $1,000 dollars of rent will go towards the down payment of your home! The $1,000 each
month will (be) held as a deposit. That will make your rent only $2488 for a brand new home in Cupertino!...It is your
option whether to purchase the home."
Presumably, someone with the savvy to finance $1.2M would also demand
terms to get their $12,000 "deposit" back if they choose not to buy. (Maybe this turned out to be an issue since the
$2,488 version of the ad has now been taken down.) If implemented, an almost-breakeven cash flow at $4,000/month
would have been underwater by ~-$18,000 (Underwater by ~-$6,000 at $3,500/month). This forces us
to the re-rate this strategy down to v0.4.
Strategy v2.0 was pointed out by a reader:
"I'm looking to sell my house but then
lease it back for 2-5 years. The lease could be a monthly payment, or could be
figured into the price of the house. The property is 3 bedroom 2 bath & is located insouth
San Jose." This guy is also using a broker, which figures to eat into his profits
from the $640K asking price.
Not bad! Lock in today's price and also your rent payments for several years. If the buyer
is an "investor," save him the trouble of finding a tenant. The seller maybe dodges some capital
gains taxes, and the buyer some property taxes, by discounting the purchase price vs. future rent. The
seller then lives payment-free for a few years. If the market drops, the seller has cash and might be able
to buy the house back at a lower price. This strategy covers two problems-- locking in today's high prices
and today's low rents, hence the version number...
Strategy v3.0 is last and, possibly, least. A government-guaranteed
rent-to-own program. As explained by the real estate agent, "Say for example the market value of the home is 500K when
you enter into the lease, and 3 years from now when you decide to exercise your option to buy it is worth 700K.
If you exercise your option to buy the home, the 200K in equity is yours" anywhere from 12 to 36 months in the
future. "If prices go down, then you could opt not to exercise your option to buy."
The singular virtue of all the earlier strategies was the "investors"
were risking their own money. (They were undoubtedly able to convince the bank to risk even more of Fannie Mae's
money, but that's another missive...)
Various local politicians and public figures have taken to
the airwaves to publicly congratulate themselves for having the foresight to get taxpayers to underwrite a bond
to finance an "affordable housing" bond. Thanks to the government, "qualified" buyers can rent a "qualified" property
with a right to purchase at today's price, or less. Coincidentally, mainly school teachers and other public
servants tend to qualify for this program.
To name just three problems with this "strategy", the
government is removing houses from the sale market (driving up prices), it puts tax-payer money at risk (if the market
falls) and transfers risk to taxpayers to subsidize privileged groups. I'm sure we could all list several
more problems with this "strategy" (higher taxes for everybody else, removes incentives from builders, penalizes non-"qualified"
groups, ...) but you get the idea, hence the version number...
In summary, each "strategy" assumes house prices will only
and always increase. Even a period of just flat prices will cut all the v0.x "strategies" off at the
knees. Imagine what happens if the highest prices ever recorded start to fall or the lowest interest rates
in 50 years start to increase...
Per Warren Buffett, "It's only when the tide goes out that you learn who's been swimming naked."
* * * *
The above is strictly for entertainment purposes and should not be construed
as advise to buy, hold or sell any security of financial product. Always consult a licensed investment professional
before making any investment decision.
