Regarding negative cash flow, I contend that overall rate of return is a better measure of investment quality.
Negative cash flows can always avoided simply by paying all cash for a property. But that doesn't mean it is a good
investment. Rental property in SV is currently a poor investment because of the high ratio of purchase price to rental
income. In contrast, I am currently shopping for investment property in Charlotte, NC, where purchase price is typically
75% less than SV, but rents are only 50% less.
---Paying all cash for a property is now what has driven prices to where they are today. Even
so, $180K (or whatever the prices are in Charlotte) at 5%+ in T-bills over the next couple years seems more attractive,
and much less risky, than buying illiquid RE.
--Or maybe you are the one person to find and exploit Charlotte as the last remaining area of
RE alpha on the globe?
Regarding attempting to "time" the housing market (i.e. buy low, sell high), I contend
that being in the market is more important than timing. I remember reading about a study of stock market returns over
the past 30 years that showed 90% of the gains occurred in just 10 of the 360 months of the studied period. If you had
been out of the market during these 10 months, you would have missed out on 90% of the gains for that 30-year period.
I'm sorry I don't have the specific reference, I'll try to dig it up.
--This was exactly the argument used by Wall Street hoping to keep their sheep invested in the
NASDAQ while it fell from 5,000 to 1,250. The "trick" is to also be out of the market during the big "down" months. We
suggest reading Hussman's comments on this subject.
Of course, your planned holding period can have a large
effect on your overall return. If you plan to hold for 5 years or less, downturns can have a significant impact.
However, for 10 years or more, short-term fluctuations can be ignored. You even cited this yourself:
http://www.viewfromsiliconvalley.com/id21.html"At the risk of wandering off the topic, it is interesting to observe a median buyer at the peak in late-1989
did not get back to even until ~mid-1999."
--1) Very, very few flipper/investors are interested in holding on for 10 years.
--2) Even fewer of those flipper/investors can handle the negative cash flow for more
than a couple years.
--3) Those who do hold may be hard-pressed to achieve returns in excess of inflation
I
found a very interesting report which provides data for 66 price correction events in the past 20 years. This data shows the
mean duration of a correction is 14 quarters, and the maximum duration was 29 quarters. The report also noted that the
most overvalued markets produced larger corrections, but were also of shorter durations. http://www.globalinsight.com/gcpath/1Q2006report.pdf (see Appendix C: Past Price Corrections
--A three-and-a-half-year mean price decline (which is already underway
in several markets) will easily flush out marginal buyers running negative cash flow. Coming off a price spike
driven by generation-low interest rates, "innovative" loans, lax lending standards and belief RE is "safer" than stocks, it
seems likely will get a much larger decline than average, regardless of how long it lasts.
Given this
data, I believe a 10-year holding period is sufficient to ride out any future market correction.
--A primary tool employed by the Feds for helping the US consumer cope with
recent debt accumulation figures to be inflation. Even without excessive inflation, breaking even over even ten years
is not enough to capture most rational people's investment dollars. Many people argue we are about to get deflation,
in which case debt become more burdensome as RE prices fall.
I have also been looking for data about past
corrections that examine the different segments of a single market. My gut feel is that in any correction, the top half
of a market experiences a greater correction than the bottom half. Therefore, owners of homes below the median will
experience a smaller decrease. But I don't have any data to support this theory.
--Valid arguments are made for the opposite. High-end RE is held by people
who pay cash and/or can weather financial storms. Low-end or median prices have been leveraged up by people
of low-end or median means, suggesting they will be less able to hold on through an extended slump. In both cases, we
are arguing which is less bad. Absolute returns are negative in both scenarios.
Considering the seemingly
stratospheric housing prices, can they go still higher? There are factors exerting both upward and downward pressure.
Some of the upward pressures include:
- Short of filling in the Bay, there is just no more land to build in the Bay
Area.
---This has been true for 50 years. Why does it matter now? Japan has
the same "problem," yet prices are down 16 years and counting.
- SV residents received a disproportionate share
of the wealth from the Internet boom. The effect of this wealth injection is still being played out.
---SV has -170K fewer jobs than during the boom and is bumping along at 1995
or 1996 employment levels. Why "invest" in RE where jobs are at the same level as ten years ago?
- More single
people own their own homes, doubling the buying power of new couples who purchase a home together.
---Without looking it up, the aging of the baby boomers suggests there are fewer
people in this condition today than there were 15 or 20 years ago.
- SV residents who have owned homes
for 5-10 years have enough equity to move up without incurring the outrageous mortgage payments that a new buyer would face
with only 3-5% down payment.
---You need to think this one through: Suppose you sell at today's median
$770K in order to "move up" to a $1M house. Even if you walk away with $650K cash, your $120K mortgage triples
to $350K and your RE tax bill goes from maybe $5K to $12K+. How many people will line up to burn up this
much extra cash? (Not to mention the $22.5K capital gains tax for the gain over $500K.)
- Immigrants
arriving with significant wealth.
---This keeps getting reported but evidence is nonexistent.
Can you quantify how this impacts ~425Ku-house market in Santa Clara County?
- Immigrants living in extended family households that provide daycare for children, multiple income streams, etc.
This is a factor in the construction of larger new homes.
---If this is a significant impact (which we doubt) it actually argues fewer homes are needed.
-
Immigrants are less likely to suffer from American Consumerism, and are more likely to save and be willing to devote more
of their income to long-term purchases such as real estate.
---Again, this is often stated but never documented. In an environment where the US is maxed
out on H-1B visas, jobs are being off-shored and the government is actively clamping down on immigration, incremental
immigration seems unlikely to impact RE prices. (Unless you're counting the indigents sneaking across the border?)
-
Real estate continues to be a popular alternative to those who distrust the financial markets.
---Well, duh! Any investment becoming popular" is generally
acknowledged as the universal signal that it's time to move on to something else.Some of the downward
pressures include:
- Obviously, rising interest rates. Also, there could be a backlash against predatory lending
if politicians can "make hay" of it for the 2008 elections. All that is needed is a few high profile cases where homeowners
suffered foreclosure of a home with significant appreciation that was sucked away by the lender through negative amortization.
If such a tactic succeeds, lenders could overreact and radically tighten lending requirements.
- Large numbers of SV
residents cashing out and moving to other areas, such as Sacramento, Oregon, and Las Vegas.
- The demise of manufacturing
in SV and advances in telecommunications have made the remaining jobs essentially portable, and vulnerable to being siphoned
off to less expensive areas, the Stockton-Sacramento corridor being the largest beneficiary.
- Despite Governor Arnold's
efforts, California's business appeal continues to wane. A recent article in Inc. magazine chronicled the move of Buck
Knives from San Diego to Idaho Falls, ID. ("The Buck Stopped Here", Inc. Magazine, May 2006,
http://www.inc.com/magazine/20060501/buck-stopped-here.html) This has been a trend for several years, and I believe will continue.
What will the SV market do
this year or next? I have no idea, and I don't care. I am certain only that prices 10 years from now will be equal
to or higher than now.
---With continued inflation, not to mention carrying costs, will you really
come out ahead?
In my opinion, setting yourself up so that you can ride through a downturn while reaping the
benefits in the meantime is a better strategy than waiting around to try to "catch" a possible downturn.
---But how many flipper /investors are actually able to ride out a multi-year RE
decline?
Because I already own my primary residence, I have the luxury of looking for investment opportunities
in areas I consider to have better values. But in my opinion, the benefits of home ownership outweigh the disadvantages
enough that the best time to buy your primary residence is always NOW. A major portion of
the economy, financial
markets, and tax structure are biased in favor of homeowners, so why miss out?
---The best time to buy "is always NOW"? Buyers who "missed out" in
1989 saw the San Jose median price decline -27% over the next few years. Given the more-extreme leverage and exotic
financing used lately, "the next time down" figures to be much deeper.
Regards,
XXXX
Conclusion:
These must be the arguments they "teach" at RE seminars. How to get rich
by doing nothing but laying down a few dollars (or maybe zero dollars) and signing a couple documents.
All those other easy, risk-free get-rich-quick schemes were fake but this one is the really
true! And we've got a bridge in Brooklyn we'd like to sell you...
* * * * *
The above is not intended as advice to buy, sell or hold any stock, bond, real estate nor any other
financial product or service. Invest at your own risk.
