Minyan Mailbag: How to Cut Your Losses In Real Estate
The biggest mistake in investing, which destroys wealth, is selling at the bottom...
I have the all the respect in the world for you. I don't send e-mails unless I'm really concerned, and you have me VERY concerned for my family and me. I live in West Palm Beach and every time you mention the housing bubble, you have me looking clearly in the mirror. We have four houses and four condos. All my properties have at least 30% in Principal and 30 year fixed mortgages, ranging from 5.75% to 7.75%. They all have renters and I'm barely breaking even on a few and losing a couple hundred on two properties. How is this all going to blow up in my face? I feel that I have staying power with these. I have tried to sell two of my properties in Naples the last two months at 40K less then the next closest house…still no bites. I hate to reduce the price more even though I feel when all the ARMS run up the house will drop even more. As I said we are breaking even building equity.
When I started my real estate buying in 1998, my goal was to have 10 houses paid off in 2020 when I turn 50. My retirement! Am I the person you see getting beat?! I'm a big boy, please tell me the truth. We also have 401K's worth 300k, a brokerage account worth 290k and equity in these eight properties worth over a million. I don't count that because I feel they're all going to drop but if we fight through this cycle and don't lose all the renters at once, we'll be alright. Where does my whole life fall apart? Please be brutally honest!
Thanks for your time,
This reminds me of someone that has a position that is wrong-sided and then tries to 'defend his position' by buying more. Institutions do it and retail does it. It simply doesn't work, particularly when leverage is down. And 25% equity doesn't seem like a huge cushion to me in any event. Personally, when I find myself 'wrong-sided,' I re-examine why I put on the position in the first place. If I am wrong, I reverse course. The key here is to not wait until it is too late. The signs are there. The bubble IS unwinding. Therefore, you might want to consider reducing the position size, even at a loss, even if it hurts.
The biggest mistake in investing, which destroys wealth, is selling at the bottom. This is caused by not correctly assessing risk, understanding what you can lose versus what you can afford to lose. Being able to hold onto assets through price declines is essential in building wealth.
I cannot predict the future. I have tried to warn Minyans of what I see as the potential problems that lie ahead (or may manifest themselves immediately) due to the great macro experiment being conducted by central banks: fostering accelerated globalization by accepting great financial imbalances. Combine this with (in the U.S.) the fact that $40 trillion in credit that has been created in 20 years and we truly have a risky situation. If the credit bubble unwinds during this phase of global economic development there would be a depression in the U.S.
I don't think you can dismiss that as a low probability. In managing risk you must consider all possibilities and handicap them accordingly. I put the probabilities of a depression in the U.S. in the next year or so at 15%. I put the probability of a significant recession at 35%. To me that is real. A depression would cut property values in half at least; a recession 10-20%. You must decide for yourself if those probabilities make sense to you and more importantly, if you can withstand each scenario (not sell at the wrong time).
A few areas of concern I should point out.
Your equity may be low to sustain shocks and it is concerning that you are carrying the properties at less than rental value. You may want to do a cash flow sensitivity analysis to understand the likelihood of rental income declining. I suspect W. Palm Beach properties (I am guessing they are vacation properties or related to the industry) would suffer in either scenario, but don't really know the sensitivity (I could easily be wrong on that as rich vacationers continue even in recession).
Notice I did not comment on your impressions of current prices and the market. If you decide that your risk is too high they are irrelevant to your decision. It does not matter if you take a loss: if given a serious analysis of risk you decide that you are carrying too much risk and would be forced to sell given either scenario, you might think about selling it now.
Only you can make that decision.
A few observations:
- I don't know your market specifically; if you were in the DC area, and your 30% equity cushion were based on today's valuation, my sense is that there is a great likelihood you'll be upside down on your mortgage when the next downturn is in full swing.
- This piece I wrote recently touches on a lot of your dilemmas. After reading it, ask yourself: is my goal saving or investing? I know the two are easily confused in the main stream financial media, but the first looks for return of capital plus the equivalent yield on a risk-free instrument; the latter looks for a return on capital, which inherently requires risk.
- How long can you absorb vacancies for? Could you make do with rents 10%-20%-30% lower than they are right now?
- What you do with your homes is not an 'all or nothing' proposition. We just sold 50% of our real estate and are going to keep the other 50%.
- If you are speculating with your homes, do you have a stop loss plan – as you would with stocks? Think about that, because a margin call in stocks liquidates your positions. A margin call in real estate often = foreclosure.
- Are you sleeping well at night? And this is not meant to be a joking/rhetorical question.
- How much equity do you think you have tied up in your homes relative to your other assets?
- I'll echo what John and Bennett suggested: what you paid for the properties, in my humble opinion, is irrelevant. Can you afford today's losses? Can you afford a loss twice as big? Can you afford losses more than foregoing potential gains?
- It's bad enough to make an investment based on the hope that it will appreciate. Are you hoping that your properties will not lose you money? As Toddo often says, hope is not a viable investment base, let alone something you should rely on to avoid serious financial pain.
-All the best, Prof Zucchi.
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