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Minyan Mailbag: Home Edition

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Editor's Note: Minyanville is a community of people who share an interest in fiscal literacy. As perspective is an important aspect of our daily routine, we share this email with hopes that it adds balance to your process.

Fil -

Regarding your comments on the Buzz on July 21 (and every day it seems) about housing, etc. etc., it would seem that there is almost encouragement to either sell one's house or not buy at all. Excluding the speculative flippers, wouldn't you agree that there are some advantages to OWNING a home as opposed to renting. Namely . . .

1. Tax advantages
2. Building equity
3. Creating an environment to raise a family
4. Enjoying your environment as opposed to living in a beige rental.

I have owned a very nice home for over three years. The tax advantages alone would make me not want to sell and rent. In fact, it would most likely cost considerably more on a monthly basis and would not allow me any tax advantages or the opportunity to build equity. In addition, it would not be nearly as big or as nice as what I have now. Forget the other costs of moving, etc., taking kids out of school.

If one has a long enough time frame, I'm sure you agree that owning is more advantageous to renting. Appreciate your feedback.

Minyan MW

Hi Minyan MW:

What you raise are very valid points for owning a home. Certainly there is more to a house than its "investment value" and there is no way to objectively quantify those intangibles. However, your positive outlook toward buying a home in today's market seems to assume that 1) you can "exclude the speculative flippers" from the equation, and 2) building equity through appreciation is a given; and 3) the opportunity for equity appreciation comes without the corresponding risk that one might actually lose equity in the home.

With regard to point No. 1, excluding the flippers from the equation would be tantamount to excluding the net stocks from the 2000 Bubble. While the speculative flippers may be a minority of the real estate buyers, they represent the price inelastic buyers which inflate prices across the board. They dictate the price for speculative and non speculative buyers. For valuation purposes, comparables do not exclude speculative transactions, indeed the whole real estate services industry - from realtors, to mortgage lenders, to appraisers, to lenders, has a vested interest in focusing on the highest possible price point. And today's flippers-driven price increases are beyond reason - literally - because at the very core of their modus operandi, is the assumption that there will be a greater fool to bail them out in short order. In their framework the intrinsic value of the asset is irrelevant. Since the prices of all of today's buyers are being hijacked by the flippers, regardless of whether you are a "flipper" or not, everyone is paying speculative prices.

Building equity: this hinges on value appreciation and/or debt reduction. If one believes that values over the next 15 years (let's call that the "long enough time frame" you refer to) will continue to increase, then naturally homeowners will have a nice equity build. But if over the next three years home values were to return to 2001 levels (a statistically likely assumption, and if not right away, certainly in the near future), it would mean that today's buyers in most major metropolitan areas would find themselves in the hole by 30-40%. Assume thereafter a return to the historical 4% annual appreciation, and in 15 years today's buyers will be lucky to break even. And this, in my opinion, is the rosy scenario. With the help of the recent price levitations, the real estate machinery has been able to effectively smother any kind of risk analysis when buying a home. I submit to you that should home values fall 30% over the next three years, today's ARM's buyers will likely find themselves with negative equity and forced to come out of pocket to refinance their loans. If they can't come up with that cash, the avalanche of foreclosures is likely to drive home values much lower than 30%. And for those who have the better sense of actually paying down their principal debt on a monthly basis, congratulations: you just may be back to square one at the end of the debacle, rather than getting buried.

I also see the "tax advantages" argument for owning real estate as a red herring: I presume you are talking about the deductability of mortgage interest. With interest rates as low as they are today, even assuming a 35% tax bracket, a $500,000 IO mortgage at (let's say) 5% (though few people today are paying such high rates because they all hang on short term ARM's) would result in a tax benefit of $8,750 per year. Back out the real estate taxes and homeowner insurance costs, and perhaps PMI premiums for those who do not put down much of a down-payment, and there goes your tax benefits. I am a firm believer that it rarely pays to allow the tax tail to wag the investment dog.

The intangible value of creating a "home environment": it is undisputable. But it can also be ruined by the stress of being in financial straights, if not the more tragic possibility of losing the home altogether.

Let me also clarify something given that, yes, hardly a day goes by without me bashing the real estate market. I don't seem to be able to stay away from it even on vacation since I am typing this from beautiful Disneyworld (come down here for a reality check on the government inflation numbers): I do not hate real estate. I am the third generation of a real estate family (ok I am the black sheep of a third generation of a real estate family, but so be it) and real estate has treated my family very well. But the leverage and lack of liquidity of the real estate market, especially in tough times, when liquidity is needed the most, still makes it the Wild West of investing. It is a vicious business where survival of the fittest is often the rule, if not the number one rule. Unlike perhaps other asset classes, profits in real estate are made when one buys at the right price. When one sells, he/she merely monetizes the spread between the purchase price and the intrinsic value (meant in a Benjamin Graham kind of way) of the particular asset, plus, perhaps, some value added development/management work. None of that, purchase price, intrinsic value or value added work, means anything in today's market. People buy real estate today because it will - for sure - be worth more tomorrow, and to compound this - in my view - fatally flawed approach, the game is being played with financial instruments that are creating systemic risks exponentially larger than the S&L crisis of the late 80's. If - or rather when - sanity returns to the process, I will be more than glad to go real estate shopping with Hoofy.

Regards,
Prof. Zucchi

No positions in stocks mentioned.
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