Rediscovered −All Time Classic Article − Patrick Killelea

by Ken Kappel on February 13, 2011

Way way back in the day we discovered the excellent housing article writings of the wise and widely praised Patrick Killelea who has held the fort down at Patrick.Net for some time.  He continually updates the following very very very long article.  But, it is oh-so worth reading if you own a home, or, are currently considering purchase of a home under any circumstance.  He understands when to own ‘em and when to rent ‘em. After reading his article you will too.

Remember this, renting today is kinda like holding gold. Most people simply don’t get it. Think renting and holding gold are for, well, for  fools. The opposite is true, as will be clearly shown over time.

Patrick’s article is entitled:  “Why It’s A Terrible Time To Buy An Expensive House,” which you can find by clicking on the article title. But actually the article relates to buying and owning a house no matter it’s alleged price value.  Not the time to buy, for sure. However it is time consider removing yourself from what has become the Great American Nightmare, through a “fair” short sale or Debt Reorganization.  [That's a Loan Mod − though Banksters call it Debt Reorganization when they get one for themselves for "free" from the Fed.]

We have nothing to add to the article: so here it is without italics or “quotation marks.” Clearly out of respect for Patrick, and clarity of the article, we did not (as often usual) intersperse comments.  It is all Patrick, except for some folks “he quotes.” Finally, this is not only a Must Read, it is a print and read and share article with your family and friends.

“Why It’s A Terrible Time To Buy An Expensive House,“

The complete article by Patrick. ↓

  1. “Because house prices will keep falling in the areas where prices are still dangerously high compared to incomes and rents. Banks say a safe mortgage is a maximum of 3 times the buyer’s annual income with a 20% downpayment. Landlords say a safe price is set by the rental market; annual rent should be at least 9% of the purchase price, or else the price is just too high. Yet in affluent areas, both those safety rules are still being violated. Buyers are still borrowing 6 times their income with tiny downpayments, and gross rents are still only 3% of purchase price, even after recent price declines. Renting is a cash business that proves what people can really pay based on their salary, not how much they can borrow. Salaries and rents prove that affluent neighborhoods are still in a huge housing bubble. Anyone who bought a “bargain” in those areas last year is already sitting on a very painful loss.

On the other hand, in some poor neighborhoods, prices are now so low that gross rents exceed 10% of price. Housing is a bargain for buyers there. Prices there could still fall yet more if unemployment rises or interest rates go up, but those neighborhoods have no bubble anymore.

  1. Because it’s usually still much cheaper to rent than to own the same size and quality house, in the same school district. In rich neighborhoods, annual rents are often 2.5% of purchase price while mortgage rates are 5%, so it costs twice as much to borrow the money as it does to borrow the house. Renters win and owners lose! Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is more than three times the cost of renting and wipes out any income tax benefit.

The only true sign of a bottom is a price low enough so that you could rent out the house and make a profit. Then you’ll know it’s pretty safe to buy for yourself because then rent could cover the mortgage and ownership expenses if necessary, eliminating most of your risk. The basic buying safety rule is to divide annual rent by the purchase price for the house:

annual rent / purchase price = 3% means do not buy, prices are too high
annual rent / purchase price = 6% means borderline
annual rent / purchase price = 9% means ok to buy, prices are reasonable

So for example, it’s borderline to pay $200,000 for a house that would cost you $1,000 per month to rent. That’s $12,000 per year in rent. If you buy it with a 6% mortgage, that’s $12,000 per year in interest instead, so it works out about the same. Owners can pay interest with pre-tax money, but that benefit gets wiped out by the eternal debts of repairs and property tax, equalizing things. It is foolish to pay $400,000 for that same house, because renting it would cost only half as much per year, and renters are completely safe from falling housing prices. Subtract HOA from rent before doing the calculation for condos.

Although there is no way to be sure that rents won’t fall, comparing the local employment rate (demand) to the current local supply of available homes for rent or sale (supply) should help you figure out whether a big fall in rents could happen. Checking these factors minimizes your risk.

  1. Because it’s a terrible time to buy when interest rates are low, like now. House prices rose as interest rates fell, and house prices will fall if interest rates rise without a strong increase in jobs, because a fixed monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates have nowhere to go but up, prices have nowhere to go but down. The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. Then you get a low price, and you get capital appreciation caused by future interest rate declines. To buy an expensive house at a time of low interest rates and high prices like now is a mistake.

It is far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.

  • A low price lets you pay it all off instead of being a debt-slave for the rest of your life.
  • As interest rates fall, real estate prices generally rise.
  • Your property taxes will be lower with a low purchase price.
  • Paying a high price now may trap you “under water”, meaning you’ll have a mortgage debt larger than the value of the house. Then you will not be able to refinance because then you’ll have no equity, and will not be able to sell without a loss. Even if you get a long-term fixed rate mortgage, when rates inevitably go up the value of your property will go down. Paying a low price minimizes your damage.
  1. Because buyers already borrowed too much money and cannot pay it back. They spent it on houses that are now worth less than the loans. This means most banks are actually bankrupt. But since the banks have friends in Washington, they get special treatment that you do not. The Federal Reserve prints up bales of new money to buy worthless mortgages from irresponsible banks, slowing down the buyer-friendly deflation in housing prices and socializing bank losses.

The Fed exists to protect big banks from the free market, at your expense. Banks get to keep any profits they make, but bank losses just get passed on to you as extra cost added on to the price of a house, when the Fed prints up money and buys their bad mortgages. If the Fed did not prevent the free market from working, you would be able to buy a house much more cheaply.

As if that were not enough corruption, Congress authorized vast amounts of TARP bailout cash taken from taxpayers to be loaned directly to the worst-run banks, those that already gambled on mortgages and lost. The Fed and Congress are letting the banks “extend and pretend” that their mortgage loans will get paid back.

And of course the banks can simply sell millions of bad loans to Fannie and Freddie at full price, putting taxpayers on the hook for the banks’ gambling losses. Heads they win, tails you lose.

It is necessary that YOU be forced deeply into debt, and therefore forced into slavery, for the banks to make a profit. If you pay a low price for a house and manage to avoid debt, the banks lose control over you. Unacceptable to them. It’s all a filthy battle for control over your labor.
This is why you will never hear the president or anyone else in power say that we need lower house prices. They always talk about “affordability” but what they always mean is debt-slavery.

  1. Because buyers used too much leverage. Leverage means using debt to amplify gain. Most people forget that debt amplifies losses as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or a mortgage rate adjustment, he lost 100% in the real world.

The simple fact is that the renter – if willing and able to save his money – can buy a house outright in half the time that a conventional buyer can pay off a mortgage. Interest generally accounts for more than half of the cost of a house. The saver/renter not only pays no interest, he also gets interest on his savings, even if just a little. Leveraged housing appreciation, usually presented as the “secret” to wealth, cannot be counted on, and can just as easily work against the buyer. In fact, that leverage is the danger that got current buyers into trouble.

The higher-end housing market is now set up for a huge crash in prices, since there is no more fake paper equity from the sale of a previously overvalued property and because the market for securitized jumbo loans is dead. Without that fake equity, most people don’t have the money needed for a down payment on an expensive house. It takes a very long time indeed to save up for a 20% downpayment when you’re still making mortgage payments on an underwater house.

It’s worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is kept unfairly high because of the Realtor® lobby’s corruption of US legislators. On a $300,000 house, 6% is $18,000 lost even if housing prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less.

  1. Because the housing bubble was not driven by supply and demand. There is huge supply because of overbuilding, and there is less demand now that the baby boomers are retiring and selling. Prices in the housing market, even now, are entirely a function of how much the banks are willing and able to lend. Most people will borrow as much as they possibly can, amounts that are completely disconnected from their salaries or from the rental value of the property. Banks have been willing to accommodate crazy borrowers because banker control of the US government means that banks do not yet have to acknowledge their losses, or can push losses onto taxpayers through government housing agencies like the FHA.
  2. Because there is a massive and growing backlog of latent foreclosures. Millions of owners have simply stopped paying their mortgages, and the banks are doing nothing about it, letting the owner live in the house for free. If a bank forecloses and takes possession of a house, that means the bank is responsible for property taxes and maintenance. Banks don’t like those costs. If a bank then sells the foreclosure at current prices, the bank has to admit a loss on the loan. Banks like that cost even less. So there is a tsunami of foreclosures on the way that the banks are ignoring, for now. To prevent a justified foreclosure is also to prevent a deserving family from buying that house at a low price. Right now, those foreclosures will wash over the landscape, decimating prices, and benefiting millions of families which will be able to buy a house without a suicidal level of debt, and maybe without any debt at all!
  3. Because first-time buyers have all been ruthlessly exploited and the supply of new victims is very low. From The Herald: “We were all corrupted by the housing boom, to some extent. People talked endlessly about how their houses were earning more than they did, never asking where all this free money was coming from. Well the truth is that it was being stolen from the next generation. Houses price increases don’t produce wealth, they merely transfer it from the young to the old – from the coming generation of families who have to burden themselves with colossal debts if they want to own, to the baby boomers who are about to retire and live on the cash they make when they downsize.”

House price inflation has been very unfair to new families, especially those with children. It is foolish for them to buy at current high prices, yet government leaders never talk about how lower house prices are good for American families, instead preferring to sacrifice the young and poor to benefit the old and rich, and to make sure bankers have plenty of debt to earn interest on. Your debt is their wealth. Every “affordability” program drives prices higher by pushing buyers deeper into debt. Increased debt is not affordability, it’s just pushing the reckoning into the future. To really help Americans, Fannie Mae and Freddie Mac and the FHA should be completely eliminated. Even more important is eliminating the mortgage-interest deduction, which costs the government $400 billion per year in tax revenue.

The mortgage interest deduction directly harms all buyers by keeping prices higher than they would otherwise be, costing buyers more in extra purchase cost than they save on taxes. The $8,000 buyer tax credit cost each buyer in Massachusetts an extra $39,000 in purchase price. Subsidies just make the subsidized item more expensive. Buyers should be rioting in the streets, demanding an end to all mortgage subsidies. Canada and Australia have no mortgage-interest deduction for owner-occupied housing. It can be done.

The government pretends to be interested in affordable housing, but now that housing is becoming truly affordable via falling prices, they want to stop it? Their actions speak louder than their words.

  1. Because boomers are retiring. There are 70 million Americans born between 1945-1960. One-third have zero retirement savings. The oldest are 64. The only money they have is equity in a house, so they must sell. This will add yet another flood of houses to the market, driving prices down even more.
  2. Because there is a huge glut of empty new houses. Builders are being forced to drop prices even faster than owners, because builders must sell to keep their business going. They need the money now. Builders have huge excess inventory that they cannot sell at current prices, and more houses are completed each day, making the housing slump worse.

Who disagrees that house prices will continue to fall?

Everyone making money off you!

Buyer’s agents disagree, because they get nothing if there is no sale. Buyer’s agents get paid only if their clients buy, no matter how bad the deal is, which is the exact opposite of the buyer’s best interest. Agents take $100 billion dollars each year in commissions from buyers. Agents claim the seller pay their commission, but fail to mention that the seller gets that money from the buyer. Think about it: who brings the money to the table – the seller or the buyer? All money comes from buyers. No buyer, no money.

Real estate in America is all about preventing the buyer from getting information. There is no free market because bids on houses are never published and you have no way of knowing whether bids are faked to get you to think you have to pay more. There should be a law to make all bids public and validated by a bank, but the NAR is one of the largest lobbyists in Congress, so don’t expect any changes soon.

Quote from a patrick.net reader: “When I’m told that the seller has multiple offers, I tell the broker that we’ve also put offers on several other houses. Fear of loss works both ways…”

Another reader:

Never trust a word from the realtor. They are constantly lying that “I heard there’s another offer, make your highest offer” or “The bank has a verbal with someone, but if you come in with a strong offer they might take it.” They don’t seem to understand that I want a deal, there’s no reason to get in a bidding war over any particular property in this market, and if one owner isn’t willing to consider a low bid, there’s a house right down the street for sale too. As soon as I told one agent I didn’t want to make an offer if there was a second bidder, that bidder mysteriously disappeared and he claimed he mis-heard the information and there wasn’t anyone else.

If a house is a really good deal, agents have a big financial motive to buy it first and flip it to you. Great quote from patrick.net reader Linda:

Realtors ALWAYS GET FIRST DIBS AT EVERY HOUSE even before it is listed. Realtors always have a shot at the best deals. In fact, IF A LISTED HOUSE WAS NOT ALREADY PURCHASED BY A REALTOR OR one of their buddies—that means IT IS A BAD DEAL. If it were a “good” deal—they would have bought it. Under the REALTOR / MLS monopoly system— prospective buyers only get to look at the junk left over that Realtors and their “friends” do NOT want.

This means that your best chance of finding a good deal is by looking at the listings the MLS is not showing you: FSBO sites, Craigslist, foreclosures, builder inventory. It’s also productive to talk to people you know who might want to sell, or send out postcards in a certain area. Avoid the agents to avoid commissions and to get a more complete view of the market.

Why should you give up nearly two years of your life working to pay an agent who is not even really helping you? That 6% commission means 6% of the 30 years of work it takes to pay off a house. That’s 1.8 years donating your labor to a real estate agent! Just find a house on your own, hopefully a house for sale by owner, and get a real estate lawyer by the hour to draw up the offer and complete the sale.

There are agents who really believe they are helping the buyer, but they’re in denial about their conflict of interest. Author Upton Sinclair had a great explanation for this: “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

Seller’s agents are not necessarily much better. A famous study by economist Stephen Dubner pointed out that agents get higher prices when selling their own houses than when selling clients’ houses.

  1. Mortgage brokers disagree, because they take a percentage of the loan. They want buyers to take out the biggest loan possible to maximize their commission. Even worse – mortgage brokers get paid according to how bad the deal is for the buyer. The worse the deal is (higher interest rate, points, fees, etc) the more the mortgage broker gets!
  2. Government agencies like Fannie, Freddie, and the FHA disagree, because their own existence (read “executive salaries”) depends on guaranteeing private loans with public money. These agencies are perhaps the largest scam ever devised. Most people will borrow as much as they possibly can to buy a house. The existence of Fannie and Freddie just make it possible to borrow yet more money by pushing lending risk onto taxpayers, benefiting bankers with larger interest payments, and harming buyers with higher housing prices. Ironically, Fannie and Freddie drive up the price of housing in the name of “affordability”. The public is unlikely to ever understand this. The perfect crime.
  3. Banks disagree, at least when they can get origination fees and then sell the mortgage, because in that case they do not care about the bankruptcy of borrowers. Banks sold most loans to the government agencies Fannie Mae or Freddie Mac, and now use the FHA the same way. The conversion of low-quality housing debt into “high” quality government debt was the main support for the housing bubble. Fannie and Freddie already imploded, and the FHA is now on the edge.

The other way for banks to dump the risk of loan default has been the Wall Street market for private mortgage-backed securities. When mass foreclosures eliminated the loan-resale market, the Federal Reserve bought private mortgage-backed bonds in huge quantities, using newly printed cash. The Federal Reserve is nothing short of a criminal conspiracy to protect the banker class at the expense of the rest of us.

  1. Appraisers disagree, because they are paid by mortgage brokers and banks, so they are going to give the appraisals that mortgage brokers and banks want to see, not the truth. Appraisers that kill a deal by telling the truth do not get called back to do other appraisals.
  2. Newspapers disagree, because they earn money from advertising placed by real estate agents, lenders, and mortgage brokers. Papers are pressured by that money to publish the real estate industry’s unrealistic forecasts. Worse, agents have a near-monopoly on actual ask and bid information, and newspaper reporters never ask agents hard questions like “how do we know you’re not lying about those prices?” The result is an endless stream of stories reporting that the real estate agents say it’s a good time to buy. Asking real estate agents about housing is like walking into a used car dealership and asking the salesman if today would be a good day to buy a car.
  3. The Federal Government disagrees, because everyone in Congress gets bribes (oops — I meant campaign donations) from the NAR and from the banks. So every Federal law will be aimed squarely at increasing commissions for the NAR and increasing interest payments to banks. Buyers lose, because they have no lobbyists in DC. The very laws of our country have been corrupted to squeeze more profits out of you.
  4. Current owners disagree, because they do not want to believe they are going to lose huge amounts of money. Anyone who owns is likely to encourage you to buy too, to prop up their own house value via comps, and so that they can feel that they are not alone in their sinking boat.

What are their arguments?

  1. Houses always increase in value in the long run.
    FALSE. Price is what you pay and value is what you get. The value of a house is constant. It just sits there. You get shelter, but you have to pay property tax and maintenance and the loss of alternative uses of capital. A house is a dead asset. The price of a house rises with salary inflation, but house prices cannot increase more than incomes in the long run. This is obvious if you think about it. If house prices go up more than people can afford to pay, buying stops, like it has stopped now.

For example, prices in the Netherlands are about the same as they were 350 years ago, in terms of how many years of work it takes to buy a house. Warren Buffett and Charles Schwab have both pointed out that houses don’t increase in intrinsic value. Unless there’s a bubble or a crash, house prices simply reflect current salaries and interest rates. Consider a 100 year old house. Its value in sheltering you is exactly the same as it was 100 years ago. It did not increase in value at all. It did not spontaneously get bigger, or renovate itself. Quite the opposite – the house drained cash from its owners for 100 years of maintenance, taxes, and insurance – costs that never go away. The price of the house went up about as much as salaries went up.

My grandmother always used to complain about the cost of milk. “Why, when I was a girl, a gallon of milk cost a dime! Just look at how much people are overcharging for milk now.” I asked her how much people got paid back then. “Oh, about $15 a week”, came the reply. Hmmm, sounds very much like the reasoning people use now when they talk about how much their father’s house appreciated “in the long run” without considering that inflation and salaries rose a proportional amount.

I don’t see any salary inflation in our future for years to come, and that’s the only kind of inflation that boosts house prices. Inflation in everything else (food, energy, medical) just takes away from the money people have to spend on housing.

  1. As a renter, you have no opportunity to build equity.
    FALSE. Equity is just money. Renters are actually in a better position to build equity through investing in anything but housing. Renters can get rich much faster than owners, just by saving the money that owners are wasting on mortgages, taxes, and maintenance. Renters are getting paid to wait, both by the monthly savings and by watching the value of their savings increase relative to housing.
  • Owners are losing every month by paying much more in interest than they would pay in rent. The income deduction does not come close to making owing competitive with renting.
  • Owners are losing principal in a leveraged way as prices decline. A 14% decline completely wipes out all the equity of “owners” who actually own only 20% of their house. Remember that the agents will take 6% if they possibly can.
  • Owners must pay taxes simply to own a house. That is not true of stocks, bonds, or any other asset that can build equity. Only houses are such a guaranteed drain on cash.
  • Owners must insure a house, but not most other investments.
  • Owners must pay to repair a house, but not a stock or a bond.
  1. Renting is just throwing money away.
    FALSE, renting is now much cheaper per month than owning the same thing. If you don’t rent, you either:
  • Have a mortgage, in which case you are throwing away money on interest, tax, insurance, and maintenance.
  • Own outright, in which case you are throwing away the extra income you could get by converting your house to cash, investing in bonds, and renting a similar place to live for much less money. This extra income could be 50% to 200% beyond rent costs forever, and for many is enough to retire right now.

Either way, owners lose much more money every month than renters. Currently, yearly rents in the San Francisco Bay Area are about 3% of the cost of buying an equivalent house. This means a house is returning about 3% rent minus taxes and maintenance, bringing the landlord’s return down to 0%.

Landlords are loaning a house to their tenants at a 3% interest rate, called rent. This is a fantastic deal for renters. When it is possible to borrow a million dollar house for 3% yearly rent at the same time a loan of a million dollars in cash costs 6.5% interest, plus 1.3% property tax, plus 1% maintenance, something is clearly broken. Renters are enjoying an extreme discount at the owner’s expense.

If someone tells you that you are throwing money away, you can reply “The landlord is giving me a huge gift. He’s subsidizing me to live in his rental. I’ll take free money any day.”

If someone tells you that you are “Not building equity”, you can reply you are not LOSING equity, which happened to millions of people, and is still going on right now.

To add insult to “owners”, their property is declining in value. Renters are completely protected from the massive losses owners are experiencing. Here’s a great quote from NPR:

Underwater owner: “We would do it [pay the mortgage] if the equity was there, but in a case where we’re already so behind… Imagine that for five years, say, we’re gonna pay four grand a month and then we’re just gonna be back up at what we bought the house for. We feel like we’re throwing away money.”

  1. There are great tax advantages to owning.
    PARTIALLY TRUE. It’s true for high-income couples with expensive houses and big mortgages, but not for modest-income couples in modest houses, especially if there is no mortgage.

Every married couple filing jointly automatically gets to subtract an $11,400 deduction ($5,700 for singles) from their adjusted gross income to arrive at their taxable income. Alternately, you may add up modest deductions in seven categories: Medical, Taxes, Interest, Charity, Casualty and Theft, Job Expenses, and Other Misc. If the total of your expenses in these categories exceeds the standard deduction, you can itemize them on Schedule A of your tax return to reduce your taxable income.

Let’s assume that your only deductible expenses fall into the Taxes and Interest categories. Taxes mainly include the income tax you pay to the state (or its sales tax) and the property taxes on your home or other non-investment real estate. In a high-tax state like New Jersey, you might easily pay $7,200 in property taxes and $200 in income taxes, for a total of $7,400. So the first $4,000 of interest expenses just brings your deductions up to the standard $11,400, without reducing your taxable income.

For a high-income couple, let’s assume they can itemize their state income tax of $3,400, contributions of $1,000, and medical expenses of $1,000. These deductions use up $5,400 of the $11,400 standard deduction. So the first $6,000 of property taxes and interest save them nothing. After that, their savings depend on their tax bracket, which could be as high as 35 percent.

For couples with modest incomes and mortgages, the first $11,400 of taxes and interest save them nothing.

Evaluate your situation before making a buy-rent decision based on potential income-tax savings. Be sure to consider the deduction limit imposed by the AMT, too. Interest is paid in real dollars that buyers suffered to earn. That money is really entirely gone, even if the buyer didn’t pay income tax on those dollars before spending them on mortgage interest. You don’t get rich spending a dollar to save 30 cents!

Buyers do not get interest back at tax time. If a buyer gets an income tax refund, that’s just because he overpaid his taxes, giving the government an interest-free loan. The rest of us are grateful.

If you don’t own a house but want to live in one, your choice is to rent a house or rent money to buy a house. To rent money is to take out a loan. A mortgage is a money-rental agreement. House renters take no risk at all, but money-renting owners take on the huge risk of falling house prices, as well as all the costs of repairs, insurance, property taxes, etc.

Even if you pay outright, you’re still renting the house to yourself, losing alternative uses of that money, and taking the risk of falling house prices.

Compare the cost of owning to renting.

  1. All real estate is local, so you cannot say anything about the national market.
    FALSE. Lending is global. All loans are harder to get. This will push prices down everywhere.
  2. Owning is a loss in monthly cash flow, but appreciation will make up for it.
    FALSE. Appreciation is negative. Prices are going down, which just adds insult to the monthly injury of crushing mortgage payments.
  3. As soon as prices drop a little, the number of buyers on the sidelines willing to jump back in increases.
    FALSE. There are very few buyers left, and those who do want to buy will be limited by increasing difficulty of borrowing.

No one has to buy, but there will be more and more people who have no choice but to sell as their payments rise. That will keep driving prices downward for a long time.

  1. House prices don’t fall to zero like stock prices, so it’s safer to invest in real estate.
    FALSE. It’s true that house prices do not fall to zero (except in Detroit), but your equity in a house can easily fall to zero, and then way past zero into the red. Even a fall of only 4% completely wipes out everyone who has only 10% equity in their house because agents will take 6% if they can trap the seller with a contract. This means that house price crashes are actually worse than stock crashes. Most people have most of their money in their house, and that money is highly leveraged.
  2. The bubble prices were driven by supply and demand.
    FALSE. Prices were driven by low interest rates and risky loans. Supply is up, and the average family income fell 2.3% from 2001 to 2004, so prices are violating the most basic assumptions about supply and demand.

The www.census.gov site has data for Santa Clara County for the years 2000-2003 which shows that the number of housing units went up at the same time that the population decreased: year units people

  • 2000 580868 / 1686474 = 0.344 housing units per person
  • 2001 587013 / 1692299 = 0.346
  • 2002 592494 / 1677426 = 0.353
  • 2003 596526 / 1678421 = 0.355

So housing supply in Santa Clara County increased 3% per person during those years. There is an oversupply compared to a few years before, when prices were lower.

At a national level, there is a similar story in the years 2000 to 2005:

  • 2000 115.9M / 281M = 0.412 housing units per person
  • 2005 124.6M / 295M = 0.422

At a national level, there is 2.4% more housing per person now than in 2000. So national prices should have fallen as well.

A for-sale sign in a yard instantly increases the supply of houses on the market. There is no need to wait for builders.

The truth is that prices can rise or fall without any change in supply or demand. The bubble was a mania of cheap and easy credit. Now the mania is over.

  1. They aren’t making any more land.
    TRUE, but sales volume has fallen 40% in the last year alone. It seems they aren’t making any more buyers, either.

Japan has a severe land shortage, but that hasn’t stopped prices from falling for 15 years straight. Prices in Japan are now at the same level they were 23 years ago. If we really had a housing shortage, there would not be so many vacant houses.

  1. Your calculator says the house I’m interested in is worth far less than the asking price. That’s not very helpful in coming up with an offer. FALSE. It’s very helpful to be able to document that you could be paying much less to live in the same location and same quality house, just by renting. It’s a great negotiating point.
  2. It is hard to find a rental that is the equivalent of this home. PARTIALLY TRUE. Sometimes there just is no equivalent rental available in the same area. Placing an ad saying you’re looking for a rental in that area in a certain rent range is often enough to bring new rentals out of the woodwork though.
  3. Attractive areas will not follow strict economic laws of their worth. If I keep bidding what a home is strictly worth, I will always lose to someone who simply wants to live there, even if their money could be better invested elsewhere. FALSE. You can’t lose by winning. Renting the same quality house in the same area for much less money every month than an owner pays is winning. Maybe others get the intangible feeling of ownership, but you get the cash that they are losing.
  4. If you don’t own, you’ll live in a dump in a bad neighborhood.
    FALSE. For the any given monthly payment, you can rent a much better house than you can buy. Renters live better, not worse. There are downsides to renting, such as being told to move at the end of your lease, or having your rent raised, but since there are thousands of vacant rentals, you can take your pick and be quite happy renting during the crash. There are similar but worse problems for owners anyway, such as being fired and losing your house, or having your interest rate and property taxes adjust upward. Remember, property taxes are forever.

Some people want the mobility that renting affords. Renters can usually get out of a lease and move anywhere they want within one month, with no real estate commission. On the other side, if you can get a long-term lease, you will probably find it worthwhile to repair the place to your taste. The average time of owning a house is only seven years anyway.

It is cheaper to rent a house in a good school district than to buy a house in the same place. In fact, children benefit in several significant ways from living in a rental. Aside from having a choice of school district, kids in a rental benefit from better parks in nicer neighborhoods, more living space, and less stress in their parents’ voice — all because it is still so much cheaper to rent than to own in bubble areas.

A fun trick to rent a good house cheap: go to an open house, take the agent aside, and ask if the owner is interested in renting the place out. Often, desperate sellers will be happy to get a little rental cash coming in and give you a great deal. Sometimes they will rent to you for free ($0) as long as you keep the place up and pay the utilities.

The biggest upside is hardly ever mentioned: renters can choose a short commute by living very close to work or to the train line. An extra two hours every day of free time not wasted commuting is the best bonus you can ever get.

  1. Owners can change their houses to suit their tastes.
    FALSE. Even single family detached housing is often restricted by CC&Rs and House Owner’s Associations (HOAs). Imagine having to get the approval of some picky neighbor on the “Architectural Review Board” every time you want to change the color of your trim. Yet that’s how most houses are sold these days.

In California, the HOA can and will foreclose on your house without a judicial hearing. They can fine you $100/day for leaving your garage door open, and then take your house away if you refuse to pay. There’s a good HOA blog here.

  1. The house down the street sold for 25% over asking, and that proves the market is still hot.
    FALSE. agents have been known to create the false impression of a hot market by deliberately “underpricing” a house, especially in California. I personally have seen this happen repeatedly. Say a seller’s agent knows that house will probably go for $400,000. He places ads asking $300,000 instead, a price lower than the buyer would accept. (Bait-and-switch is illegal when selling toasters, but apparently not when selling houses.) The goal is to first of all prevent buyers from knowing what a realistic price is, and secondly to get buyers to blindly bid against each other. There are four players in this game and three of them are against the buyer — the seller, the seller’s agent and the buyer’s agent. Yes, the buyer’s own agent works against the buyer, because there is no commission if there is no sale. There’s a saying in Las Vegas: “There’s a patsy in every game, and if you don’t know who the patsy is, you’re it.”

If you want to prove your agent is not on your side, ask to see houses “for sale by owner” or houses listed by discount brokers. If the agent cannot make a commission, you will not be told about the house.

There is a way around the conflict of interest inherent in being a buyer’s agent: let the seller’s agent be your agent too, just for that one house he’s trying to sell. Then the seller’s agent has a big motive to lower the price, because he will get double the commission if you buy it rather than some buyer with his own agent.

Note that you are free to bid far lower than the asking price. You might be pleasantly surprised to find out how desperate the sellers are. Another good reason to start low: you can easily raise your offer, but it’s awkward to lower it. A suggestion from a reader: have all your friends bid extremely low for the house before you, then your own low bid will seem more reasonable.

Another suggestion for dealing with underpricing:

Get over it, and just beat them at their own game: Beat out all other bidders by bidding unrealistically high, and just be sure to have your offer contingent upon financing & house inspection. Since the bank won’t finance you above the appraised value, you’re then in a very strong position to re-negotiate the price far lower during escrow. The other bidders will be long gone.

  1. I was lucky that my agent told me to increase my bid by $50,000. Otherwise I would have lost, because my agent knew about a secret bid $40,000 above mine.
    FALSE. Your agent gets paid nothing if you don’t buy the house, and he gets more if you waste more money by bidding too high. It is unwise to take at face value “secret” information that costs you money.
  2. The MLS proves things are great.
    FALSE. The MLS (Multiple Listing Service, a private network of databases controlled by real estate agents) is a used-house sales tool designed to restrict access to critical market information to prevent the free market from working efficiently.

I have been told that all sorts of funny things happen in the MLS. For example, if a house just doesn’t sell, that agents can remove its record in the MLS so that you cannot see that it failed to sell. Then the house comes back on the market at a lower price, and unsuspecting buyers think it’s on the market for the first time. Their agent can “prove” it’s a new listing by showing the MLS record to the buyer: “See, here’s the listing date, just came on the market. Better hurry and buy it, this one is hot.”

There is no government agency checking that the MLS shows true transaction prices.

Furthermore, the MLS will not list any house for sale by owner, and will resist listing property for sale through a discount broker, or bank-owned property, or extreme discounts from builders, or many other cases where you could save huge amounts of money. Those cheaper prices are often not in the system, because if you save money, they lose money. Even if some cheaper properties are listed, your agent is not likely to tell you about them if they require more work on his part, or get him a smaller commission.

  1. I’ll just amortize the commissions and other transaction costs over 30 years and they’ll be OK.
    FALSE. The average length of ownership is seven years, not thirty. That means the 7% or so that you’ll pay in commission and closing fees comes out to about 1% per year, and that’s actually a lot of money. You may think you’re different and will actually stay put for 30 years, but statistically you’re not, and you won’t.
  2. Rich Chinese (or Europeans, or Arabs) are driving up housing prices.
    FALSE. The percentage of US houses bought by rich foreigners is tiny. Furthermore, American housing is clearly a bad investment at this point. Foreigners can just wait and watch American housing continue to fall, and then buy for much less in a few years. Rich foreign investors are not dumb enough to buy into a badly overpriced market, but your agent is hoping that you are.

Patrick.net reader John H. points out that when the Chinese property bubble implodes, there will probably be sales of property in California and British Columbia to cover their losses at home.

  1. Local incomes justify the high prices.
    FALSE. Most bankers use a multiple of 3 as the maximum “safe” price-to-income ratio. We are well beyond the danger zone, into the twilight zone. The price to income ratio is still around 10 in the SF Bay Area.
  2. Prices were always way beyond equivalent rent in San Francisco (or whatever expensive town)
    FALSE. Price to rent ratios were normal in San Francisco and other the other expensive towns in 2000. That ratio more than doubled by 2005. See page 34 of John Talbott’s excellent book called “Sell Now!”
  3. Higher-income people can afford to spend a larger portion of their income on a mortgage, so your 6% rule of thumb does not apply to them.
    FALSE. Even if you can spend more than 6% of the purchase price each year on a mortgage and other costs to own a house, that does not mean you should. In fact, gross rents are almost always less than 6% in richer neighborhoods, making it an even worse deal for the buyer in these places. The renter living in the same quality house next door loses far less money per month.
  4. You have to live somewhere.
    TRUE, but that doesn’t mean you should waste your life savings on a bad investment. You can live in a better house for much less money by renting during the crash. A renter could save hundreds of thousands of dollars, not only by paying less every month, but by avoiding the devastating loss of his downpayment.
  5. Newspaper articles prove prices are not falling in my neighborhood.
    FALSE. The numbers in the papers are not complete and have murky origins. Those prices are “estimated” from the county transfer tax and making that tax public record is optional. A buyer who does not want you to see how little he paid has only to ask to put the transfer tax on the back of the deed and it will not show up on computer searches of the deed, which show only the front. Others voluntarily pay more tax than they have to, in order to inflate the apparent price to fool the next buyer. At a tax rate of about $1 per thousand of sale price, as in San Mateo county, you have to pay only $100 extra tax to make your purchase price look $100,000 higher.

Even though you can in theory go to your county building and get sale price information, in reality the county will give it to you in a painfully slow and inconvenient way. For example, in Redwood City’s county building there are PC’s where you can look at data for any particular house, but you cannot print, you cannot save to a floppy disk, you cannot email data out. All you can do is write things down manually, one at a time. And that’s how real estate interests like it. Your elected representatives are serving them, not you.

Supposedly impartial sources like Dataquick are paid for entirely by people with a large financial interest in “proving” that prices are not falling. This makes it unwise to take their numbers at face value.

For the obviously biased sources like real estate agents, you should assume that their sales price numbers do not include the effective price reductions from “incentives” like upgrades, vacations, cars, assumed mortgages and backroom cash rebates to buyers.

  1. My appraisal proves what my house is worth.
    FALSE. “An appraisal in its typical residential real estate form is little more than a comparative analysis conducted by someone with no skin in the game offering confirmation that other lemmings are paying too much for their houses as well.” -from an article on morningstar.com

Amazingly, government house price measures do not include houses with jumbo mortgages. This excludes well over half of all houses in California. So the government can report a slight price rise, but fail to mention that prices actually fell for the other 60% of houses in California.

  1. Foreclosures destroy neighborhoods, so we should stop foreclosures.
    FALSE. Empty houses destroy neighborhoods. Houses remain empty only because the prices are too high. “Anti-foreclosure” programs just keep prices too high, and keep houses empty. In areas where there are jobs, if prices were allowed to fall enough so that salaries can easily cover the cost of owning, people would move in and take care of the houses. In areas without jobs, the first priority should be jobs.
  2. It’s not a house, it’s a home.
    FALSE. It’s a house. Wherever one lives is home, be it apartment, condo, or house. Calling a house a “home” is a manipulation of your emotions for profit. Don’t let them push your buttons.

A house is a wooden box that sits out in the rain and slowly rots. No one would buy in this market if they really thought about how much pain it’s going to cause them in the long run. That’s why they sell you a home, not a house.

  1. If you don’t own, you’re a failure.
    FALSE. Maximizing your savings and escaping the slavery of debt is success. Most people have a hard time understanding this, but they do understand cash. You could show them your bank statements to prove you’re way ahead of the game as a renter, but then they would probably just ask you for a loan!

The use of the status card is another well-known button that agents push to trick people into making foolish purchases. Don’t let them do it.

  1. Property in the San Francisco Bay Area is a luxury good, and so will be less affected by economic downturns.
    FALSE. Most San Francisco Bay Area mortgages are ARMs, and ARM loans are not taken out by the rich. People on the border of bankruptcy take out ARMs because they can’t afford fixed rate loans. The rich don’t have loans at all.

Many of these ARM loans have exceptionally deadly repayment terms, and so are known as “neutron mortgages”. Like the neutron bomb, they destroy people, but leave buildings standing. They are also known as “suicide loans”.

  1. House ownership is at a record high, proving things are affordable.
    FALSE. The percentage of their house that most Americans actually own is at a record low, not a high. We do have a record number of people who have title to a house because they have dangerous levels of mortgage debt, but that is no cause to celebrate.
  2. Rents could shoot up, making it a better deal to buy.
    FALSE. Rents are limited by the money people actually earn, not by how much they can borrow. Try walking into a bank and asking for a loan to pay your rent. For rents to shoot up, salaries would have to shoot up first. Salaries are not likely to rise at all given the current unemployment rate.
  3. You failed to factor in emotion. More houses are sold on emotion than will ever be sold based on perceived value. They buy all they can afford plus.
    FALSE. Buyer emotion doesn’t matter at all to the lenders, not on the way up or on the way down. Most people will borrow as much as the possibly can. The limiting factor is lending, not emotion.
  4. It’s unpatriotic to talk about mispriced houses. It might drive down prices.
    FALSE. Lower prices are better for America, especially for new families. Aren’t lower food and energy prices better for America? Housing prices are the same: lower is better. Most Americans directly benefit by a decrease in house prices. Only the banks benefit from increased mortgage debt.

If you own a house, lower prices have very little effect. If you want to sell and buy another house, higher prices mean you’ll just have to pay more for the next house, while lower prices mean you will get a discount when you buy. If you want to buy a bigger house, you come out ahead with lower prices.

  1. My wife will divorce me if I don’t buy a house.
    FALSE. She will divorce you if you do buy a house and go bankrupt trying to pay the mortgage. She won’t divorce you if you rent a much nicer place than you can buy, and then take her to Paris for a month each spring, which you can do just by avoiding that suicidal mortgage.

If she’s religious, you could also point out Proverbs 22:7: “The rich rule over the poor, and the borrower is servant to the lender.”

  1. My new baby needs a house.
    FALSE. If you’re pregnant and desperately want to buy a house for your new child, that’s a perfectly normal feeling called “nesting”. It is also the leading avoidable cause of financial fatalities! You most definitely do not need a house for a baby. A baby is utterly unaware of whether it lives in a rental or not. Babies also don’t need much space.

Your baby will do better if you’re not stressed out about a mortgage. You have five years before school quality becomes an issue, and at that point you can more easily move into the best school district as a renter than as an owner. Avoid debt and save your money so your child has a better start in life.

  1. I just want to own my own house.
    TRUE, most people do. There’s nothing wrong with that. Buyers will get their chance when housing costs half as much and they have saved a fortune by renting. House ownership is great – unless you ruin your life paying for it. If you can save even just 10% on the price of a house, you can retire several years earlier than you would otherwise. If you can save 50%, then you can easily take a ten year vacation and still come out ahead. Great quote from http://healdsburgbubble.blogspot.com/: “People want to buy a house, they want to have someone tell them it is the smartest decision they are making in their lives, and they don’t want to hear about any downside risk.”

Housing is the biggest expense in nearly everyone’s life, far more expensive than food, gas, energy, even more expensive than education or medicine. To reduce the time you spend working to pay for housing is to increase the time you have for everything else.

Cheap housing is good for us all! High housing costs take away from families’ ability to save for retirement, fund their children’s education, travel and lead a quality life.

How can we make lower house prices our official government policy? How can we completely eliminate the mortgage interest deduction which drives up housing costs and discriminates against renters? How can we wipe out Fannie Mae, Freddie Mac, the FHA, and other agencies whose job it is to enslave Americans to mortgage debt?

As reader Sean Olender put it: “Many people have forgotten that the number one restriction on their future freedom to do what they want, when they want, and to go where they want isn’t the Iraqis, or Iranians, or North Koreans — it’s their mortgage lender.”

What should you do?

First of all, both sides should avoid using agents, especially Realtors(R), who are corrupting our laws in Washington with lobbyists. Agents suck money out of the deal and monopolize the critical information of exactly how many bids there are and at what prices. Just find a property or buyer on your own, have the property inspected, and get a real estate lawyer to draw up or review the offer. If you make an offer, mail the offer to the seller yourself so that your agent or the seller’s agent can’t block it. If you are accepting or rejecting an offer, mail that information to the bidder yourself so that your agent or the bidder’s agent can’t block it. agent have been known to block offers that don’t give their own agency both sides of the commission, or that exclude some other buyer they want to favor.

Never sign any contract with any agent! Agents try to trap you with a contract so that you cannot know for sure what is going on or make independent decisions. If you don’t want to sell a house yourself or negotiate a purchase, hire a lawyer or someone else by the hour to do the work for you. You’re likely to save many thousands of dollars by avoiding commission fees.

Post on the patrick.net Addresses Forum to get uncensored feedback about a particular property.

If you own an expensive house, sell now so you can actually keep some of that funny money that appeared out of thin air. Otherwise, it will be painful to watch it vaporize back into thin air. Investors in mortgage-backed bonds subsidized the increase in the price of your house. Now they want their money back, and your challenge is to prevent them from getting it. The only way is to sell before your neighbors do. Time is not on your side.

If you can’t sell without a loss, it’s probably best to just walk away and free yourself from mortgage slavery. It depends on whether your loan was “recourse” or “non-recourse”. In the latter case, the deal is simply that you can stop paying the loan and give back the house at any time. It’s perfectly legal and moral according to the terms of the mortgage. Now that the government has temporarily stopped taxing forgiven debt, you can do it without owing anything! But talk to a lawyer and accountant first. If you refinanced, you may have given up your non-recourse status.

A long-term rental with a multiple-year lease is a good way to get stability with the economic benefits of renting. Many landlords are desperate, and you’ll probably find them quite willing to negotiate a long term lease. Make sure they can’t raise the rent much during the lease term, and make sure there is only a small penalty for ending the lease early. Even if you sign a normal 1-year lease, most landlords are happy to keep good tenants as long as possible.

If you want to buy, look around and see that house prices are falling. Why hurry to buy into a falling market? Time is on your side. Save your cash and buy for much less in the future. All your savings on the price of a house are tax-free earnings! For Californians: buy after the earthquake, not before.

Good advice from reader Stephen G. Bishop:

Signing a 30-year commitment is absurd. Can you guarantee your income will be uninterrupted for 30 years? It worked in the previous generation, when Dad worked at the same factory for 40 years and retired. Those days are gone. 80% of all mortgages are never kept to maturity. Triple the price of the property when you add interest for 30 years in. It’s only worth it if the property doubles in value every ten years. Those days are gone.

Do not buy anything that wasn’t built properly, no matter how cheap it gets. Many foreclosures are houses that weren’t built properly, and these houses tend to be foreclosed over and over again. Lots of houses are ugly, but an ugly but well built house is often the best deal.

The way to win the game is to have cash on hand when others cannot get a loan. You do not want to be bidding your hard-earned savings against people who are bankrupting themselves with debt. It will be time to buy when lenders once again demand a 20% downpayment from everyone and get serious about checking ability to repay. You’ll know prices are reasonable when it’s cheaper to own than to rent the same thing. We’re not there yet, not even close. Find a nice cheap rental, invest your savings every month, and enjoy the show till then.

Please tell friends about patrick.net, because people need to know the arguments against buying a house.   About 4,500 email subscribers.

Annual income twenty pounds, annual expenditure nineteen six, result happiness.

Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.

–Charles Dickens, David Copperfield, 1849

Saying it is “good” for housing prices to rise is saying that it is good for housing to take an increasing share of salaries each year, forever. There’s a limit, and it is somewhat shy of 100%. –Bryce Nesbitt

If you need a mortgage, you can’t afford it. –Stephen G. Bishop

From anonymous: The Mexican Dream is to escape from debt peonage. The American Dream is to get into debt peonage.

Lowering interest rates will help the housing and stock market for about as long as peeing your pants will help when you have to go. It will give a warm feeling for a minute.

Everybody hates house-agents because they have everybody at a disadvantage. All other callings have a certain amount of give and take; the house agent simply takes. — H. G. Wells

Nick Naylor, in Thank You For Smoking: “99% of everything done in the world, good or bad, is done to pay a mortgage. Perhaps the world would be a better place if everyone rented.”

From The Politics of Life by Craig Crawford: “Beware the boss who encourages you to buy a house or new car. Mortgages and car payments enslave you to the paycheck that your boss controls.”

From Benjamin Graham, in The Intelligent Investor: “The outright ownership of real estate has long been considered as a sound long-term investment, carrying with it a goodly amount of protection against inflation. Unfortunately, real estate values are also subject to large fluctuations; serious errors can be made in location, price paid, etc.; there are pitfalls in salesmens’ wiles.”

Why do the buy side idiots ALWAYS fall for the FALSE CHOICE FALLACY????

Choice 1: Buy today, right now, this second.

Choice 2: Rent until you die.

Um, I’ll take door #3: let prices fall another couple hundred $K on a home like this, and buy it in a year or two. What did I win?  –Roberto Aribas

What the public believes, or can be induced to believe, no matter how wrong, is reality to politicians.

Subsidies simply increase prices by increasing demand. Subsidies benefit the first few recipients, but the sellers quickly catch on to the new source of revenue and increase prices to negate that benefit for all subsequent recipients. Ultimately, all subsidies flow directly to businesses as excess profit at public expense. This is true especially for housing and health care subsidies, and the businesses that benefit from these subsidies spend lavishly on lobbying and campaign contributions to make sure the subsidies continue, in the name of the “public good” even though subsidies are obviously a public harm. The true solution to shortages is to increase supply of houses, doctors, or whatever. But increased supply harms profits, so business interests squash all public talk of increasing supply.

Republicans think the rich are not rich enough, and the poor are not poor enough.

Just as an unobserved tree falling in the forest makes no noise, a big beautiful home out in the lonely woods does little to increase status. The key to appreciating status is to have an audience-and there is no bigger audience than that of our major cities and the playgrounds of their wealthiest residents. — John Talbott

They hang the man and flog the woman Who steals the goose from off the Common;
But let the greater criminal loose Who steals the Common from under the goose

Interest never sleeps nor sickens nor dies it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation; it never visits nor travels; it takes no pleasure; it is never laid off work nor discharged from employment; it never works on reduced hours. Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, or orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you. — J. Reuben Clark

It is better to get a poor interest rate than own a depreciating asset. — Michael Surkan

I’ll repeat that the best approach [to buying a car] is to use the Internet, have the car delivered and avoid going to dealerships altogether. — Edmunds.com

Everyone in Western Europe, Japan, Canada, Australia, Singapore and New Zealand has a single-payer system. If they get sick, they can devote all their energies to getting well. If Americans get sick, they have to battle two things at once, the illness and the fear of financial ruin. … And don’t believe for a second that rot about America having the world’s best medical care or the shortest waiting lists: I’ve been to hospitals in Australia, New Zealand, Europe, Singapore, and Thailand, and every one was better than the “good” hospital I used to go to back home. The waits were shorter, the facilities more comfortable, and the doctors just as good. –Lance Freeman at escapefromamerica.com

The first truth is that the liberty of a democracy is not safe if the people tolerate the growth of private power to a point where it becomes stronger than their democratic state itself. That, in its essence, is fascism — ownership of government by an individual, by a group, or by any other controlling private power. ~ Franklin D. Roosevelt

From Our Lot by Alyssa Katz: “The secret, he was learning, was to trigger buyers’ emotions, specifically women’s emotions.”

50 Ways To Leave Your Mortgage

You just slip out the back, Jack

Make a new plan, Stan

You don’t need to be coy, Roy

Just get yourself free

Hop on the bus, Gus

You don’t need to discuss much

Just drop off the key, Lee

And get yourself free

The End”

 

Ken here. We believe Patrick might agree when we say.

Best to Dump Your Debt.

Rent and Save MONEY.

Come back to homeownership when we have an actual bottom.

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