Monday, January 17, 2022

Buying Versus Renting In An Overheated Market


There are so many factors to consider, that each person's situation is unique.  You have to do your own research and make your own conclusions.

In some earlier postings, I noted that if it was cheaper to rent a place than to buy it, then it probably isn't a good idea to buy.  That is not to say this is the only factor to consider, only that it is a huge one.  If you buy a place and later on have to take a remote assignment, if you can't rent the place for at least the cost of ownership, then you are paying a tenant to live there.

Worse yet are people who bought investment properties like mad during the height of the 1989 and 2008 bubbles and rented them out for a loss - hoping to recoup their investment in capital gains when they sold.  I knew one guy who bought rental properties and left them vacant ("less hassle" he said) and hoped to double his money in a few short years.  A few short years later he was bankrupt and the banks took back the properties.

So yea, that is one good litmus test to use - but not the only one.  In today's market, things are crazy.  A lot of investors bought up the housing stock back in 2008 and are now renting it out.  I mentioned before how we went to Cape Coral back in 2011 or so, and saw properties on the market for under $100,000 that were sold just a few years before, for over $400,000.  The previous owners smashed the granite countertops in a fit of pique when they left - and took all the appliances.  It didn't  matter, the new owners put in new countertops and appliances and rented the places out for a healthy cash-flow and a nice depreciation deduction.   By the time we arrive there - a few weeks later, all the hot properties were sold.  The point was moot anyway, we were in no position to buy an investment property at that point in our lives (we foolishly bought a vacation home instead - although it was fun).

Back before 2008, a lot of "investors" and landlords were small-time operators like myself, who might have 2-4 properties which were easy to manage.  Yea, I knew a few slumlords who had dozens of properties - they were not nice people.  And for the effort they put into slumlording, they could have made twice as much money fixing those places up and bringing up the neighborhood.  Some follow the path of least resistance.

Since then, a new type of landlord has emerged - the institutional landlord, who owns hundreds if not thousands of homes. In the past, such landlords owned apartment buildings, not houses.  But with the flood of cheap houses on the market in 2008, that changed.  As a result, housing prices are through the roof and rents have jacked up as well.  Some young people report that they are paying $1800 a month to rent a condo, which would cost them $1600 a month to own - if they could come up with the $20,000 down payment.  They can't.  So they are stuck renting.

It is a weird market.  And a lot of people are reporting that they believe it to be a bubble market - me among them.  But timing bubbles is hard to do.  We sold our investment properties back in 2005 or so, thinking that for sure, the market had peaked.  We bought a duplex for $99,000 and  a decade later, sold it for $230,000.  I never expected to make much more than twenty grand on that deal.  Five years later, those houses are selling for over $400,000 apiece!   I clearly got out "too early" but then again, too early is always better than too late, when it comes to timing bubbles.  Yes, I could have made a lot more money, buying more properties, leveraging myself further and further and then holding out for the absolute peak of the market.   But you miss it by even a day, and well, you lose it all.  I made a million, I have no regrets.

And it all depends on your timeline.  As the chart above illustrates, if you "hung on" long enough, well, you'd be back in positive equity territory by now.  In fact, most people never left it - those who bought long before the 2008 bubble.  It is like the accompany stock crash of 2009 - if you waited a year, most of the losses were clawed back.

But there is a bubble for sure and it is going to burst.  The only question is, will it be a gentle deflation or even a leveling-off, or a dramatic free-fall?  And more importantly, when will this happen?  The latter question is, oddly enough, easier to answer.  There are a number of factors in the pricing of a house, but the most important of these is this:  There is no such thing as unaffordable housing.  Someone, somewhere, buys these houses - they don't sit empty and abandoned because no one could afford them.  People on the Left complain there is no "affordable housing" which translates into "I want to live rent-free" (no really, I have heard this from some young Communists - they would be shocked to learn that even in Soviet Russia, people had to pay rent!).

Markets reach equilibrium, and until that happens, people get crushed sometimes.  Yes, even in Communist countries - markets exist there, legal and illegal.  The market economy is not a construct is it how human operate so just get over that.  If a house sells for an enormous amount it is only because some idiot could afford it or thought he could afford it.  And that means either they had the cash to pay for it (and the income to keep it) or they had the income to pay for it.  None of this means they could really afford those houses anymore than someone leasing a car can really afford it - even as they drive it around.  As I noted before, today, car dealers sell cars to insolvent people on onerous terms knowing full well the car will be repossessed as part of the deal.

Most people buy houses on monthly payment, period.  Most of us are working and make X dollars a month and hope to pay Y dollars a month for a house, where X>Y.  In fact X has to be greater than Y or it ain't gonna work.  And since you have to pay taxes, eat food, own a car, buy clothes, have children, smoke pot and play video games (or whatever) it is hoped that X>Y/3 or that your mortgage payment is less than a third of your monthly income.  Above that level, banks consider you to be "mortgage stressed".

But the mortgage payment is only part of the picture.  In years gone by, things like property taxes were not even considered, as they might amount to a few dollars a month.  Today, they can top $1000 a month.  Similarly, homeowner's insurance was a few hundred a year, if that.  Today, in coastal areas, you need "named storm coverage" as well as FEMA flood insurance and a traditional Homeowners or "fire" policy.  These can run into the thousands a year, cumulatively.  What's worse is that these bills might seem low at first, but increase dramatically.  In the run-up to the Florida real estate meltdown in 2008, we saw a number of hurricanes in a row, and insurance skyrocketed as a result.  Making things worse were things like mold claims and people trying to get judges to cover wind damage with a fire policy.  Before you root for "the little guy" for "sticking it to the insurance companies" remember that when someone "wins" a case like that, we all pay for it.

The real problem, though, was funny-money mortgages. "Liar's loans" they called them - you stated income and assets and they did a "zip code appraisal" and you got the loan - often in minutes.  It was harder to get a car loan.  As a result, a lot of people got into this "buy and flip" game who had no idea what they were doing other than it seemed everyone else was making money at it.

But even rational people did irrational things, like getting adjustable-rate notes that often ratcheted up dramatically after several years.  As a result, three years into the deal, their mortgage payment increases 20-30% and their homeowners insurance and property taxes jump up as well.  Suddenly, the "affordable" house is unaffordable.  So they put it on the market - and their neighbors do the same thing as well.  Whole neighborhoods blanketed with "for sale" signs - it was only 14 years ago, people! And the shit hits the fan.

Today, we see something similar on the horizon.  The Fed has been giving away money at zero or near-zero interest rates as well as buying back bonds.  They finally came to their senses when inflation topped 7% last year - the highest since the stagflation era of the early 1980's - and that era sucked.  So they are going to increase rates, which means quite a few people who were talked into adjustable-rate notes will be utterly fucked in the coming months.

"But the mortgage broker said if rates went up, I could always refinance!"  Oh, geez.  People didn't learn a damn thing from 2008, did they?   Here's the deal.  When rates go up, so do fixed rate mortgages, which are always a little higher than variable rate notes.  So to save 0.5% you got a variable rate.  And now your variable-rate note is higher than what a fixed-rate would have been.  Yes you can refinance to a fixed-rate note, but guess what?  Those are even higher now.  In fact, if rates rise high enough, you may not be able to refinance at all, if your income doesn't qualify you for the new payment.

It gets worse.  Since everyone is selling, prices are depressed.  Suddenly your house doesn't appraise for what you owe on it.  No bank will refinance.  Some brave souls tried to "hang in there" by cashing in their 401(k) money (also devastated in the recession) and paid taxes on that, including the 10% early withdrawal (and that withdrawal likely put them in a higher bracket).  Banks win twice!

Wait, it gets even worse.  The new people entering the market looking to buy a home are looking at higher interest rates.  This means for the same monthly payment, they can only afford less house.  So demand slackens.  These same buyers start to hear rumblings about foreclosures, and they scared and maybe stop thinking of buying.  So the whole thing spirals downward, until houses are being sold at fire-sale prices and that's where the Cape Coral narrative comes in.

That's what happened in 2008.  Could a similar thing happen today?  Well, as interest rates rise - and they will rise, no doubt about that, the Fed has said so, not that they had a choice - mortgage rates will go up and something will happen.  Again, will this be a soft landing or a harsh cliff - that's the part that is harder to figure out.  And exact timing is hard to figure out as well.  These things tend to overshoot and undershoot.  I got out of the real estate market in 2005 as by ordinary standards that's when it should have leveled off.  Instead, euphoria took it to new insane heights.  Euphoria and funny-money loans, that is.

But in the next year or so, I believe we will see "adjustments" in ordinary housing markets.  Then again, the fellow who prepared the chart above thought this would happen two years ago!  Of course, the pandemic intervened, and the government poured yet more money into the economy, in the form of PPP loans, stimulus checks, extended unemployment and so on.  I think this means that the bubble would have burst during the Trump era, but he threw money on the fire to keep the economy going.  Now, well, when it does blow, it is going to be a lot worse than before.  Rubber-band theory - the further you stretch back, the harder it will hurt when reality kicks in.

This does not mean a row-house in a tony neighborhood in San Francisco is going to sell for $20,000 next year, though. Markets like the Bay Area have their own cycle and it is hard to predict how they react.  Ditto for Seattle, Vancouver, and Toronto, or any other market that has seen insane gains in the last few years.  Remember it was only two years ago that people were "leaving the cities" for the country.   How quickly things change!

A reader writes, wondering whether they should downsize in retirement as they want to travel more and see the world.  Sounds like a good plan.  But should they rent or buy?   That's the difficult part, and without knowing what market they are going into and where and how much they want to spend and what their age, income, and timeline are, it is hard to figure out.  All I can say is, do what you want to do in retirement and don't let being tied to a "thing" hold you back.  Advice I should take myself.  We keep wanting to go to Europe and travel, but I am not sure the middle of a pandemic is a good time to do it.  I think for time being, we will stick to the RV and explore America.

Renting could be a good option, if it costs less than owning the same property.  And if the market does relax, well, at the very least, it might be less costly to buy two years from now - perhaps far less.   But again, not knowing specific markets, it is hard to say.  Believe it or not, there are many parts of the country where it is very inexpensive to live today! Usually these are places where there are not a lot of jobs, which are often not good places to retire to, due to lack of local resources such as shopping and health care.

That being said, it would be hard for me, personally, to go back to renting. Why?  Well, the monthly cost of living in our paid-for home is about $1000 a month.  Hard to rent an apartment for that much, even in depressed Brunswick.  When I turn 66, my property taxes drop to $800 a year - they've trapped me in the house!

That being said, we might "downsize" eventually, to a retirement community, an over-55 park model, or a condominium somewhere.  We could "buy" Mark's Grandmother's old apartment in Shell Point Village for under $200,000.  However, the monthly cost is pretty high - although you get lifetime care and two meals a day in the cafeteria.  Maybe someday....

But I am in no hurry to do so.  So far, this has been the perfect place to wait out a pandemic!