Tuesday, August 05, 2008

Should I Buy or Sell? Seven Considerations
August 4, 2008

I have received many emails from readers which pose one of two critical questions: should I sell my house? Should we buy a house now? It can be a difficult decision for any number of reasons, many of them emotional.
To cut through the emotional stakes and reach a sound business decision, here are questions I ask of these readers. (Note: I do not give advice on any investment dilemma, but if you answer the questions fairly and honestly, they might help you reach a well-grounded decision.)

Before I start, I should confess to having made this critical decision earlier in my life on raw emotional attachment. We'd built a house with our own little hands in the early 80s, and when the Japanese Credit Bubble reached the shores of Hawaii in the late 80s, our modest house zoomed in market value from about $85,000 to about $180,000 (about $312K inflation-adjusted to today). Realtors began sending us letters soliciting a listing, and we actually had need of the capital trapped in the low-mortgage property.

But I was emotionally attached to the house we'd built ourselves, and held on too long, selling a few years later after the bubble burst for $45,000 less--a needless 25% haircut which was in fact a staggering amount of money to us and a huge percentage of our net worth.
Lesson: despite the great difficulty, you must separate your emotional attachments and memories from your investment decisions. We all become bound up with our homes in ways we don't with bonds, stocks or gold coins. But nonetheless real estate is for most of us our largest investment and the one we can least afford to screw up.

OK, on to the questions. The answers to these questions will help pare away deeply emotional issues such as "we have another child on the way" and "we really like this house" which play into what is essentially a massive financial decision-- a decision which will likely have an enormous impact on one's future financial health/wealth.

1. What if you can't sell the house later? All real estate is local, until it's global. The cost of money is now set by global markets, so in this sense all real estate is indeed global. While realtors will tell you the value is set by local appraisals and comps (comparable properties which recently sold), in a very real way the value of any property is set by bankers in Beijing, Tokyo and Dubai--if they stop buying U.S. debt in the hundreds of billions of dollars each and every quarter, then interest rates rise and the value of all property declines in see-saw fashion as prices come down to what is affordable to borrowers paying higher rates.

As interest rates begin to rise (and I've explained my reasons for considering this as certain as sunrise) then lenders will begin hesitating to write long-term 30-year mortgages. Why write a mortgage at 8% when you fear rates will be 10% in a few years? That's simply too big a risk to take.

In the analogous period in the 1980s, 30-year mortgages from FHA carried outrageous "points" (origination fees) on the order of 7, 8 or even 9 points. That is a cash closing-cost expense of $18,000 on a $200,000 mortgage.

Needless to say, few buyers stepped up for such costly mortgages, and so the market for cash-out home purchases essentially froze up.

In most cases, sellers had to carry the mortgage themselves, so-called "agreements of sale." In other words, no cash-out: the buyer paid the seller monthly instead of paying a lender. Obviously those needing their entire capital from the sale of the home were out of luck.
In an era of rising interest rates, real estate becomes a capital trap. If you might need the capital for other purposes, consider the risks of rising rates and capital traps.

2. How close is the house to public transit, walkable shopping areas, good public schools and other community resources like parks, libraries, etc.? I have already posited that there will be two sets of housing: those homes far from these community assets and job centers will sink toward zero while those nearby these assets will decline much less.

If the primary facility in the area is a shopping mall, think about what will happen to values when that mall closes/becomes a ghost mall/skateboard "park".

3. How recession-proof is the local economy? All real estate values are essentially based on income--if there are no jobs, then the value of property sinks to near-zero. Who wants to live there/can afford to live far from their job? Do not assume this recession will be short and mild--assume it will be long (at least four years), deep and global.

If you work for a government agency, ask yourself: is my agency dependent on property taxes or sales tax revenues? As those decline, what will happen to the agency? How will payroll be trimmed as revenues fall? Does the agency face skyrocketing pension and retiree healthcare costs? How will those extra expenses be paid as tax revenues decline?

Being honest about the prospects of being laid off is not easy. Again, assume a four-year decline in everything related to sales, income, tax revenue, etc. and a 20-year cycle of rising interest rates. If the area around your house is heavily dependent on bubble-era businesses like retail, construction, finance, etc., then you have to ask: who can buy my house later if few have jobs?
Recession-proof (meaning they will survive in some fashion) industries include energy, farming, education (colleges), alternative energy, submarine and aircraft carrier shipworks and hospitals. Unfortunately, all government agencies, including Medicare and Defense, will get haircuts as the costs of paying interest on our stupendous deficits and meeting unfunded public pension obligations eat away at all current spending.

Tourism is based on cheap credit and oil, surplus income/savings and the euphoria of good times. It will decline sharply as every one of those preconditions goes away on a global scale.
4. Can you afford the mortgage on one income? Again, be realistic about the odds that one of a working couple might get laid off for a time, or have reduced hours or salary. As painful as it is, be hardnosed about the odds of an entire company/ division/industry just drying up and going away. "Creative destruction" is the academic term for how capitalism cuts away the dead wood, but it's not academic when it takes away your livelihood.

Again, consider the nature of housing as a capital trap in a potentially illiquid market. If someone can't afford the mortgage, and they also can't sell/cash out, then they will lose the home and their equity. Renters have the option of moving somewhere cheaper and conserving their capital/deploying it for other uses.

5. How great is the differential between renting and owning? If it costs twice as much to own as to rent, you then should ask: what are the odds of rent doubling in a recession? What are the odds of housing continuing to decline? If housing declines further, then why pay twice as much every month for the privilege of trapping your capital in a depreciating asset?
If the cost of owning is comparable, and you don't need the capital for other purposes (medical care, caring for elderly parents, college for your kids, etc.) then buying makes sense in this way: your housing costs are fixed (along with your capital) so you won't get rent increases. In fact, if housing keeps declining, then your property taxes will also decline (if you pursue a valuation/tax reappraisal).

6. Can some part of the house be rented to boarders/tenants? If the home is near jobs, a walkable downtown/shopping area, parks, schools, libraries, etc. then it will probably be desirable to tenants/renters. If your income falls in half due to recessionary loss of a job, then renting out part of your house/building is one survival technique many are already pursuing.
6. How much of your thinking is emotion-based and how much is cold, calculating financial investment analysis? If you love a house, but fear buying it could destroy you financially, then consider the house purely as an investment: how much will it cost--really, not some minimal number. Dwellings need maintenance. What is the opportunity cost, i.e. what else could you do with the money that might have a better rate of return? Can you afford to trap your capital in an asset which might decline for years to come? Could anything happen which could disrupt your plan "to live here for the rest of our lives"?

Yes, a house is a deeply emotional investment--but it remains an investment. The guiding light in a recession is "preservation of capital." Can you preserve capital by owning real estate? That is an iffy bet if interest rates are set to rise and the global economy is entering a long, deep recession.

In sum: what's your Plan B if the recession drags on until 2012, your income falls in half, housing continues to slide, etc.? What are the odds that real estate will suddenly double next year, and you'll regret not buying "at the bottom"? What if the folks "buying the bottom" now are, in correspondent Azvitt's apt analogy, like those who rushed out to gather up the flopping fish on the beach, just before the tsunami roars in, wiping out all in its path?

No one can tell us what to do, or what's right for us and our family, but answering these questions analytically, based on the best available evidence and data, will help ground the decision-making process.

Correspondent Unix Ronin notes that there is one other reason to own property, and it's an important one:

You state "there are only two valid reasons for buying a dwelling, [...] It's cheaper to buy than rent, or you can make money on Day One by buying the dwelling and renting it out."

There's a third, but it goes beyond the pure dismal economics of the transaction. Ownership of housing, or more particularly, the land it sits on and is surrounded by, has historically conferred a measure of power to the owner. The more land you own, the more power you have. (Although, in absence of a functioning government, you only own what you can control.) Even if that power basis is only reflected in being able to make certain decisions without anyone else's approval, such as: "I would like to knock this wall down to build a library," or, "I want several dogs in my home."

The ability to make these decisions is worth a premium over Maslow's needs, for those who can afford it, and is typically unavailable to the serfs that rent their dwelling. I don't see this factor disappearing. I find it likely that a sizable number of people will choose to live in Thoreauian shacks than rent, wherever possible. Perhaps I over-estimate the power of the "American Dream" that got us here in the first place.

I also expect "Squatter's Rights" to make a comeback in those 15 million unsellable, unused homes; or rather, that no one's going to care if someone wants to live in the hovel that is left behind when the pipes and wires have been ripped out of them. No one's going to waste the dynamite, though. Those 15 million homes are scrap material. Excellent points; thank you, Unix Ronin. I would add this single caveat: owning land does confer benefits--but only as long as the owner of the land can pay the ownership costs.

Four New stimulating Readers Journal Essays:

two new readers' poems

The Self-Selected Remnant (Chris Sullins, August 4, 2008) One of the very few simple Arabic phrases I bothered to learn in Iraq was "I am a doctor." If I was captured despite my best efforts to die in a blaze of glory, I thought the phrase might buy me some time. Although it was not quite an accurate description of my actual military occupational specialty it sounded better and a lot shorter than "I am a licensed master of force multiplication and controlling angry combat."
The Carp Culture (Rene Andre, August 4, 2008) I am just an average joe schmoe who is trying to suck up an existance from the detritus and flotsam cast off by the Cream of Society. I know it, and so do you, that Americans are a wasteful bunch, who'd rather buy new than repair. They're trendy and competitive as well, so they have to have the newest latest gadget or toy so that they can continue to put on airs as the creme de la creme of society. Enter the bottom feeders. I am not ashamed to claim that moniker. I have always been a scrounger and a trash can entrepreneur.
Energy and the Balance of Power (Mark A. Ancona, August 4, 2008) The United States is losing global hegemony. This is an uncomfortable, yet immutable truth, now repeated by an increasing number of powerful industry leaders and government officials. Having bankrupted our Nation with an un-winnable war, public bail-out of private investment bankers and Alan Greenspan’s nuclear housing bubble, we can no longer afford to engage in the frivolous waste of oil and natural resources. Many countries are coming of age with the re-discovery of their valuable natural resources. Previously third world nations are building first world infrastructures and economies with their new-found bounty.
Astounding Facts of Hidden History (R. Christoffersen, August 4, 2008) Things They Didn’t Tell You in History Class

Thank you, Dennis G. ($55.62), for your outrageously generous donation and kind words regarding this site. I am greatly honored by your support and readership.

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