- "There are great tax advantages to owning."
FALSE. It is now far
cheaper to rent a house in the San Francisco Bay Area than it is to own
that same house, even with the deductibility of mortgage interest
figured in. It is possible to rent a good house for $1800/month. That same
house would cost about $700,000. Assume 6% interest we can see that a buyer
loses at least $4,936 per month by buying. Renting is a loss of course, but
buying is a much bigger loss.
Monthly Loss: $1,800
Property Tax: $486 ($729 per month at 1.25% before deduction, $486 lost after deduction.)
Interest: $2,333 ($3500 per month at 6% before deduction, $2333 lost after deduction.)
Other Costs: $450 (Insurance, maintenance, long commute, etc.)
Principle loss: $1,667 (Modest 3% yearly loss on $700,000. Reality will be much worse.)
Monthly Loss: $4,936
This is a very conservative estimate of the loss from owning per month.
If you include a realistic decline in house prices, as in
this rent-vs-own calculator,
you'll see that owning right now is a very poor choice.
Remember that buyers do not deduct interest from income tax; they deduct
interest from taxable income. Interest is paid in real pre-tax
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.
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.
Under current conditions, a renter would be able to live in a Bay Area house
for 30 years, then buy that $700,000 house outright with the saved principal
payments and have avoided $810,846 in interest payments. Rent would be only
$648,000 over those 30 years, so the renter comes out at least $162,846 ahead.
See an "amortization table" if you don't believe that interest will cost more
than the house. This doesn't even count the huge losses the owner will suffer
as the value of his house falls year after year for the next decade or more,
just as in Japan, nor property taxes, insurance, and maintenance.
Rents will rise eventually, even though they have been falling every year
for about five years now. Rising rents should be more than offset by
appreciation on the renter's saved principle payments, assuming the renter
invests in index funds or any other investment that brings in more than a CD.
There is no need to wait 30 years to buy a house. As this crash accelerates,
prices will fall to the point where it is cheaper to buy than to rent, though
that could take five years or more.
If you don't own a house but want to live in one, your choice now 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.
It is much cheaper to rent the house than to rent the money.
There are large tax disadvanges to buying in California. Because of Proposition
13, more properly called "screw the newcomer", it is common for new buyers to
pay ten times the property tax that their neighbors pay. Tax rates are set at
the time of purchase, which means those who bought long ago pay essentially
nothing, and the new buyers pay all property tax for everyone else. Upgrading
houses makes you a newcomer all over again.
Then there's earthquake insurance. It's really expensive, so most people just
skip it and risk everything on the chance that no earthquake will happen.
- "A rental house provides good income."
FALSE. Rental houses provide
very poor income in the Bay Area and certainly cannot cover mortgage payments.
A $1,000,000 house can be rented out for 25K maximum per year after expenses.
The return is therefore 2.5% with zero liquidity and a huge risk of loss.
If you actually have a million dollars, you can get 5% with no risk, no work,
and no state income tax by buying a US Treasury Bond. And your money will be
liquid and secure.
- "OK, owning is a loss in monthly cash flow, but appreciation will make up
FALSE. Appreciation is negative. Prices are going down, which just
adds insult to the monthly injury of crushing mortgage payments.
- "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, but also true that
the value of your equity in a house can easily fall to zero, and then way
past zero into the red. Even a fall of only 10% completely wipes out everyone
who has only 10% equity in their house. 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.
- "We know it will be a soft landing, since it says so in the
FALSE. Prices could fall off a cliff. No one knows exactly what will
happen, but the risk of an massive crash in prices is severe. As Yale professor
Robert Shiller has pointed out, this housing bubble is the biggest bubble in
history, ever. Predictions of a "soft landing" are just more manipulation of
buyer emotions, to get them to buy even while prices are falling.
Most newspaper articles on housing are not news at all. They are advertisements
that are disguised to look like news. They quote heavily from people like
Realtors, whose income depends on separating you from your money. Their
purpose is not to inform, but rather to get you to buy.
- "If you buy, at least you have a house, but if you rent, you end up with
FALSE. Renters in the Bay Area end up with much more money, while
living in the same quality house as an owner. At the end of 30 years, a renter
would have enough principal saved to buy the $700K house mentioned above and
would have spent $162,846 less on rent than he would have spent in
interest payments. And he would have lived in an equivalent house all that
time. Owners frequently end up with nothing because they lose the house to
- "Prices have been driven by supply and demand."
Supply is increasing rapidly as building continues, and demand is falling as the
population of the Bay Area decreases and the salaries of those who remain
decreases. Prices have been driven by low interest rates and increasingly risky
loans. The dramatic drop in rents and widespread rental vacancies prove that
demand for housing is actually much lower now than a few years ago.
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
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 ago. In a sane
market, prices should fall 3% to compensate for the extra supply of housing.
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.
Banks caculated that risky loans were offset by rising prices, allowing them
to recover their money from bad borrowers through foreclosure. Now that
prices are falling, those risky loans cannot be justified. If the borrower does
not pay, the sale price of the house will not cover the loan. Banks now have a
real incentive to improve lending standards, and that will lower house prices
more because fewer people will qualify for loans.
- "Nobody is making land."
TRUE, but builders are making houses at a record
rate, which is increasing supply dramatically at a time when new houses are not
needed. We have the highest rental vacancy rates since the 1950's.
- "There's an under-supply of housing. That's why prices will rise."
FALSE. There is a large oversupply of housing. To repeat: builders are
making houses at a record rate, which is increasing supply dramatically at a
time when new houses are not needed. The Bay Area has the highest rental vacancy
rates since the 1950's.
- "Population increase will fuel housing price increases."
The Bay Area is losing population the fastest of any area in the US right
now - worse than Buffalo, worse than Detroit. Immigration won't change this
because jobs are emigrating even faster. Rents are falling in part because so
many recent immigrants are leaving, with some going back to China because
opportunities are so much better there.
Nationally, there is going to be a huge glut of housing as old baby-boomers
sell their houses to use the cash for retirement, putting 20% of houses onto
the market for that reason alone. An additional 25% of houses are owned by
speculators, who will soon sell because they are losing money. Birth rates are
declining in all industrialized countries, with the US birth rate barely
replacing the citizens who die.
- "As a renter, you have no opportunity to build equity."
are actually in a better position to build equity because:
- Owers are losing every month on a cash flow basis. The tax deduction does
not come close to making owning competitive with renting.
- Owers are losing principal in a leveraged way as prices decline. A 20%
decline completely wipes out all the equity of "owners" who actually own only
20% of their house.
- Owers 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.
- Owers must insure a house, but not most other investments.
- Owers must pay to repair a house, but not a stock or a bond.
- "If you rent you are a buyer. You are just buying it for someone
FALSE. It may be true that rent covers mortgage payments in
other places, but not in the Bay Area. No one buys with the intention to rent
out in the Bay Area because that's not viable. The owner is generously
subsidizing the renter, a wonderful thing for renters during this crash.
- "If you don't own, you'll live in a dump in a bad neighborhood."
For the any given monthly payment, you can rent a far better house than you can
buy. Renters live better, not worse. All the best neighborhoods have rental
vacancies. There are downsides to renting, but since there are thousands of
vacant rentals, you can take your pick and be quite happy renting during the
You may worry about being forced to move, but the law says the landlord has
to offer you a one year lease at a minimum, and they'll probably be delighted
to offer you a two year lease and give you a discount for that. Other 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
It is far easier and cheaper to rent a house in a good school district in the
Bay Area than to buy a house in the same place.
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.
- "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
- "People buy a house for the long term, so things can't crash
FALSE. People are now buying houses for the very short term. This
is how they justify interest-only adjustable mortgages to themselves. The
thinking is, "I will own this just long enough to make a profit, maybe a year or
two, so there's no need to get a long term loan at a higher interest rate." The
distinction between the long-term owner and the short-term flipper has gone
- "If and when the market goes south, you can walk away."
FALSE. If you
have a single loan with just the house as collateral, it may be a
"non-recourse" loan, meaning you could indeed walk and not lose anything other
than your house and any equity in it (along with your credit record). But if
you refinance or take a "home equity loan", the new loan is probably a recourse
loan, and the bank can get very aggressive, not to mention what the IRS can do.
A reader who lived through the 1989 housing crash in LA pointed out the
following nasty situation that can happen:
- Let's say you buy a house for $600,000, with a $500,000 mortgage.
- Then the house drops in value to $400,000, you lose your job, or otherwise
- If you can't make your payments, the bank forecloses on you and nets
$350,000 on the sale of your house.
- The bank's $150,000 loss on the mortgage is "forgiveness of debt" in the
eyes of the IRS, and effectively becomes $150,000 of reportable income
you must pay tax on.
It is true that buyers who put zero down and have nothing invested in
the house are much more likely to walk away. The large number of new uninvested
buyers increases the risk of a horrifying crash in prices rather than a "soft
- "The house down the street sold for 25% over asking, and that proves the
market is still hot."
Realtors try to create the false impression of a hot market by deliberately
"underpricing" a house. Say a seller's agent knows that house will probably go
for $500,000. He places ads asking $400,000 instead.
illegal when selling appliances, 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.
- "I was lucky that my Realtor told me to increase my bid by $100,000.
Otherwise I would have lost, because my Realtor knew about a secret bid
$90,000 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. Those
are two big motives to invent false bids.
- "The MLS proves things are great."
All sorts of funny things happen in the MLS (Multiple Listing Service, a
private database controlled by real estate agents). For example, if a house just
doesn't sell, Realtors 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 Realtor 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 nobody checking that the MLS shows true selling prices. The MLS prices
are often just wrong.
Furthermore, the MLS will not list any house for sale by owner or for sale
through a discount broker, except perhaps those listed by Help u Sell. Those
cheaper prices are just not in the system, because if you save money, they
- "The Bay Area is a special place that will always be expensive."
but it was just as special ten years ago, so that does not account for the
current housing bubble. Even at half of current prices, it will still be
Many people are confused about the difference between high prices and
increasing prices. Prices are high, but they are not increasing. They are
falling. This makes housing a bad investment.
- "Rich Chinese (or Koreans, or Arabs, or Ethiopians) are driving up housing
FALSE. The percentage of US houses bought by rich foreigners for
investment is tiny. Furthermore, American housing is clearly a bad investment
at this point. Rich investors are not dumb enough to buy into a badly
overpriced market, but your broker is hoping that you are.
- "There's always someone predicting a Bay Area real estate crash."
yet irrelevant. There are very real crashes every decade or so. Even a broken
clock is right twice a day.
- "But housing was high when interest rates were 21%."
Inflation was much higher then, so fixed debt was easier to pay off with
increasing salaries. Now we have stagnant salaries and adjustible mortgages.
House price increases exactly mirror the increase in mortgage
debt. According to the Washington Times: "Consumers have doubled their mortgage
debt from $3.5 trillion to $7 trillion since 1996, borrowing and spending
profusely on the assumption that house prices will keep rising." So the
increase in house prices is not backed by assets. It's backed by debt. The debt
in turn is backed by the houses. It's just smoke and mirrors.
- "My dad made money on his house, and it will work for me too."
Your dad bought his house when houses were cheap compared to salaries, maybe 3
or 4 times annual salaries. Go ask him. Things are different now. Here is a
chart of median house price vs median income in Palo Alto:
Year Median House Price Median Income Multiple
1980 148900 24743 6.0
1990 457800 55333 8.3
2000 910000 90377 10.0
Most bankers use a multiple of 3 as a "safe" price to income ratio. We are well
beyond the danger zone, into the twilight zone. Another rule of thumb is that a
fair house price is between 100 and 200 times the monthly rent. If a house
rents for $2000 per month, then a fair price is from $200,000 to $400,000.
- "The government will make sure housing prices don't fall, because all the
powerful people in the government have houses and want to keep values
FALSE. There have been many local crashes, and the government can't stop
them. Nor would they necessarily want to; the current Republican administration would
probably be happy to see blue states like California, New York, and
Massachusetts crash and burn, and those states are where the worst bubbles are.
- "Look, housing continued to rise after the dot-com crash, so it
will always rise."
FALSE, consider the turkey in the farmer's barnyard. He
thinks the farmer will always come feed him and not ask for anything. Then
Thanksgiving comes. Whack. Past performance is no indication of future results.
- "Rent can go up, but a 30-year fixed mortgage payment cannot."
irrelevant. House owners lose even with a fixed mortgage, because the price of a
house falls as interest rates go up. Most people want to sell within 7 years of
moving in, and many have to sell because of job loss, illness, or divorce. No
one can afford what the owner paid for it, so the owner has to take a large
loss. Renting it out will not come close to covering the mortgage. Bay Area
rents have fallen 23% in the last 4 years.
- "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 the same kind of
house 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. In fact, it's currently cheaper to live in a nice
hotel in most parts of the US than it is to make mortgage payments in the Bay
- "Newspaper articles prove prices are going up."
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. Another common occurrence is for the buyer to get a large cash
payment back from the seller. So the house price looks high in the paper, but in
reality the buyer got a huge rebate.
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.
Please vote against County Clerk Warren Slocum in San Mateo County unless he
fixes the Redwood City computers to allow you to save data.
- "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
Anyway, as transaction volumes decline, the first few low sales will have
a large and sudden impact on appraisals.
- "If one house sells for a million dollars, a million houses are worth a
FALSE. If all of those million houses were all on the
market they would sell for far less. Less than 5% of all existing houses were
sold last year. The other 95% are merely assuming they can get the same
- "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.
Also, Realtor is a commercial term, not a real word. Note the "" symbol.
- "If you don't buy now, you'll never get another chance."
argument was also popular in 1989 in Los Angeles, just before a huge crash.
There are always sellers and there are always buyers. Prices are always
corrected when they get beyond what buyers can pay. In fact, they're being
corrected right now.
Here is a great quote from June Fletcher, a Wall Street Journal reporter, that
says it all: "The real issue isn't whether you will be stuck being a renter all
your life, she says. Its whether you'll get so scared about being shut out
that you'll buy at the market's peak and be stuck in a property you cant afford
- "Property in the Bay Area is a luxury good, and so will be less affected by
FALSE. 82% of last year's Bay Area mortgages were 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.
- "Housing will be permanently higher since downpayments are
FALSE. The first big wave of default will cause downpayments to
suddenly seem like a good idea again. Lending standards are already improving.
- "House ownership is at a record high, proving things are
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.
- "Long term rates are still at historic lows!"
TRUE, but irrelevant. Most
new mortgages and refinancings are now short term, and those will definitely be
affected by rising short term rates.
- "The limited land in the Bay Area means prices will always go up."
Japan has a very severe land shortage, but that hasn't stopped prices from
falling for 14 years straight. Prices there are now at the same level they were
23 years ago. If we really had a housing shortage, rents would be going up, but
they're going down instead.
- "It would take another 911 terrorist attack or a major earthquake that
wipes out this area in order for the price to fall by 50%."
FALSE. Even with
a 50% decline in prices to $350,000 or so, the median price in the Bay Area will
still be roughly double the median price in most of America, and the median Bay
Area household income of about $70,000 will still not be sufficient to buy a
house. So a 50% decline is well justified by the fundamentals.
- "Housing is an excellent hedge against inflation, so you should buy now
FALSE. Interest rates go up with inflation, and higher interest
will be the last straw for ARM mortgages in the Bay Area. Their defaults and
foreclosures will drive down the cost of housing for everyone else around here.
Remember that 82% of recent Bay Area mortgages were adjustable. There is little
chance that salaries of ARM owners can keep up with inflation because of two
billion people in India and China who would be happy to do their jobs for much
- "Houses always increase in value in the long run."
values are actually constant. Adjusted for inflation, prices in Holland, for example,
than one quarter of one percent annually in the 350 years since their
tulip bubble. Warren Buffett and
Charles Schwab have both pointed out that houses don't produce anything. They
do not increase in intrinsic value. Unless there's a bubble, 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 - it drained cash from its owners for 100
years of maintenance and taxes. Its price went up about as much as salaries
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 salaries rose a
- "Maybe we should just accept that we missed out on a great opportunity to
get into the real estate in the past N years."
FALSE. Did we all miss out on
a great opportunity to get into the stock of pets.com or other Internet
companies with no business model? The real question is what is likely to happen
in the next few years according to fundamental economics. The answer is a
massive crash. The last guy to buy into the bubble will get hurt the most.
- "I just want to own my own house."
TRUE, most people do and that's fine.
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 own, consider selling so can actually keep some of that funny money that
appeared out of thin air. It would be a pity to watch it vaporize back into
thin air. There is no real profit until you sell.
If you want to buy, look around and see that house prices are falling. Why
hurry to buy now? Save your cash and buy for much less in the future. Find a
nice cheap rental, sit back, and enjoy the show till then.