Rent vs Purchase: A Comparison

Also posted at Priced Out Forever.

Buy If You Must. Why Must You Buy?

by guest poster Eleua (with contributions and spreadsheets by Tim)

Click here to download the Excel Spreadsheet that the numbers below are based on.

I need to take a step back and insert a personal note. While I disagree with the motives and actions of the faceless Real Estate Industrial Complex (REIC), there are genuine, honest, intelligent and wonderful people that work as RE agents, mortgage planners, title agents, contractors, appraisers, granite counter fabs, etc. It might be difficult to find one of these in an sub-prime boiler-room, or on a CNBC interview, but there are those out there making a living that are just as much of a victim as their customers. Please separate my disdain for the high priests and the overall entity from the honest people that believe they are trying to help someone achieve a dream. Second, difference of opinion does not constitute condemnation. I enjoy a healthy, spirited, raucous discussion more than most. At the end of the day, drinks are on me.

With that said, let's get on with the flogging.

I will be the first to say that buying is a good idea if you intend to live in the house for the bulk of the mortgage period, you can afford it, and it is viewed as your nest, rather than your nest egg. If you are a transient, or you are trying to save for retirement by living in your 401(k), you might get lucky and you might get ruined. Houses are homes. They should not be investments.

200-7! You Crapped Out.
For the past several years, we have been living in a speculative economy. During the late '90s, this was manifested in stocks, and now it is takes the form of residential real estate. Everyone wants in on the fun. Why not? Real estate, like stocks, always goes up in value. It is a great investment, and the way for normal people to build wealth. At least that is what the Real Estate Industrial Complex (REIC) wants you to believe. They don't make as much money if you are skeptical.

At first glance, it sure seems like a dynamite investment. Everyone has a grandmother that bought her $600,000 home back when it was $60,000, and if you live in California or Seattle, you can't go 15 minutes without running into someone yammering on about how much their home has gone up in value. Some idiots treat a daily visit to Zillow like they would a call from their stockbroker.

By Your Lease, My Landlord
The new homeowners are buying into the idea that America does, in fact, have a class system: the Landed Class, and the Perpetual Renters. The Landed Class have unlocked the secret to passive wealth, and the Perpetual Renters are condemned to the outer darkness of blowing their savings on their landlord's mortgage - a double insult.

All current living generations in America have been force-fed the idea that home ownership is absolutely essential to financial freedom. It is an article of faith in the national religion. Question this and you are branded a heretic. Somehow, through an Orwellian twisting of the language and a corruption of the educational system, debt became wealth. The last two generations that would have disputed this have passed on.

Morons + Money = Lumpeninvestoriat
The REIC sells homes as investments to the Lumpeninvestoriat. Homes are more expensive if the parties attach a high speculative premium. The higher the speculative premium that accompanies a property, the higher the price will be. This reinforces the validity of the speculation. Normally, this is called a bubble. The REIC makes a lot of money fomenting a bubble.

Is a home a good investment? If by investment you mean that it throws off the dividend of a place to call home, then yes. Renting provides the same benefit. If you are seeking a "forced savings program" and capital appreciation, you might be better off with payroll deduction and a quality, value oriented, contrarian investment portfolio.

Pay No Attention To The Details Behind The Curtain
Let's examine a common exercise that many in the REIC like to conduct to shore up their position that your home is your nest egg.

A gracious local mortgage planner responded to my stunned disbelief that someone would refer to a mortgage as a "forced savings plan" by posting a comparison between a hypothetical renting scenario and buying the same house. This is her example that shows how a house can be a great savings plan.

Owning a home is not right for everyone. There are certain benefits to not owning the home you live in. If something goes wrong with the property, you simply ring up the landlord and they get to fix it. You pretty much know what your cost are going to be month to month (unless your landlord decides to sell the property, increase rent, convert the condo, etc.). On comments from last Friday’s post on interest rates, there is a discussion debating if one could consider having a mortgage as a forced savings plan. I know I'm going to seem biased since I am a Mortgage Planner…and I fully expect all of the number-crunching-junkies out there to have a heyday with what I'm about to post…but here goes!

I found two similar homes, both in the north Seattle area. The rental property is available for $1850 per month. The home for sale, with close square footage, rooms, area, etc., is available (actually, an offer is pending) for $499,995.

With the comparison, I'm going to assume someone has 20% down to either invest in the stock market or to buy a home. The current rate for a 30 year fixed is 5.75% (APR 5.904%). Principal and interest is $2,334 plus taxes and insurance equals a total payment of $2623. First year monthly tax benefits are $606 (mortgage interest benefit will decrease, property tax benefit will most likely increase).

The prospects are in the 28% tax bracket; they have a gross income of roughly $8000 per month and can have $700 in monthly debts with credit scores at 680 or better. The investor will receive 11% from the stock market and the homeowner will benefit from an appreciation of 7% on their real estate.

Rent	at 5 years		Homeownership	at 5 years
Total Payment	$117,863		Total PITI	$157,396
Principal Paid	0		Principal Paid	$28,951
Tax Benefit	0		Tax Benefit	$35,293
Net Cost	$117,863		Net Cost	$93,152
Real Estate Value	0		Real Estate Value	$701,269
Loan Balance	0		Loan Balance	$371,045
Total Home Equity	0		Total Home Equity	$330,224

Rent	at 10 years		Homeownership	at 10 years
Total Payment	$254,498		Total PITI	$314,792
Principal Paid	0		Principal Paid	$67,519
Tax Benefit	0		Tax Benefit	$67,893
Net Cost:	$254,498		Net Cost:	$179,381
Real Estate Value	0		Real Estate Value	$938,566
Loan Balance	0		Loan Balance	$332,477
Total Home Equity	0		Total Home Equity	$651,089

Investment			Investment
Opening Balance	$109,000		Opening Balance	0
5 Yr Return @ 11%	$188,452		5 Yr Return @11%	0
10 Yr Return @11%	$325,817		10 Yr Return@11%	0

5 Year Net Worth	$188,452		5 Year Net Worth	$330,224
10 Year Net Worth	$325,817		10 Year Net Worth	$651,089

The first five years with the mortgage provide an average monthly principle reduction of $482.47 per month. Taking out any appreciation factors, the principle principal paid each month is a forced savings plan. With that said, home equity does not earn interest. And I would probably encourage most clients to consider not using the entire 20% for the down payment to stay more liquid (depending on their entire financial picture).

For many Americans who do not have a savings plan (and the statistics show that many do not save), owning a home is as good as it gets for building savings…and it ain't so bad.

Let the games begin!

This is a very common proof put out by the REIC to keep the Lumps feeding from their trough. I've seen it in a dozen different forms. If it was posted on a billboard, and you drove past it at 70 mph, on a crowded freeway, it would make sense. Fortunately for the REIC, the flashbulb attention span, in combination with the economic and historical illiteracy of your average homebuyer makes this work.

Is This Apples-to-Apples, or Salmon to Mullet?
Using the provided example as the basis for comparison, we will take out our pencils, calculator, green eyeshade, and a case of Mountain Dew and hammer out a valid side-by-side look at renting vs. owning.

Rent is $1,850/mo. I guess if you show up looking like you just crawled out from a flophouse in Pioneer Square, you would pay full price. In this market, if you showed any semblance of responsibility and wanted to negotiate, you could knock 15% off that price. However, we will go with the $1,850 to keep as close as we can to "apples to apples."

Our poor, pathetic loser renter is on the hook for $1,850/mo + 3% hikes per year. Over the first 5 years he lays $117,863 on the altar of his landlord's good fortune. In 10 years it amounts to $254,498. This assumes that rent tracks at 3%, which with all the building and speculating in real estate is a pretty bold assumption.

Over the same time our budding noble is also shelling out money for his living situation. He paid $100,000 for the down payment, and (according to Rhonda) currently pays out $2,623/mo in principle / interest / taxes / insurance (PITI).

Up until now, I am in agreement with Rhonda. We now need to look deeper into the realities of home ownership to find the true value of each living situation.

Real Estate Always Goes Up - It's In The Constitution
Perhaps the biggest flaw in the classic "Rent vs. Own" comparison, as put out by the REIC, comes in the form of assumed appreciation of the underlying asset. It is given as an absolute certainty that real estate always goes up. Yes, in the past few years that has been the case. Will it happen tomorrow? Nobody knows - nobody. To assume this is, at best, irresponsible. Capital appreciation is never assumed when assigning value to an investment. Capital appreciation may be estimated for speculative purposes, but not investment purposes.

I am not against speculation - I do it all the time. However, it is speculation; it not investing, just as meaningless sex is not love. There is a huge difference. It is very important not to have expectations of one when engaging in the other. Assigning a value based upon the dividend or benefit an asset provides is investing. Assigning a value based upon someone else's view of the price is speculation.

It's Clear Sailing In The Rear-View Mirror
I wonder how anyone in the REIC can so confidently forecast an appreciating market? How do we know the market will not shift into reverse? We don't. Yes, we can guess, but we don't know. I would submit that after the breathtaking run in real estate over the past few years, and the problems that we are facing in the mortgage finance space, a very strong argument can be made for a precipitous drop in real estate prices - even in Seattle.

If you run the appreciation at +7%, you would be well served to run it in reverse to give a range of expectations. Back in 2000, many stock bulls (especially those on Wall Street that profit from high priced stocks) believed in the "New Economy." This New Economy was based upon the absolute fact that certain, high quality stocks will always go up in price. Microsoft, Yahoo, Intel, Cisco, Juniper, Qualcomm, eBay, Lucent, Corning, etc. were all touted as fail safes. Seven years later, these predictions look foolish and self-serving. Had speculators prepared for a significant rollback, the pain may have been alleviated to some degree. Going "all-in" at the wrong time is devastating.

Removing the miracle of perpetual appreciation, the 5 and 10-year numbers for owning would have to be reduced by $201K and $438K respectively. If we reduce the appreciation by the same amount as we assume it appreciates, the owner's position is reduced further by $126K at 5 years, and $240K by 10.

This is a pretty wide differential for something we don't know. A prudent analysis would be to not factor in any appreciation. Such was the example in Northern California from the late '80s to the late '90s.

Show Me The Money! - Well…Let's Hold Off On That.
In addition to the folly of just assuming that an asset will appreciate, it is incumbent upon the buyer to understand why an asset appreciates. Home prices track incomes as well as the ability to find easy money. Without easy money, homes could not appreciate beyond what incomes could support. A house is not a bank account that accrues compounding interest.

Unfortunately for our prospective homebuyer, both sources of rising home prices are under attack. Mortgage lending has been a festival of economic irresponsibility since 2003. Up until early 2007, anyone could qualify for just about any amount of money with absolutely no documentation or lender vetting. The finance industry made billions selling high fee mortgages and chopping them up for sale in the secondary markets. It was a fundamental blunder to build a business model (or an entire industry for that matter) on lending money to questionable borrowers with lousy collateral. That business is now disintegrating right before our eyes. Lending standards will be increasing dramatically (driven by both government and investors), and rates will certainly rise. The go-go days of insane lending are in the rear-view mirror.

Global wage arbitrage with Mexico, India, China, Russia, and Brazil are keeping a tight lid on incomes. Incomes have been stagnant over the entire duration of the housing bubble, and show no sign of any broad-based increase. Other considerations include rising taxes to pay for the increasing scope of government, immigration pressures, and the retirement of 77 million Mouseketeers.

Comparing With Four Hands Tied Behind Your Back
While Rhonda was generous with her assumptions of the ROI of the renter's investment portfolio, I wonder why this investment wasn't treated in the same manner as the appreciation on the house? Why can't the investment portfolio also include 4:1 leverage? Why assume 11%? If we are in the business of forecasting good things by looking in the rear view mirror, why not use a real example from another investment that took place over the same time period as the latest housing bubble? A 4:1 leveraged investment on silver bullion would have returned $1,120,000 on a one-time buy-in of $100,000 over the past 7 years.

Tax Benefits Need A Tummy Tuck
The tax benefit is overstated. Yes, itemizing mortgage interest and property taxes is a great benefit. If you make $96K/yr, you can do quite well come tax time. The problem comes with the "standard deduction," which is the tax deduction that you get without itemizing. The standard deduction is less for a single man, than it is for a family. Rhonda assigns $35,293 of tax benefit for 5 years and $67,893 for 10. If we correct for the standard deduction for a family, that tax benefit is reduced to $20,873 and $39,053.

Oops, Your PITI is Slipping
The PITI was probably too low. $288/mo for taxes and insurance is probably more like $550. Tax rates are considerably above ½%.

It is doubtful that the county would keep property taxes stable. Even in a period of decreasing values, it is very easy for local governments to keep their bloated budgets going on the backs of the local citizenry. Even if you assume the tax rate holds steady, if your property is increasing in value, so is your property's government-assessed value, right? 5 to 10 % property tax increases are certainly well within normal assessments. Let's say the assessment increases at the same rate as the assumed appreciation, but with a 5-year lag.

So, What Are You Doing This Saturday?
Houses are also maintenance intensive. Rhonda assumed that our homeowner never needed to repair his castle, nor make a visit to Home Depot. If the homeowner spends 1% of the value of his home on maintenance and improvements (what's a trendy Seattle home without granite, stainless, and bamboo?), we need to add another $400/mo to the equation.

The Highest Fee Brokerage
Finally, the REIC never likes to bring up that a hefty fee exists for cashing out of the home ownership money machine. You need to pay them a minimum of 7% of the gross sale to get at all that wonderful equity. Assuming the home price remained constant, that is another $35,000 out of the piggy bank.

The Bottom Line
Now that we have a more complete picture of the situation, let's take a look at the financial bottom line for rent vs. purchase in few possible scenarios. We'll use Rhonda's given purchase price, down payment, investment return (11%), and rental price, varying only the assumed appreciation in each case. "Home Value" refers to the total amount of money you pocket upon the sale of the house (since that is the only way you can get the money).

7%	Rent	Purchase
Appreciation	Investment Value	Home Value	Difference	Advantage
@ 5 years:	$224,343	$275,668	18.6%	Purchasing
@ 10 years:	$402,613	$574,573	29.9%	Purchasing
@ 25 years:	$1,662,659	$1,815,340	20.3%	Purchasing

4%	Rent	Purchase
Appreciation	Investment Value	Home Value	Difference	Advantage
@ 5 years:	$224,343	$189,950	18.1%	Renting
@ 10 years:	$399,918	$350,060	14.2%	Renting
@ 25 years:	$1,565,654	$1,030,024	52.0%	Renting

0%	Rent	Purchase
Appreciation	Investment Value	Home Value	Difference	Advantage
@ 5 years:	$224,343	$90,051	149.1%	Renting
@ 10 years:	$396,625	$128,619	208.4%	Renting
@ 25 years:	$2,172,580	$461,100	371.2%	Renting

-2%	Rent	Purchase
Appreciation	Investment Value	Home Value	Difference	Advantage
@ 5 years:	$227,271	$45,749	396.8%	Renting
@ 10 years:	$399,452	$44,272	802.3%	Renting
@ 25 years:	$1,454,580	$156,786	827.7%	Renting

The Million-Dollar Taffy Pull
So, did we answer the question of it being better to rent versus own? Not really. It is all based upon how congruent your assumptions about the future are with the reality. Nobody knows what will happen next week, much less 10 years from now. I would say that wildly optimistic assumptions of owning compared to a watered down forecast of the economic flexibilities of renting is not a valid comparison.

People always forget that using borrowed money for investing (whether it is a brokerage margin account or a mortgage) is leverage. Leverage works both ways. It amplifies your success or failures. What turns 4 walls and a roof into the American Dream is the same mechanism that makes it your financial coffin.

Yes, if you get enough appreciation of a home's value, it makes sense to buy. This is true on any investment. However, if the home stagnates in value, or falls, the damage is magnified by the mortgage, taxes, and illiquidity.

Home ownership brings certain benefits like some level of sovereignty over the use of the property and any ephemeral value from "pride of ownership." It also brings other pitfalls, such as illiquidity, maintenance, acts-of-God, or even your overweight, aging hippie neighbors that insist on walking around naked as they oscillate between the hot tub and the "herb" garden.

Renters may need more than just the consultation of a sledgehammer and a case of Mickey's Big Mouth to knock out a wall, but if a heavy-metal band moves into the house next door, they can give notice, pull up stakes and move into a nicer home. If a renter gets transferred, they don't have to put up with the agonizing process of selling a home in a squishy market, and then paying 7%+ to the REIC. At worst, they lose their deposit and move on.

Lending While Intoxicated
As the mortgage finance industry scraped the bottom of the barrel to find new suckers buyers to put into homes, they swerved head-on into the world of the financially illiterate. Many of these buyers did not have sufficient savings to pay the standard first/last/deposit as required for most rental contracts. Many did not have sufficient income to qualify to rent, yet the finance industry was able to qualify them for a home. This was done under the pretense of getting them into a beneficial financial situation. Rhonda summed it up as follows:

"For many Americans who do not have a savings plan (and the statistics show that many do not save), owning a home is as good as it gets for building savings…and it ain't so bad."

Yes, I guess you can refer to the principal paydown on a house as a "forced savings plan." It is true that most Americans do not have any form of savings, other than their aging Beanie Baby collections, so I guess this is better than nothing. It also presupposes that most Americans are idiots. With that, I agree, but would like to add that allowing an idiot to juggle a half-million dollar, highly leveraged, speculative savings plan is a recipe for an unmitigated disaster in their personal life. Set this against the backdrop of tens of millions of the very same, and you have the certainty of a national financial disembowelment.

Given the recent activity in the sub-prime mortgage finance companies, this hypothetical is now a reality.

Seattle Immune to Financing Woes?

When the question is "how will the current home lending meltdown affect the housing market in Seattle," the answer depends on who you ask. For instance, if you ask #1 Seattle real estate cheerleader Elizabeth Rhodes, the answer is something to the effect of: "Seattle is special. Don't worry your pretty little head about it."

Q: Local real-estate experts keep saying Seattle's housing market will stay strong because the local economy is strong. But I think all the subprime loans going bad will mean a lot more houses on the market and prices here will sink. Why don't you report that?

A: Let's start with an interesting fact from Douglas Duncan, chief economist for the Mortgage Bankers Association: More than one-third of all homeowners have paid off their mortgages (or paid cash). This significantly decreases the potential for overall risk.

However, the growing crisis in the subprime mortgage industry, fueled by an increasing number of mortgage defaults, is real.

How much of an effect it may have is very location-sensitive, said Bob Visini, a spokesman for LoanPerformance, a California company that tracks nationwide mortgage activity.

The Seattle/Bellevue/Everett area "is exposed," but way down the list, Visini said.

The Seattle area is in the bottom 20 percent for subprime mortgages among 331 major metropolitan areas — far below other parts of the country, particularly parts of Texas and California's Central Valley where subprime accounts for nearly a fifth or more of all mortgages. At the top of the list was McAllen, Texas, where some 26 percent of loans are subprime.

By comparison, only 7.9 percent of all Seattle-area mortgages were subprime at the end of 2006 (ranking 278th out of 331), down from 8.7 percent the previous year.

And only a fraction of those loans were in trouble — some 7.6 percent at the end of 2006 were 60 days late or more, a sign foreclosure is looming. This put Seattle in the bottom 10 percent.

Those are certainly some convincing statistics Ms. Rhodes has pulled out. Unfortunately, she still employs her mad misdirection skillz in composing the answer. The reader didn't ask "how does Seattle's rate of subprime mortgages compare to other cities?" Nor did they say "the subprime lending implosion is already affecting Seattle." Rather, they pointed out the high likelihood that the subprime mess will adversely affect Seattle's housing market. Granted, it may not affect Seattle as much as other areas with higher percentages of subprime loans, but there is no reason to believe that it will not have any affect.

On the other side of the media spectrum, ask Mike Benbow of the Everett Herald the same question, and he might say: "Foreclosures are already on the rise, and will likely increase. If the country heads into a recession, the housing market will almost certainly suffer even more."

Others are using risky loans, such as those where they're paying only interest for a while, to get into homes they can't afford. That can only lead to trouble.

In fact, it already has.

A recent article in the Puget Sound Business Journal quoted RealtyTrac Inc. as saying there were 2,377 foreclosures on homes in Snohomish County last year, a 35 percent increase over 2005.

That was lower than King County, where foreclosures rose 41 percent, and Pierce County, which showed a 58 percent hike. But it was higher that the 25 percent increase for the state as a whole.

Such a sharp increase in foreclosures tells us there are problems in the industry.

A local or national recession could trigger even more.

What am I trying to say here?

I guess that a rising local economy has kept the housing market relatively strong locally, but that things could change rapidly if economic circumstances change. Now, more than ever, home buyers should be careful about the types of loans they're using and not expect home appreciation to bail them out of a purchase they never should have made.

Wow, it's refreshing to read something that honest in the media once in a while. Foreclosures up 41 percent in King County? Funny, I must have missed the article in the Times where Ms. Rhodes covered that. I thought our housing market was the picture of perfect health. How could foreclosures be rising so quickly? Hmm.

(Elizabeth Rhodes, Seattle Times, 03.17.2007)
(Mike Benbow, Everett Herald, 03.19.2007)

Let's talk Financing: Gross Income outdated?

Bonus Picture Day (billboard next to Everett Events Center): Looks like the banking industry is aware of the debt picture.

Gross Income outdated?

For years the lending industry has utilized gross income as the yardstick by which consumers are qualified to obtain mortgages. Let's say the median priced home in King County is $465,000. What would the gross income need to be to qualify for this mortgage?

Here's the generic scenario: Specifically, let's use a 100% financed program as our sample; not to ridicule the program, but because it is used so often. Property Taxes are presumed to be $5000/yr. Homeowner Insurance is presumed to be $600 per year. We won't worry about Mortgage Insurance for this illustration. This is just to make you think, so don't pull out your calculators.

A single 1st Deed of Trust loan is $465,000 @ 6% fixed for 30 yrs: Using the Bankrate.com Mortgage Calculator, the Principle & Interest is $2787.91 Now add $466 per month for taxes/insurance, so your total monthly payment is: $3253.91.

If a rule of thumb is to not exceed, say, 33% of your gross income, then what should my income be to qualify for this loan? If your payment is $3253.91, roughly a third of what you make, then you would need gross income to be roughly $9900.00/month. That is a lot of dough.

But, hey! Meet Bob. After tax income for Bob the borrower is actually around $7,000/mo. That's his net income. But, hey! Wait! Bob spends at least $500 per month on utilities and he needs cable to watch pay per view specials like the UFC Championships. And he spends hours blogging, so Bob needs a high speed internet service at $50/mo. He also drives that sweet Acura TL, so his payments are around $600 mo., including insurance--which would have been less, but that's another story. He loves the Sonics and attends at least 2-3 games per season. Bob and his close friends eat out at least once a week and dang it, he wants to go to REI and buy that Thule car roof rack for his new boards that he purchased last year. Up to a few weeks ago (conditions have been horrible recently) Bob was skiing at Crystal Mountain every weekend. That's a hundred dollar day, just to ski and play. When Bob really thinks about it, he's spending about $2000.00 month on food, utilities, car payments, and other stuff. Once in a while he likes to travel.

What I'm illustrating is probably not terribly far off from reality. After tax income on this borrower does not leave very much left for a housing payment, provided the income stated was a full doc loan---full employment and income verified loan. If the borrower did not actually make $9900 mo/ gross (went Stated Income or NINA--no income or asset verified) but ACTUALLY brings home $5000.00 per month, NET, this borrower is on borrowed time.

Fortunately for Bob, his co-worker is also a part-time loan officer! Bob went with an 5 yr. Interest-only ARM, amortized over a 30 yr term. Bob is paying interest only, $2325 plus taxes and insurance, so his payment is about $2791/mo. That is about $500 less than the previously mentioned loan program. He could take that difference and invest it or have more fun. Is this scenario plausible to readers? It should be. It works well with those who use it wisely.

Should the lenders stick with gross income? I'm probably old fashioned, but when I look at my monthly obligations, my decision making (usually) is based upon take home pay, not gross income. Borrowers should know what they actually bring home and use that figure as the real number to stay within their comfort level.

Fleckenstein: Seattle "Just a Little Less Dark"

Wow, Aubrey Cohen over at the P-I is really slipping lately. First he prints the prediction that Seattle will see "slight year-over-year price declines this spring or summer," and now he has penned an entire article about Bill Fleckenstein's "not-so-rosy" outlook for local real estate.

Like many economists and real estate professionals, hedge fund manager Bill Fleckenstein thinks Seattle's housing market is, relatively speaking, in decent shape. But, while others see Seattle as a bright spot, he describes it more as just a little less dark.

The national market is going through "probably one of the biggest, most dangerous bubbles we've had in this country," said Fleckenstein, president of Seattle's Fleckenstein Capital, MSN columnist and a panelist Tuesday at a forum on housing trends sponsored by the Greater Seattle Chamber of Commerce.

Although Seattle is in better shape, its home prices will go down, Fleckenstein said after the meeting. Asked if he would buy a home in Seattle now, his response was an immediate, definitive "no."
...
"I really think it was more of a lending bubble and an abdication of responsibility by the lending institutions," he said. "Anybody with a pulse could borrow any amount of money."

Meanwhile, the rising home values created equity, which homeowners cashed in to live beyond their means, Fleckenstein said. He said the [national] market peaked in mid-2005 and has serious potential for prolonged trouble.

Real estate prices declined for a decade after Japan's equity bubble burst in 1989, with commercial property values falling 90 percent and home values down 70 to 80 percent, Fleckenstein said. "You can look to see what happened in Japan as where things could go."

The ultimate depth of the fall is not yet knowable, he said. "When the tide starts to go out, then you start to find out all the crazy stuff that's gone on."

Fleckenstein said the recent tightening of lending standards could affect the lower end of Seattle's home market, while the national fallout would hit the city's higher-end buyers.

I don't really have much to add. I've been reading Bill's stuff over at MSN Money for a while now. He's a sharp guy, and was accurately warning of a national slowdown and credit tightening well before it all began. I'd think carefully before dismissing his local predictions just because they don't reflect your preferred version of the future.

(Aubrey Cohen, Seattle P-I, 01.31.2007)

HouseMath 2.0 - Lending Woes - News

I've received a few e-mails over the past holiday season, some asking if I disappeared. Yes, I read this and many other Blogs every week. I'm not hibernating. So here's what's up:

When people decide it's time to buy in the market this is a cool tool to use.

May I introduce the HouseMath 2.0 website. Last week, I e-mailed Kerill Sheynkman, the wizard behind this tool, if I could get his permission to blog about it. Some may have already seen the introduction to this over at Zillow Blog, but for those who haven't seen it I would encourage you to spend a few minutes to familiarize yourself with this great resource.

When you hit the "Analzye " button, your presumptions come to life. Please don't make fun of the $315,000 sales price for a home in Seattle that I used, it's for illustration only.

Below is a screenshot of financial analysis tools such as creating your reports in .PDF format.

Interestingly, Kerill Shenkyman resides in New York and has previous working relationship ties to Glenn Kelman over at RedFin. Small world. 2007 is going to be a great year in the innovation of real estate tools and Web 2.0 blog arena.

Lenders are scrutinizing loans

One of the perks of being in real estate is that I enjoy discussing issues with the people who are actually conducting business. It encompasses a large sphere: from builders, to Ardell and loan officers.

A lot of discussion is taking place about lending right now and the struggles of the sub-prime market. Seems like the tune out there is changing quite a bit. Inman News has a lot on the plate this morning (check it out quickly before the articles go subscription).

From Inman News:

Bernice Ross on "The demise of the housing ATM"
Bradley Inman on "The subprime tsunami"
Mortgage Lenders Network being shut down (evidently failing to fund on 1,409 loans across the country)

I spoke with a couple loan officers early this week and the responses were that lenders were scrutinizing transactions more. For example, one broker mentioned that an underwriter actually dropped the value of an appraisal from x amount to x amount and required that interior photos be taken along with obtaining two new comp's (comparable homes). In another example, funding conditions came back with more hoops to jump through in terms of actually verifying borrower deposits and funds to close.

Stuff

Before I forget, check out ShackPrices new mapping tools. Packed with innovative features. I had the pleasure of briefly meeting Galen Ward, the wizard behind this great tool at a function a few weeks ago. I look forward to them rolling out some new features that are coming soon.

- S-Crow

Lending News: Washington State Cracks Down?

A pair of articles printed Saturday in the Seattle Times show some slight tightening of lending practices in our state.

Nineteen states, including Washington, and the District of Columbia have moved quickly to warn state-regulated lenders about the hazards to consumers from nontraditional mortgages.

Tens of thousands of state-licensed lenders and mortgage brokers are affected by the advisories, also known as a "guidance."

Such loans include interest-only mortgages and other arrangements where the borrower cuts monthly costs by paying back less than full interest and nothing toward principal.

The states are following closely behind federal banking regulators, who issued a sternly worded advisory in late September to the lenders they supervise, telling them they should not make these loans to borrowers who may be unable to repay them.
...
In 2003, just 10.6 percent of new loans tracked by First American LoanPerformance, a San Francisco-based real-estate information service, were nontraditional mortgages. But during the first nine months of 2006, about 34.1 percent of borrowers used these loans to buy or refinance homes.
...
Many economists now say the surge in these loans contributed to the real-estate boom of the past few years. Regions that had the highest rates of nontraditional lending were those areas where housing prices rose most quickly.
...
In Washington State, where the Department of Financial Institutions sent out its warning about three weeks ago, the guidance covers 1,767 mortgage brokers and 356 consumer-loan companies.

Not being in the mortgage lending business myself, I am not qualified to comment on whether the new "warning" will actually slow the spread of suicide lending. Hopefully potential home debtors will at least be better informed about what they're potentially getting themselves into with the more dangerous loans.

The second article deals with who is allowed to work as a loan officer in our state.

Until this month, virtually anyone could work in Washington as a loan officer for a mortgage broker — even convicted felons whose job gave them access to borrowers' most sensitive financial information.

But a new day has dawned, and it's mortgage brokers who pushed for the change.

A new state law, which went into effect Jan. 1, requires the state's 8,000 loan officers employed by mortgage brokers to be licensed. They write more than half of Washington's home loans.

Exempt from the new law are loan officers working for banks, credit unions and savings and loans. Also exempt are those working for consumer-finance companies.

Loan officers at mortgage brokerages must pass a background check meant to weed out those convicted of recent felonies or financially oriented misdemeanors, such as credit-card fraud. Also out are those who've generated a significant number of business-related complaints to state regulatory agencies.

I would think that shady loan officers are more likely to push people to take on more loan than they can truly afford, so this also comes as welcome news. I don't know if either one of these will do much to stem the tide of suicidal financing, but they couldn't make the situation worse. If these new regulations actually do significantly decrease the number of exotic loans that are issued, it would go a long way toward reigning in the runaway appreciation of the last few years.

(Kirstin Downey, Washington Post, 01.06.2007)
(Elizabeth Rhodes, Seattle Times, 01.06.2007)

What to Blame? Not Growth Management.

Here's a guest editorial from today's Seattle Times that says something I've been saying all along: The "home prices are high because we're running out of land because of Growth Management" argument doesn't hold water.

The cost of housing is spiraling out of control in many parts of the Puget Sound region. King County is redefining sticker shock for homebuyers as the median price of housing approaches $440,000. Years of double-digit increases are a serious threat to many people's dreams of home ownership, and to our region's livability.

As the problem escalates, the search for real solutions has become increasingly high-stakes. To tackle this challenge effectively, we must work together with accurate information. We must also move beyond misleading and misdirected attacks on environmental and growth-management laws. The evidence suggests these attacks are misleading and unwarranted.

Opening rural areas to sprawl development doesn't increase housing affordability, nor does protecting rural areas from irresponsible development make housing unaffordable. The state's Growth Management Act actually requires local governments to take steps to improve housing afford-ability and choice.

The Brookings Institution has found that market demand, not land constraints, is the primary determinant of housing prices. Its study, "The Link Between Growth Management and Housing Affordability: The Academic Evidence," reported that "housing prices are actually determined by a host of interacting factors, such as the price of land, the supply and types of housing, the demand for housing, and the amount of residential choice and mobility in the area." In other words, the impact of growth management on housing prices is only a part of the equation, and a relatively small one here.

In our popular area, demand is the big driver of housing cost; people want to move here and stay here. Increased income and purchasing power also are major factors in the rising cost of housing in our region.

"Market demand... is the primary determinant of housing prices." You don't say. Like maybe, market demand created by loose lending and low interest rates? The article mentions "increased income and purchasing power," but then goes on to over-emphasizes "our relatively high local wages" (without providing any actual comparative data), and essentially ignores the fact that the "increased purchasing power" comes from loose lending and rock-bottom interest rates.

In the end, our message is simple. We must do more to tackle the housing affordability problem in our region. But, we cannot succeed unless we focus on the facts about what is really driving our housing costs.

I agree completely. Which is why I am so disappointed that in the entire 56-page study, the hand that lending standards and interest rates have had in creating the excessive demand of recent years is essentially completely ignored. Go ahead, search the pdf for "interest rate" or "financing" or "lending." Nada. They also chose to ignore the mass psychology that comes into play when appreciation of an asset is believed to be a "sure thing." In my opinion those are the two biggest reasons that the price of housing has shot up so much in the last few years.

I get the feeling that the purpose of the study wasn't to highlight the true reasons that housing is unaffordable, but rather to prove that growth management isn't the reason. I have said all along that "not enough land" is a bogus argument for skyrocketing prices, but this study does a disservice by ignoring the true driving factors in our recent price run-up.

(Aaron Ostrom & Carla Okigwe, Seattle Times, 01.05.2007)

Elizabeth Rhodes: Master Of Misdirection

Wow, Elizabeth Rhodes is on a real anti-bubble roll this weekend. Did one of you submit this letter to her "Home Forum" Q & A?

Q: I keep reading that home prices aren't expected to decline in the Seattle area. Aren't you overlooking the possible effect of "suicide loans" — those adjustable-rate mortgages that are common and dangerous? I think the interest rates on those loans will go so high that many will be forced into foreclosure. Won't that produce a glut of for-sale homes that will force prices down?

A: Let's start with the basics on those adjustable-rate loans.

The riskiest are teaser-rate loans. These start at an exceptionally low interest rate (like 2 to 4 percent), then reset upward later to a higher rate that can double the borrower's monthly payment. Obviously borrowers who can't refinance out of these loans are at great peril — particularly if their loan has allowed them to make interest-only payments, their home hasn't appreciated much and they have little equity to work with.

However, it's not a given that foreclosure is in their future. If the local economy is robust, jobs are plentiful and housing demand is strong about the time their loan resets, holders of teaser-rate loans have options. They may be able to increase their income and keep the house or find a buyer and escape foreclosure.

Okay I have to stop right there. "They may be able to increase their income"?!? Did she really just say that? Yeah, it's that easy Ms. Rhodes... When Mr. & Mrs. Too Much Homebuyer find that they can't afford to make their payments, why they'll just get new jobs that pay more!

Maybe I'm confused, but aren't there cities right now (San Diego, Sacramento) that have "robust economies" with "plentiful jobs" and yet are still experiencing a decline in prices? It seems to me that the one and only component that matters is that "housing demand is strong." Oh, and incidentally, housing demand is weakening across the nation, and even here in Seattle.

Moving on.

These loans can reset more than once, from one to 10 years after origination — meaning there's no one point at which distressed sellers will flood the market. Obviously, it's impossible to forecast whether the economy will be good years from now, allowing them to ride it out. Maybe it will. Maybe it won't.

Okay, so we admit that basically "who knows" if it'll be a problem or not...

Loan Performance, a San Francisco-based mortgage-information provider, calculates that teaser-rate loans comprise 13 percent of mortgages in the Seattle-Bellevue-Everett area. Since January 2005, teaser-rate foreclosures have consistently been lower than 1 percent a month.

Did you catch what she did there? The question was about adjustable-rate and "suicide" loans in general. However, Ms. Rhodes decided to shift the focus to solely "teaser-rate" loans, and then provided a statistic that shows "only" 13 percent of local mortgages fall under that specific category. What about non-teaser-rate loans such as plain old ARMs, negative amortizing, payment-option, etc.? Excellent use of misdirection, Elizabeth.

Furthermore, of course foreclosures are still going to be low for our area. As long as we're still experiencing double-digit year-over-year appreciation, it's easy to sell or refinance your way out of a risky loan. It's as though Elizabeth forgot the question (or more likely, just didn't feel like answering it), which was about where we're going, not where we've been or are.

I'm not going to bother quoting and responding to the rest of her answer here, because she's obviously chosen to answer a completely different question than what was asked. Go read it for yourself, and if you're convinced that her answer is sufficient, I guess you should go out and buy a house for 10 times your yearly income on a negative-amortizing, payment-option, no-money-down, adjustable-rate loan.

(Elizabeth Rhodes, Seattle Times, 09.30.2006)