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Many people have a weird obsession with homeownership.
When it comes to buying a house, they are willing to overlook, or even completely throw out, a bunch of financial values and principles they claim to hold dear.
The unfortunate truth is, for many middle-class folks, buying a house is often a very silly financial decision, especially if they are young (in their 20s or early 30s), or have a low net worth.
A well diversified portfolio
The most mind-boggling thing I’ve come across is that most people who punt the importance and wisdom of home ownership, will also tell you they believe you should have a well diversified investment portfolio.
“Spread your investments over many asset classes.”
“Don’t put all your eggs in one basket.”
And so on.
Well, for the average middle-class-30-year-old Joe, buying a house is akin to gathering up all his eggs, borrowing another 9 times as many, and putting them all together into one basket.
Not only is the the average middle-class-30-year-old-home-owner Joe way over-invested in exactly one asset class (residential property), he is also completely undiversified within that asset class, since he owns exactly one property, in exactly one area, based in exactly one town, located in exactly one country.
In short, it’s just about the most undiversified investment portfolio a person could dream up and manage to get himself into.
Leverage basically comes down to borrowing money to invest in something.
If you invest R1,000,000 in something, but you borrow R900,000 and only use R100,000 of your own money, then you have an investment in which you are leveraged 10:1.
That 10:1 is called the leverage ratio of your investment. And it is 10:1, since the thing you’re investing in is worth 10 times as much as the cash you put in.
Leverage is great if the thing you invested in grows a lot in value over a short period of time, because it allows you to make a lot of money by investing only a small portion of your own cash!
Unfortunately, the reverse is also true.
If the thing you invested in loses value, then it is very easy for you to lose a lot of money – even more than the initial amount you put in!
While Warren Buffet’s ethics may be a stinker, I do agree with his views on employing leverage:
- If you’re smart, you don’t need leverage. If you’re dumb, you have no business using it.
- Warren Buffet
Even though, over the long-term, returns made on equities outperformed returns made on property, by far, almost no sane person will leverage themselves 10:1 to invest in equities (i.e. shares).
For most people, this is way too nerve wrecking to even consider. If you suggest such a thing, you might be labelled a gambler, or worse, a madman.
And yet, everyday, average middle-class-30-year-old Joes all around me are buying properties in which they are leveraged 10:1 (and even more), without a second thought.
After spending many months thinking about this phenomenon I can only put it down to the fact that the truth doesn’t matter.
It’s just another asset class
In case you think I have a deluded and deep seated mistrust of property that most likely stems from a childhood nightmare of being swallowed by a house, let me just make my position official:
I have zero issues with investing in residential property.
Residential property is just another asset class.
I don’t currently, but I have in the past allocated a portion of my investment portfolio to residential property (both locally and abroad), by buying shares in publicly listed companies whose business it is to buy and rent out houses and flats.
I just don’t view residential property as a magic-unicorn-galloping-over-a-rainbow-of-profits type of investment with which “you can never go wrong”.
I’ve spent a significant portion of my adult life looking for investments like those, but unfortunately I haven’t found one yet.
Liability and Liquidity
If you are still adamant that you want to invest in residential property, then I have a great suggestion for you:
Why don’t you just buy some shares in publicly listed companies whose business it is to buy and rent out residential properties?
If you do some research and choose a good one, chances are that they are better than you at spotting and buying well-priced properties and collecting rent, because that is what the people who work for those companies do for a living.
There are also some other advantages about investing in residential property by buying shares in publicly listed companies.
- You can have a more diversified investment portfolio: By only buying a few shares you are able to limit your exposure to residential property to a reasonable percentage of your net worth.
- You have limited liability: If the company goes bust, you will not be liable for any losses. Comparatively, if you buy a property using debt and, for whatever reason, become bankrupt and can’t afford to make the bond payments, then you most likely have quite a few years of hell to look forward to.
- Shares in publicly listed companies are liquid: If you ever need to do so in a hurry, it will only take you about 5 minutes and a few key-strokes to sell all the shares you hold in almost any publicly listed company. Selling a house, on the other hand, is a ludicrously expensive multi-month administrative nightmare.
Interest rates and timing your property purchase
Residential property is an asset class that is very directly influenced by the cost of borrowing money.
In our society, it is considered a perfectly normal and responsible thing for a person to finance the purchase of a house by getting a 20-year loan from a bank.
In fact, it is considered such a normal thing for the average middle-class-30-year-old Joe to be a debt slave for most of his life, that if you had to suggest to him that he should save up for a house and only purchase it once he had saved up enough money to buy it outright, using cash, he will probably think that you are crazy to even suggest such a thing.
But, I digress.
My point is, the vast majority of residential properties are paid for using borrowed money.
Because of this, when interest rates go up, so do monthly bond payments. When bond payments go up, some people can’t afford to make their bond payments and they are forced to sell their homes, or default on their bond. A few actually do default, resulting in a seizure and forced sale of their properties by the bank.
To summarize: When interest rates go up, property prices fall (or increase very slowly, usually at a rate lower than inflation), because the available supply of residential properties increases, while at the same time the demand for residential properties decreases. Conversely, when interest rates go down, residential property prices usually go up quickly, because more people can afford to take out bigger loans!
The first rule of business is: buy low, sell high.
This is such an obvious concept and yet, in practice, it is very difficult to do, because it usually means doing the exact opposite to what everyone around you is doing.
If you are going to buy a property, for whatever reason, then at least buy it at the best possible time.
And when would that be?
Well, of course, a few months after interest rates hit their peak after having risen quickly for two or three years in a row.
Take a look at the graph below, which shows the prime interest rate in South Africa over the last few decades.
2014 started with interest rates at record lows and just entering an upward cycle.
In my opinion, the present is just about the worst possible time for anyone to be invested in residential property.
You will know it is the right time to buy your dream home by looking for a few of these signs:
- Interest rates are starting to stabilize at a high rate, after rising steadily for two or three years in a row.
- Many people are trying to sell their properties, some in a real panic, because they are struggling to make their monthly bond payments.
- You hear many tales of properties being foreclosed on, also in neighbourhoods where people are considered to be wealthy.
- People around you are generally feeling quite negative about owning property.
When the blood is in the streets, my friends, that is the ideal time to buy your dream home.
Paying rent is simply throwing away money every month
I often hear people making this argument. I’m sorry, but that is just a silly thing to say.
Upon purchasing the average middle-class-suburbia home, you’re not only paying a massive amount of TAX to the government, you’re also forking over a significant amount in fees for bond registration, deeds and a bunch of other stupid banalities. Never mind the commission that goes to the estate agent.
Property tax, commission and other fees can easily add up to over 15% of the purchase price of a house. This makes residential property one of the most expensive asset classes to invest in, at least as far as up-front costs are concerned.
Then, once your bond is registered and you are the proud owner of your new home, you’ll be paying interest to a bank, every month, until your bond is paid off.
And don’t forget about maintenance! You know… paint starts peeling, roof start leaking, toilet stops flushing, that type of thing.
Lastly, you’ll also be forking out on a monthly basis for rates & taxes. Which,as property owners in Greece found out just recently, can easily go up by sevenfold in two years, if your government is anything like most governments are.
Safe-haven investment my ass.
Except for squatting on someone else’s land, there’s no such thing as living for free.
So are you saying no one should ever own a house?
No, of course not.
I’m saying people should save up for their family homes and buy them cash.
The saving part should be done by building a well diversified investment porfolio and the home buying part should be treated as an expense, rather than the purchase of an asset.
I know… in the world we live in I’m very much on my own in suggesting such a boring and outdated thing.
But I’ve looked at the facts, and even though I’m well aware that the truth doesn’t matter, I also know that nothing matters to anybody until it matters to everybody – and by then it’s too late.
If you disagree or find a flaw in my logic, please leave a comment below. I’d love to be proven wrong, and I’m willing and eager to consider any counter arguments.
Janet Yellen’s role as the nation’s slumlord is masked by her apparent distance from the Fed’s money spigot and the resulting institutional ownership of the nation’s rental housing stock.
Please welcome the nation’s new chief slumlord, Janet Yellen. The previous top slumlord, Ben Bernanke, has retired from the position of Chief Slumlord (i.e. chair of the Federal Reserve) to the accolades of those who benefited from his extraordinary transfer of wealth from the many to the few.
Why is the chairperson of the Fed the nation’s top slumlord? Allow me to explain.We only need to understand two facts to understand the Fed’s role as Slumlord.
1. Rental housing has long been a decentralized, locally owned industry. Over 90% of rental properties under 50 units have historically been owned by individuals or couples: the nation’s landlords have historically been Mom and Pop, middle-class folks who saved capital and used those savings to buy a single-family home or small apartment building (duplex, triplex, four-plex) as an investment that they own and manage.
Very few amass a huge portfolio of properties, as few have the income or assets (i.e. the collateral) to leverage the purchase of dozens of rental properties.
Buildings up to four units qualify for conventional mortgages; small rental properties are not considered commercial properties like strip malls or large apartment complexes.
This diverse, local ownership provided a wide spectrum of residential rentals. The wider the variety of rentals and owners, the greater the diversity of prices, locales and requirements. This is the essence of free enterprise: sellers (landlords) and buyers (renters) agree to price and conditions in a dynamic, open and adaptive marketplace.
2. No Mom and Pop real estate investor can compete with financial institutions who can borrow unlimited sums of money from the Federal Reserve at near-zero rates of interest.
Let’s start by asking what happens to the price of real estate when mortgages fall from 8% interest to 4%: prices basically double, because buyers can “afford” to pay more at low rates of interest.
When conventional mortgage rates are 8%, a rental that costs $200,000 requires a 30% down payment in cash (because the buyers are not owner-occupants) or $60,000. The simple interest on a $140,000 mortgage is about $11,200 annually. (Let’s use simple annual interest for simplicity’s sake.)
At 4%, the price can double to $400,000, with a 30% down of $120,000 and a mortgage of $280,000, and the mortgage accrues the same $11,200 in annual interest.
Declining interest rates push real estate prices higher.
At first glance, this doubling in price doesn’t seem to affect the cost of ownership. But that is deceptive; consider how many households can scrape up $120,000 in cash compared to the number who can scrape up $60,000. The higher the price, the bigger the down payment required. The higher the down payment, the fewer the number of households who can accumulate that much cash.
To households that live paycheck-to-paycheck, both sums are out of reach. But a significant number of middle class households could accumulate $60,000: such a sum could come from a family house that was sold and divided amongst the offspring, for example, or a Solo 401K that allows the retirement fund to own real estate, or from saving $5,000 a year for 12 years.
The Federal Reserve’s Zero Interest Rate Policy (ZIRP) was designed to push real estate prices higher. The Fed’s public justification was “the wealth effect”: the idea was that as the family home increased in value, homeowners would begin to borrow and spend more money due to their increased home equity.
The second Fed goal was to increase home sales by lowering mortgage rates, theoretically enabling more marginal buyers to buy a home. But since prices rise as mortgage rates drop, this goal is mooted unless marginal buyers are also given a free ride on down payments and qualifying income, i.e. offered near-zero down payments and no-document mortgage qualification processes.
But zero interest rates and unlimited liquidity don’t just push real estate prices higher–they give institutions with access to the Fed’s nearly-free money an unbeatable advantage over Mom and Pop real estate investors.
Imagine being able to borrow $400,000 at 1% with zero collateral. You can now buy the rental property for cash, and pay only $4,000 in simple annual interest. And you didn’t have to put up a dollar of actual collateral to buy the property.
Consider the huge advantages you now have over the competing Mom and Pop bidders. Sellers typically prefer cash offers, so your cash offer (of Fed money) is more attractive than Mom and Pop’s loan-based bid.
If the price jumps to $500,000, Mom and Pop are blown out of the water: they don’t have the additional $30,000 cash required as collateral.
Thanks to the Fed, you don’t need any collateral. You can borrow $500,000 as easily as $400,000, and the increase in annual interest is trivial: a mere $1,000.
Now consider the operating costs: you have a $7,000 annual advantage because you have access to the Fed’s nearly-free money. Mom and Pop have to pay $11,200 in simple annual interest, while you pay only $4,000. A property that is break-even to Mom and Pop reaps you a $7,000 annual profit, just because you can borrow money from the Fed for next to nothing.
Now multiply the $400,000 and the $7,000 by 1,000. Now you can buy $400,000,000 of rental properties and skim $7,000,000 in annual profits, just from the advantage of having access to the Fed’s quantitative easing (QE) nearly-free money.
Any advantages you can accrue from economies of scale from owning tens of thousands of rental properties are also yours to keep, courtesy of the Fed.
Now you understand why Janet Yellen is the nation’s new top slumlord. Her policies of unlimited liquidity, QE and zero interest rates directly enable financial Elites to beat out Mom and Pop rental housing investors and buy tens of thousands of rental properties at will.
Access to free money and near-zero interest rates gives institutional buyers a built-in advantage over Mom and Pop rental property owners: no collateral and free profits from super-low rates available to those closest to the Fed’s QE money spigot.
Institutional ownership turns the rental housing stock into a Fed-enabled financial monoculture. Individual Mom and Pop owners may not require a credit check, or they might not raise the rents very often; the odds that you will be treated as a human being are higher because the scale of the operation is small and local.
To Fed-enabled Institutional landlords, you are an income stream to be skimmed.You will be processed and managed remotely, and variations are not allowed, as they mess up the profit machine.
Fed-enabled Institutional landlords may or may not hire competent, responsive managerial firms to manage their thousands of properties: from the point of view of Fed-enabled Institutional landlords, the lower the costs, the larger the profits. One way to lower costs is to not respond to tenant complaints or requests for service. Another is to hire the lowest-cost (and likely understaffed) management firm.
Janet Yellen’s role as the nation’s slumlord is masked by her apparent distance from the Fed’s money spigot and the resulting institutional ownership of the nation’s rental housing stock. But guess what, Chairperson Yellen: we’re not fooled. Your phony facade of “progressivism” doesn’t mask your real role as the nation’s top slumlord.
Spanish loan delinquencies as a percentage of the total have risen for the 8th straight month to a new record high of 13.00% (even as sovereign bond spreads continue to plunge to multi-year lows signaling all is well). With unemployment rates stuck stubbornly high, however, reality is starting to dawn in the Spanish banking system as mortgage defaults are rising following the Bank of Spain’s order for lenders to review their portfolios. As Bloomberg reports, the default rate for Banco Santander alone jumped to 7% (from 3.1%) following its “reclassification” of loans that it had refinanced (never expecting to be repaid) and with home prices still falling, “there is an urgency to come clean” as regulators see the need for banks to cover a further EUR5 billion shortfall in provisions.
The slow-and-steady rise in deliquencies smacks of an industry that is dripping out there problems – hiding facts from reality and the spike for Banco Santander is merely highlighting the mis-statement…
With Spain’s persistently high unemployment rate now at 26 percent, the couple is among the 350,000 homeowners who may be foreclosed upon by lenders in the next two years as the housing crisis worsens, according to AFES, a Madrid-based association that advises on restructuring debt. Since 2008, about 150,000 families have been hit with a foreclosure.
“We refinanced three years ago, but now the noose is around our necks,” Males, 42, said. “Not only do we still owe more than the original loan. We’re losing our home as well.”
As mortgage defaults rise, lenders will have to set aside money to cover losses, hurting profits, according to Juan Villen, head of mortgages at Spanish property web site Idealista.com. Spanish banks absorbed 87 billion euros ($120 billion) of impairment charges last year after Economy Minister Luis de Guindos forced them to record more defaults on loans to developers. The government took 41 billion euros in European assistance to shore up its failing lenders.
Defaults are rising partly because of changes required by the Bank of Spain that force lenders to book more soured mortgages.
“When the real estate bubble burst in 2008, banks used refinancing en masse to cover up non-performing residential mortgage loans,”
Which led to a broad loan review…
In April, the Bank of Spain ordered lenders to review their portfolios of refinanced loans, including mortgages, to make sure they’re classified in a uniform way. Lenders had 208 billion euros of loans on their books that they’d restructured or refinanced as of the end of 2012, according to the regulator.
The review led the regulator to the preliminary conclusion that classifying all refinanced loans correctly would cause a 21 billion-euro increase in defaults. Lenders would need to generate a further 5 billion euros of provisions to cover the losses.
The default rate for Banco Santander SA (SAN)’s Spanish mortgages jumped to 7 percent in September from 3.1 percent in June as it reclassified loans that it had refinanced.
“As a bank this will be the main focus area, whether you are properly recording your non-performing loans, especially the refinanced ones,” said Alexander Pelteshki, an analyst at ING Financial Markets in Amsterdam. “There is an urgency to come clean.”
But it’s not going to get better any time soon…
“Until Spain starts creating jobs and credit starts flowing again, house prices aren’t going to recover,” Beatriz Toribio, head of research at Fotocasa, said. “We expect further price declines, albeit smaller than in previous years, in 2014.”
- Wells Fargo mortgage exec: No shadow inventory of property (bizjournals.com)
- Thousands more job cuts at big banks (bizjournals.com)
- Where Does Mortgage Money Come From And Why Should I Care (mortgagelasvegas.wordpress.com)
- TREASURIES-U.S. bond prices trim gains after Fed’s Beige Book (xe.com)
- Treasury Lying About Debt: Bachmann (hispanicbusiness.com)
- Fed Keeps $85 Billion Bond Buying Pace, Sees Disinflation Risk – Bloomberg (bloomberg.com)
- Standard Treasury Wants to Bring Banks into the 21st Century (programmableweb.com)