Cash will be King
It's amazing how many real-estate related direct mail ads I get these days. I just got one for some real estate expo, imagine that, I couldn't stop laughing. I don't know how I got on their list, but they sure wasted their time sending it to me.
These ads are incredibly polar, either how to make your fortune in the real estate market, or how to profit when the real estate market crashes. I'm actually quite surprised about the latter, those guys really don't waste any time. Psychology really is changing much faster than I imagined.
I've been thinking about position lately, when the RE market crashes, how does the average person position themselves to best take advantage. The more I went through the scenarios, the more complicated that position became.
Here is the simplified scenario:
Market crashes, homes lose 40% of their value
Buyer sweeps in, picks up a bargain, lives happily ever after
Now, I really don't think this would happen. Why? What are the mortgage rates? Have lending standards changed? How much of a down payment do these new buyers have?
Gets more complicated for sure. Lending standards would definately be stepped up, as would interest rates, so the average 'buyer' would need to have their 20% down plus closing costs, as well as good credit. Taking all these factors into account, has 'affordability' changed at all? No. I don't think so, if you compare the PITI of two scenarios, a home at 6% and that same home reduced 15% with an 8% mortgage, the monthly payments are about the same. So, if prices fall about 15%, and mortgages jump to 8%, there really is no change to the average buyer. In fact, if lending standards are tightened significantly, I might argue that even though prices have fallen, homes are still no more affordable.
So gee, that scenario fizzled out. And, I think it's one of the main arguments against bargain hunters keeping the market elevated during a crash. If homes aren't necessarily more affordable, the price might changed, but the situation didn't. So if anyone is waiting around to pick up 20 condos using 0% down IOs after the crash, sorry, not going to happen. For the average joe that wants to buy a home, but doesn't have a down payment? Sorry, you won't be able to get a decent rate mortgage unless you've got your 20%.
So doing nothing but sitting around doesn't improve your position much. So how do you benefit given the a large decline in price? Cash. Accumulate as much as you can. You will make out like a bandit if you can put down very large down payments. The more the better, 30, 40, 50% down or even more. This shields you from the premium associated with a higher rate mortgage, as well as gives you a bit of a cushion to ride out any recession. If you don't want to put the money down, but hold it in other assets, fine, you can pay the mortgage premium for the luxury of holding cash, but you need to have it.
So this is what I'm doing to position myself to take advantage of a decline, accumulate cash, take advantage of rising interest rates, I've only got 20% of my money in the market, the rest is in laddered short-term CDs. Save every penny you can. Pay off any debt you might have and clean up your credit (although I'm sure most savvy readers here have no debt and substantial cash on hand). Unless you have cash on hand, homes are going to be just as unaffordable after a crash as they are now.
So pass on the conspicuous consumption, pass on the hummer, plasma tvs, expensive toys, etc.. Live humble. Break the habit of immediate gratification. Any pain you incur for the lifestyle change now will be rewarded in the future. The easy money will be long gone and cash will be king again.
Caveat Emptor,
-grim
These ads are incredibly polar, either how to make your fortune in the real estate market, or how to profit when the real estate market crashes. I'm actually quite surprised about the latter, those guys really don't waste any time. Psychology really is changing much faster than I imagined.
I've been thinking about position lately, when the RE market crashes, how does the average person position themselves to best take advantage. The more I went through the scenarios, the more complicated that position became.
Here is the simplified scenario:
Market crashes, homes lose 40% of their value
Buyer sweeps in, picks up a bargain, lives happily ever after
Now, I really don't think this would happen. Why? What are the mortgage rates? Have lending standards changed? How much of a down payment do these new buyers have?
Gets more complicated for sure. Lending standards would definately be stepped up, as would interest rates, so the average 'buyer' would need to have their 20% down plus closing costs, as well as good credit. Taking all these factors into account, has 'affordability' changed at all? No. I don't think so, if you compare the PITI of two scenarios, a home at 6% and that same home reduced 15% with an 8% mortgage, the monthly payments are about the same. So, if prices fall about 15%, and mortgages jump to 8%, there really is no change to the average buyer. In fact, if lending standards are tightened significantly, I might argue that even though prices have fallen, homes are still no more affordable.
So gee, that scenario fizzled out. And, I think it's one of the main arguments against bargain hunters keeping the market elevated during a crash. If homes aren't necessarily more affordable, the price might changed, but the situation didn't. So if anyone is waiting around to pick up 20 condos using 0% down IOs after the crash, sorry, not going to happen. For the average joe that wants to buy a home, but doesn't have a down payment? Sorry, you won't be able to get a decent rate mortgage unless you've got your 20%.
So doing nothing but sitting around doesn't improve your position much. So how do you benefit given the a large decline in price? Cash. Accumulate as much as you can. You will make out like a bandit if you can put down very large down payments. The more the better, 30, 40, 50% down or even more. This shields you from the premium associated with a higher rate mortgage, as well as gives you a bit of a cushion to ride out any recession. If you don't want to put the money down, but hold it in other assets, fine, you can pay the mortgage premium for the luxury of holding cash, but you need to have it.
So this is what I'm doing to position myself to take advantage of a decline, accumulate cash, take advantage of rising interest rates, I've only got 20% of my money in the market, the rest is in laddered short-term CDs. Save every penny you can. Pay off any debt you might have and clean up your credit (although I'm sure most savvy readers here have no debt and substantial cash on hand). Unless you have cash on hand, homes are going to be just as unaffordable after a crash as they are now.
So pass on the conspicuous consumption, pass on the hummer, plasma tvs, expensive toys, etc.. Live humble. Break the habit of immediate gratification. Any pain you incur for the lifestyle change now will be rewarded in the future. The easy money will be long gone and cash will be king again.
Caveat Emptor,
-grim
11 Comments:
Good advice unfortunately for many they are cash poor and house rich. This will change however as the asset housing declines.
It's all relative. If rates go up the seller may get less money on the house but makes up for it in higher interest rates on the invested capital.
4.25% cd's vs 7% cd's.
Homeowners that own outright.
So if a house is 750k now but goes down to $450k look at interest $750,000 at current 4.25% 5 year or about $32k a year income. Now $450,000 at 7% 5 year is about $31,500.
Houses are going down big. But the big losers in all of this is the buyers that overpaid in last 5 years. The other homeowners should be okay..
"has 'affordability' changed at all?"
In a few ways, afforability improves under the secenario you present. First, your down payment also goes down 15%. Second, for same sized payment, the interest portion and hence the tax benefit increases. Third, you have a shot at lower property taxes stemming from a reduced property value.
Finally, if rates ever fall again, you'll have an opportunity to refi at a lower rate.
For the same sized payment, I want the highest note rate possible
what downpayment? According to Mtg bankers association 42% put nothing down to buy a house. 72% put down less than 10%.
So it's good to pay more in interest? Cuz you get a measely tax break that caps out.
Affordability doesn't improve at all it's a wash at best.
That's if noone uses their House equity as an ATM machine. We know that a majority of refi's many are taken out 105-110% more than their current loan.
Your sceraio will not pan out for many that have bought in the last 3-5 years.
what if rates go to 10%?
What about that?
You know this happened before in the late 1970's early 1980's.
This would literally crush home prices, but of course those with equity in their home after the collapse would be able to invest that capital at 10% per $100k = good return. So a $750k house drops to $300k so 4.25 % cd $750k in equity is $32k and $300k equity is $30k.
In 1979, my parents bought a house with the owner holding the note. Rates were so high, and the r/e market was so depressed, the desperate owner financed the deal. Don't be surprised to find a lot of owner financing in the future.
"So it's good to pay more in interest? Cuz you get a measely tax break that caps out."
FOR THE SAME SIZED PAYMENT, my answer is YES.
"what downpayment?"
That's *your* assumption, not mine. I'm assuming 30 year fixed self-amortizing, 20% down.
The Bottom line is a house like anything else is worth only what the next guy is willing to pay for it and the seller has to agree to it.
So why can't housing drop 20-30% in short order. This will happen under distress or forced sales. The other sellers will be in denial and will not accept.
I expect many distressed sales forced sales in next 2 years.
The point I was trying to make is that buyers who find the market unaffordable today may be in the same situation in two years from now because lending standards may tighten significantly. Sure, homes may be 40% lower, however, if you can't get a loan because you still don't have the DP, have bad credit, or are saddled with other debt (all things today's lenders don't seem to care about), you are still in the same position, you still can't afford to buy a home.
Now, if you have enough for a DP today and can afford to buy a home now but choose not to be the greater fool, you will be the winner, because you have the cash.
grim
You are correct lending standards are like a pendulum. From slick/giveaway to fort Knox.
If you can't save a down payment then you should not be able to buy a house. This is not a God given right to own a house. It's something that must be earned and appreciated. Today, we have a bunch of wantabee home owners up to their eyeballs in debt and should not be in a house.
In the end prudence and thrift do pay off. For the last 5 years anyone with these traits looked like a fool, but now it's payback time. Many of the new age Real estate moguls will be learning lessons of a lifetime.
People today are living far beyond their income capabilities and there will be a price to pay for it. Many sleepless nights or plain bankruptcy. Cycles come and go and this one will be no different than other periods of speculation and irrational behavior. It happens throughout history. But I must say this one has gone far beyond any others that I have studied. probably similar to the Japanese bubble of late 1980's whereby real estate dropped about 60%.
I've been trying to keep an eye on the wires for NJ related real-estate news. More eyes don't hurt, so if anyone sees any stories that would make good topics, post a reply or email me, and I'll post it up.
Thanks,
grim
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