Page 1 of 2 Risk - not price - is a true home guide
By Axel Merk
After renting four homes in the San Francisco Bay Area this decade, I bought a
house last month. I had been a long-time advocate of renting rather than
buying, so what drove me to buy a house now? Has the time come to buy a house
as an inflation hedge? Buying a house should be a matter of risk, not price.
First, let's look at prices. Home prices have come down substantially in areas
where subprime lending was most prevalent, but have held up better in more
affluent areas. In Palo Alto, where I bought my house, prices are down, but not
by much compared to the run-up in prior years. One reason is that the typical
Palo Alto homebuyer had a greater financial buffer and
may have been able to hold off selling their home if they don't like current
market prices.
There is also less pressure in more affluent neighborhoods because of
foreclosures; note, by the way, that the recent abatement in foreclosures on a
national level is mostly a reflection of bottlenecks in processing foreclosures
- the pipeline of homes in various stages of default has continued to grow
steadily. The reality is that many higher end homes in Silicon Valley have been
bought with "options money" - that is, the cashing in of previously awarded
stock options.
However, the number of potential homebuyers able to purchase with "options
money" is presently very small. As a result, while home prices in higher-end
neighborhoods in Silicon Valley have held up longer, the downward pricing
pressures may last longer. A similar analysis can be applied to other regions;
further, as baby boomers retire, fewer McMansions will be needed, putting
long-term pressure on high-end real estate. As a result, my assessment is
high-end real estate is likely to lag in any housing recovery.
In the same context, consider the trend to have bonuses vest over years with
claw-back provisions (in what may be the beginning of a trend, Goldman Sachs
just eliminated the cash element on bonuses for its top executives). While that
may be healthy (although never underestimate the creativity of con artists
amongst them to hide their dealings throughout the vesting period), that is bad
news for New York and Connecticut luxury goods dealers and real estate; New
York Governor David Paterson has realized that tax revenues have also
evaporated, and is now urging banks to pay bonuses. But I digress ...
A lot has been said about the affordability of homes; even with the price
adjustments to date, a dual income family can barely afford a home. Fifty years
ago, a single breadwinner in the family with an average income was able to
afford a house. Because of various government subsidies - whether through
subsidized loans (think Fannie Mae, amongst others) or artificially low
interest rates - home prices have been pushed to artificially high prices. Many
of these policies are put in place with the best of intentions, but all efforts
to make homes more "affordable" have actually done the opposite for future
buyers. If you want affordable home prices, don't subsidize buyers.
Fannie Mae was established in 1938 to promote home ownership to low-income
families; the scheme it promotes lasted for 70 years before it imploded and the
government had to take Fannie Mae into conservatorship. Few have noticed that
Fannie Mae, now that it is a quasi-government branch, continues to have access
to the Federal Reserve's discount window. That's akin to the Treasury borrowing
from the Fed, rather than issuing bonds to finance its spending.
The policies are designed to push home prices higher. That's because when a
great number of home owners are under water (owing more on the property than it
is worth) in their mortgages, they may stop spending, pulling the US consumer
"machine" to a grinding halt. And that's policy makers' worst nightmare, as it
jeopardizes their re-election odds.
What is different about the current bust is that the Federal Reserve has teamed
up with politicians to push home prices higher at just about any cost:
ultra-low interest rates and aggressive intervention in the mortgage market
through purchases of mortgage-backed securities (MBS) stems against natural
market forces playing out.
Simplistically speaking, homeowners who are under water in their mortgages have
a couple of choices:
Homeowners can work harder to earn more and pay off excess debt. Though, while
that may happen on select cases, it is unlikely real wages will soar anytime
soon.
Homeowners can downsize. That's the healthiest choice as someone who downsizes
will once again be able to save and one day, possibly, be able to afford that
larger home. However, a homeowner who is subsidized to stay in a home they
cannot afford may never be able to save, as all the family's hard-earned money
is continually poured into the home; that person won't have the savings,
either, to fix the roof or take care of other ongoing maintenance issues
associated with home ownership. However, downsizing implies foreclosures,
bankruptcies, bank write-offs, not the type of headlines that get politicians
re-elected.
Receive a government bailout through inflation. If real home prices won't move
up, the Fed can try to engineer a higher price level by flooding the market
with freshly printed dollars. Just a few days ago, Fed chairman Ben Bernanke
once again emphasized how going off the gold standard during the Great
Depression allowed the Fed to allow the price level to rise. He cherishes that
"flexibility". Of course, it's difficult to engineer just where that inflation
will fall, but if you create enough inflation, odds are that home prices may
also rise.
Potential homebuyers will find reasons why prices should be lower; once they
switch to being homeowners, many find thousands of reasons to justify why their
home's value should be higher! However, when faced with such opposing forces,
the decision to buy a home should not be an assessment of price, but one of
risk. Can you afford not just the monthly mortgage payments, but can you afford
it should the price of your home come down? Market forces warrant lower home
prices to bring them in line with incomes; as such, that risk must be taken
into account, even if we trust helicopter Ben to create house price inflation.
When discussing sustainable investing choices in my book SustainableWealth,
I list renting rather than buying as a sacrifice. Beyond the reasons given
here, Patrick Killelea in his blog eloquently lists many reasons why "it's
still a terrible time to buy". Yet, when you rent, you have few rights as a
tenant and you may be asked to leave your property when your lease is up;
often, leases are only a year. In my personal situation - we have four children
- it's not that easy to find a rental home that satisfactorily accommodates us,
and every move is a hassle.
Is it worth the many thousands one can save a year when renting? Looking at the
pocket book, yes; but it is more of a sacrifice than, say, saving money with a
low-budget vacation instead of spending vast amounts for a stay at a luxury
resort. My wife did also make the point that she would like to own a home
before the kids are in college (our oldest is 12; our youngest two).
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