Of course, if you believe D.R. Horton, potential home buyers aren't exactly eager to jump in and grab up a bunch of "bargains." In the latest quarter ...
Orders plunged 37% to 9,983 units worth $2.6 billion, compared with 15,771 units worth $4.4 billion in the same period of 2006. There was no solace to be found in the regional breakdown, either. Orders dropped in 6 out of 6 areas of operation.
If you divide the dollar volume of orders by the unit volume for Q2 2006, you get an average price of $276,659. Do the same for Q2 2007 and you get $260,372. That's good for a 5.9% drop.
Cancellation rates remain in the ozone -- at 32% in the period that ended March 31.
Just one data point, of course. But since Horton is the country's 2nd largest builders, it's worth noting the negative commentary out today
Yuck it gets worse - Burns has his hand in the ESPlanner he's promoting with this column-- he's Kotlikoff's co-author -- Dallas Morning News really needs to apologize to its readers for not vetting this -- and making him disclose -- And I quote from this piece about the book (link at bottom):
"Our goal here is not to sell you ESPlanner (although it's a good idea to buy it), but to convince you that taking traditional financial planning advice can be highly dangerous to your financial health". After this decorous disclaimer, perhaps driven by SEC requirements on financial promotions, they go on to make some rather obvious points about international diversification, the property market, and -- more controversially -- the value of gold as an inflation hedge. But the details, sadly, are not available unless you subscribe on the ESPlanner website."
This article seems to assume that people need to either buy now or be renters for the rest of their lives. What if we assume that home prices will fall for the next few years and then will stabilize or even trend up sometime during the period of home ownership. Buying a home with a modest down payment is a very leveraged investment. At some point, it seems safe to assume that home prices are near or past a peak and will fall or at least be stagnant for a while.
He has some nice results there. No analysis, just results.
For example:
It's interesting that the people who pay an additional $26,000 a year (declining over time for increased rent) in cash for, say 30 years will at retirement have nearly the same value in their investments as those who don't.
It's also interesting that the only two options available to the couple is to buy today or rent forever.
While the column was plagued by jargon, the basic premise is reasonable. If you are comfortable and committed to your community and job, and if you take the long view (10-20 years) owning is much better than renting. Just get a fixed-rate amortizing loan, and make the payments and ignore home prices for a while. In 20 years you will look back over the roller coater ride and discover yourself much better off than you were renting.
That said, clearly it is better to buy low than high. In those markets where government land use controls have rigged the market and created the high home prices, the homeowner gets both the risks and rewards of the real estate market fluctuations. But on average and over time, the homebuyer will make more money in those markets than in "normal" markets. But note the caveat- like the man who drowned in the river that averaged two feet deep, the homeowner who loses his job and is forced to sell at a bad time will be worse off in a California-style market than in a Dallas-style market.
He's using an example of a guy making 4X the median income buying the median house. Also, the example guy would probably be in alternative minimum land anyway, so the income tax assumptions are probably way off.
Today's Washington Post has a front page article on mortgage scams. Nothing really new, but I find the details riveting. For example, 50 year old Phillip Hill's fraud in Atlanta involved "400 fraudulent loan applications; nearly $100 million in mortgages; and 120 closing attorneys, appraisers, mortgage brokers and others who prosecutors say were in on the scam."
We live in a world where risk and opportunity cost have no meaning, apparently.
I sold my house last year and chose to rent instead. I can already buy about 10% more house with that money, not counting the interest its been racking up. If prices fall further (they will) I can get even more house in the future.
Furthermore I face virtually no risk of losing a job and not being able to sell etc.
Having had a home and having dealt with the unexpected costs that frequently arise, I can say it's quite a valuable thing to know what your expenses will be each month.
Being able to make concrete plans is a valuable thing indeed.
You know, Burns has been pretty decent overall, but he's clearly selling something here.
There are obviously more assumptions here then can reasonably be made, not the least of which is renting this year, does not imply renting for the rest of your life.
Also, on a smaller scale, there is the simple notion that you would be willing to rent something for a year that you would not be willing to purchase, i.e. a much smaller place with it's much smaller rent. In that case the difference in the rent v. buy cost could easily be $10K more.
I know she's doing yeoman's work at the Dallas Fed, but I wish Danielle DiMartino was still writing for the general public.
Lindsey, was just going to mention DiMartino - she was one of the few voices in the wilderness seeing the bubble mania for what it was.
As for Burns "clearly selling something," it sure isn't clear in that column. It's a very serious ethical lapse as far as he and his paper are concerned not to clearly disclose his financial stake in the companies he is promoting.
This is something that comes up a lot where I live (Monmouth County NJ) as well.
A big part of the problem in places where prices are just totally out of whack is that a guy who makes $150-200K per year really doesn't see himself in a 20- or 30-year-old three bedroom ranch house when there are McMansions down the block and all the other anesthesiologists live there.
I'm just glad I started smoothing my consumption before the market exploded.
Bill Cleary was one of the first to buy a condo in Deere Lofts, in a bustling area in downtown Atlanta. He was lured by the amenities -- hardwood floors, high ceilings -- as well as advertisements glamorizing the area. In 2001, he paid $213,000 for a two-bedroom unit.
Then Hill bought 40 units at a discount from the builder and started flipping them for about $400,000. The non-Hill condos left on the market were quickly snatched up.
But all of Hill's units ended up in foreclosure. Because Hill stopped paying homeowner dues, the condo association nearly went bankrupt and the building went downhill. Three years after Cleary bought his place, comparable two-bedroom units were selling for $130,000. "All of the promises they made went up in smoke," Cleary said of the developers.
But buyers still hold the upper hand, she said. And she has seen that directly at one of her listings. The buyers want everything, she said. Sellers dont want to give up everything. In this house, the seller has reduced the price $50,000. In her mind, she has done all she could do. And now the buyer wants her two favorite chairs.
Normally, wed see two or three for-sale signs in a neighborhood (of ours). Now you can see six to eight, said Joe LaMendola, Centex Homes VP for sales and marketing. Weve always had resales as competition, but not to this extent. We find ourselves having to discount a little bit more to meet what the resales are asking.
Look for how many homes are empty. Theres lots of them, LaMendola says. We dont have that many people transferring out of Albuquerque to have that many houses empty.
When we see a whole bunch of (for-sale) signs on one street and run the ownership (through county records), very frequently well find that almost the whole street will be owned by California investors, said (broker) Kate Southard. I know thats whats happening because the tax bills are being mailed to out-of-state owners.
Reminds me of back in the late 80s I believe, tho my timing may be off. The jingles were on TV and radio: "Now's the time.... Now's the time to buy..."
Oh. Okay. I didn't realize that. Now I'll go out and buy a house. Thanks for telling me.
Yeah, well, vader, if I were buying a house today I'd want two chairs myself. That increases one's odds of survival when the music stops.
But I remain most moved by the idea that that which is virtually impossible is nonetheless beneficial. It is virtually impossible that I will attend seminary and therefore gain the authority to excommunicate all you snotty little apostates, but I can see how that would benefit me anyway.
Oh! Look! It appears that someone put anesthesia in my coffee cup!
It's wonderful we have such modern and sophisticated ways of understanding money. It's no longer MONEY everybody - it's CONSUMPTION. MONEY = CONSUMPTION.
Therefore buying a McMansion for
$1M = More Consumption = a Better Life.
And renting a McMansion for
$2k = Less Consumption = Buying it later for $500k = a Horrible Life
Scott Burns is usually sensible in his advice, but when I read the article, I must say I had the "huh?" reaction as well. Note there were lots of qualifiers and conditions in his example.
But look, we all know the real estate market is in a slow-mo implosion, but there will always be a baseline level of people who has some savings who want to live in a house.
What if the renter put the money he saved by not making that huge house payment in CD's at 5% for the next 30 years? How far ahead of the home buyer would he be?
$200k/year and barely able to make a median priced home?
Frankly, if you want to buy in the bay area (and LA and San Diego) market, you got to practice saying "Thats DOCTOR Trailer Trash to you".
And yeah, even in the inflated market, IF you can hang on for 10-20+ years with a 30 year fixed mortgage, it makes sense to buy, mostly because of the massive hedge against inflation and the wonderful drop in housing costs when you pay off the loan.
But almost nobody is in that situation, and if the knife is still falling, there is no reason not to rent for one more year...
You can be sure the software forgets about all the secondary costs of owning a home. It clearly assumes someone lives in the same house for more than 30 years and does no maintenance, remodeling, etc.
Oh, Bob, don't be silly. Nobody is ever going to have to repair or remodel these McMansions. They're brand-new! They have granite countertops that won't scratch if you use a chainsaw to slice pastrami on them. They have blown-in insulation that has a half-life of one million jillion billion years and can survive a nuclear winter. And everybody knows that the pool fairies come at night and dump chlorine when no one is looking.
The big problem is that with all that square footage, you have to buy so many darned chairs . . .
Ya Bob. You're a party pooper. Just try to sell your facts and numbers to someone who just received a slick marketing piece with smiling models on the cover standing in front of their nice house and new car.
calvert,
I just started to read that article but stopped as the first thing that came to mind was that the people who started the ball rolling are now trying to get out of its way and blame the fraudulent borrowers for their problems so they can get a bailout from the taxpayers.
There is a name for this type of story "journamalism"
"What if the renter put the money he saved by not making that huge house payment in CD's at 5% for the next 30 years? How far ahead of the home buyer would he be?"
It seems like a simple question, does it not? But it is a very complex question - you may see lots of handy-dandy formulas that purport to answer it, but the only real way is to lay out a spreadsheet and include adjustments for cost of living, tax breaks, estimated appreciation, rate of return on alternative investments, etc., etc. If you lay it out well you can look at various house prices, down payments, rental rates and investment returns... and, when you get older like me, what happens when work income stops.
It is an interesting thing to do because it gives you a much better feel for what matters and what does not - and how much.
What really irritated me about this article when I stumbled across it was its sheer disingenuousness. Burns starts out saying that it's a great time to buy a home even when prices are falling, but not until the end of the article does he state that what he meant is that real prices are falling 2%, which means nominal prices (the ones everyone fears are falling) are actually rising. Heck, my cat even knows that real prices in CA are falling TODAY and not just a little.
Then he slips in this ESPlanner stuff, knowing that his catchy little deceptive article will rope in plenty of wanna-be CA homebuyers who he can then market his own product to. Ick.
Ok, ok. I gotta step in and defend Larry the Terrier. Bob, that counts as consumption. They don't say what you spend that money on.
The software is not as sophisticated as Burns makes it sound. Monte Carlo simulations give the most likely outcome, but I shouldn't have to spend $150 on a program to do that. Any 2nd year engineering or math undergrad should be able to do this type of simulation on an Excel sheet uning a few scripts and visual basic commands. But Burns is writing for a Dallas audience, so if it plugs into the wall and does more than burn toast, it must be high tech. (Sorry, shouldn't stereotype) It basically says that you should figure out what your lifetime income will be, and smooth consumption to match that. Ideally, you croak the second you get penniless. The software just does a time value of money calculation of savings, income, and consumption and creates a profile that will enable the highest overall uniform consumption over a lifetime. It then stress tests this assumption by varying the rates of return using Monte Carlo simulation, to arrive at some amount of money you can spend ($X) per year, with some confidence interval (Y%) that you won't outlive your money. I's sure it works great if we assume that the likeliness of economic outcomes follow a normal or exponential distribution, but I'm sure it grossly underestimates "fat tail effects", and it will probably fall to pieces if the distribution of returns used to model the expected returns going into the Monte Carlo simulation was pulled from actual performance in the last 30 years. But garbage data in yields garbage data out, albeit with great precision.
Burns is NOT an economist. Kotlikoff is, and the majority of his work is superb. "The Coming Generational Storm" should be required reading. But Burns chose Arlo's job as an anesthesiologist for a reason, and it's more than the good income. The key requirement is that he probably will never have to move unless he wants to. His wife isn't working, and he's in a profession that is largely independent of the economy.
In the earlier work, Burns and Kotlikoff took housing out of the equation entirely. Burns plays a dirty trick here, but Burns is right, it doesn't really matter a whit to Arlo when he buys, assuming he's happy with what he can afford, and can afford a house that he will want to live in for the next 30 years.
By nailing down the housing cost, we have eliminated one of the costs that would be simulated with a distribution in the Monte Carlo simulation. Remember the rule! Variability always hurts you in the long run. If we eliminate the variability, the confidence interval will get tighter. It does not necessarily mean that the most likely outcome has changed. Without giving us the mean outcome along with the standard deviation and confidence levels, Burns is only telling us part of the story.
From reading his previous work and attending a few of his lectures, it is cl
brewster, in the One True and Universal Church of the Sacred Mortgage of Jesus I am about to form for tax purposes, what you have just quoted is known as the "nunc dimwittedness."
Thanks Alo and many others for seeing this article for what it is: a demonstration of our home economic muscles that we have developed here at CR (possibly a few other blogs too).
My estimate of Kotlikoff just took a dive with this heist...he must be struggling to pay off his mortgage to be associated with this $150 heist.
The article assumes that the house is bought under traditional terms, which is impossible for many would-be buyers today. The real choice for many people is between:
- renting now
- buying with some funky I-O or teaser rate loan which will reset sharply higher a few years later.
Needless to say, for these would-be borrowers renting is a much better choice.
The article struck me as being very stupid. It assumes a situation in which homes are not overvalued to this extent. There are some people in some areas who will do better long-term by buying now, and they ARE buying. Prices in areas which aren't inflating are going up even while prices in all the inflated areas are dropping.
Your column is drivel. Your analysis is totally flawed, even if you believe the soundness of the software for life consumption. If prices are dropping over the next few years, which they MOST certainly are, then you need to do your calculations not statically. In other words, how do the results look if I buy today, in one year and in two years (at ever lower purchase prices). A decrease of 4.5% (using your stated decline for San Diego, which will accelerate in the future IMHO) will more than offset the decrease in property taxes that you state (which by the way is flawed as well as CA has Prop 13, which holds property tax increases down). So even if a person is better off to buy in general, I guarantee you that they will always be better off financially if they pay less for a house, WHICH WILL BE THE CASE.
From reading some of Kotlikoff's previous work and attending a few of his lectures, I know that Larry understands this. I'm not sure if his co-venture partners do, and I'm not sure if Scott does. Larry's an academic through and through, so I'm not sure if he's thought about the consequences that would happen if everyone strictly adhered to the ESPlanner guidelines. I'm also not sure if Larry has not made the classical "Merton mistake", where phi is simply characterized as a normal distribution to make the math easier, and because it was a nice lift from some of the Brownian motion equations. (look at the Black-Scholes option pricing equations to see what I'm talking about). These type of specific models consistently underestimate "fat tails" or "black swans".
Not to mention that I'm sure Dr and Mrs Anesthesiologist-First-Time-Home-Buyer will be perfectly happy to stay in their starter home for the next 30 years.
That's soooooo common, isn't it?
(And please, choosing an anesthesiologist with a starting salary of $200k a year as your case study? That's just insulting his readers.)
Semper,
I don't think he's trying to insult, rather he's trying to bifurcate the readers. Those who would finish the article and be satisfied with the content would also be willing to drop $150 for software that spits out unsubstantiated lies.
The software might well work...but if you let a monkey operate the controls and make the assumptions, you can fairly well guarantee that the "results" it spits out aren't worth the time invested in punching the keyboard.
I also sent Burns an email asking why he assumed the renter would never buy. Comparing Arlo to someone who waits another year or two and buys at a lower price would be more interesting.
This is the greatest miracle. No more do we live in fear of falling home prices, or living beyond our means, or under water in debt. Fear no more, for here is the joy foretold, the hope fulfilled.
Scott Burns himself, (one of the few who was warning about the bubble) believes now. The home with it's consumption-maximization utility, is the savior.
OK, I tried to read the article, but it makes absolutely no sense to me at all.
Is it all about increasing consumption now? (nevermind savings or even building wealth - whatever that may mean to you)
Although the cost of owning the house takes $55,942 of their income in the first year vs. $30,000 for renting they'll enjoy $95,560 of real annual consumption, over and above shelter expenses, for the rest of their lives. All other assumptions equal, they'd have $91,370 of consumption as renters.
Dense academic language! Why, he must be a genius! -- Let me get my checkbook and cough up that $150 post haste.
Lotta geniuses out there (no small number of them from Cato -like the Kotlikoffers) trying to shoehorn the real world into some dreamy ideal model or theory.
From the Article:
" Renters have another liability. To smooth their consumption, they need to save more because rent rises with inflation while the mortgage is fixed and shrinks in real value each year. The cash to balance that comes from other consumption."
The mortgage is fixed? Explain that to the people who have ARMs, which is lots of people in California. Maybe the analysis just doesn't apply to those people...
Dead thread again, but fwiw I think dilbert upstairs might have read that wapo article too quickly. Fraudsters like Hill, the main subject of the article, are not the "subprime borrowers" buying over their heads that the original spin tried to make into the chief villains. Hill is a pro, who might or might not have been operating strictly on his own account:
Described as soft-spoken but charismatic, Hill broke into the city's elite circles by throwing lavish parties at an estate a few blocks from the Georgia governor's mansion. Influential people began coming to him for their housing needs. Hill rented homes to several prominent Atlanta figures, including Robert L. Nardelli, the former chief executive of Home Depot.
Prosecutors said Hill and his accomplices sought short-term loans from friends and associates, including business leaders and professional athletes. The ring bought homes, then transferred them to straw buyers Hill had recruited. Using inflated appraisals and other doctored papers, the group took out big mortgages that allowed it to repay the short-term loans and pocket hefty sums.
Some home prices were inflated by 100 percent or more. One estate was pumped from $1.9 million to $5.5 million in two weeks, according to court documents. Hill's personal take from the scheme is estimated at $14.5 million, prosecutors said.
Prosecutors think most of the straw buyers, some just college students, did not know what Hill was doing with their names and credit histories. Several later testified that Hill's attorney flipped through loan documents so fast at closing that they hardly read what they were signing. Most apparently thought they were becoming the owners of homes Hill would maintain and rent out to make the monthly payments.
The methodology is similar to what Milken, Keating, and that ring was convicted of in the S&L/junk bond matter in the early 1990s. The reason it worked for them, and for Hill and others these days, is that in a relatively small but growing market niche, like maybe the downtown condo market in one city, an initially small group of manipulators can have a critical effect on prices and timing. In talking about the housing market, and especially its financials, we often take a macro view from which perspective it seems impossible for an operator of Hill's size to have significant influence. But that national, macro market is a collection of stratified local ones.
(cont.)
(cont. from above)
There's direct social harm in these frauds and manipulations as in the articleand notice that the honest condo buyer suffered harm not apparently because he had overborrowed and expected to refi in a market that was probably spoiled in part by Hill; that buyer's loss is partly a real loss because of the financial trouble that Hill put the condo association in, per yesterday's post at CR. But there's also social cost in the pattern Hill's "business model" sets, until he gets caught at least, for less sophisticated people who imitate the "smart money, " or who listen to the shills that follow on after the Hills and their "smart money" have pumped the market. I don't yet know whether anyone has tried to estimate or illustrate how small a manipulation has to be to swing a local RE market, but some surveys of the S&L case, like the famous Akerlof-Romer (Brookings Papers, 1993) study called "Looting" seem to say that the jokers don't have to make up very much of the deck.
This kind of operator is not the only cause of the disaster that appears to be taking shape, as our hardworking expert hosts here have been documenting, but they are likely to have been a critical element in seeing to it that those bubbles get inflated. We will probably see them uncovered in many bubble markets, behind chains of what appear to be smaller frauds or simply unsuitable but naïve borrowers like Hill's college students.
$200k base salary as an "ass"umption in his analysis. Helpful to most of us? Not! How about using the San Diego median income of $58k with the rest of your "ass"umptions? Is foreclosure the end result.
Tanta writes:
Oh, Bob, don't be silly. Nobody is ever going to have to repair or remodel these McMansions. They're brand-new! They have granite countertops that won't scratch if you use a chainsaw to slice pastrami on them. They have blown-in insulation that has a half-life of one million jillion billion years and can survive a nuclear winter. And everybody knows that the pool fairies come at night and dump chlorine when no one is looking.
The big problem is that with all that square footage, you have to buy so many darned chairs . . .
Tanta | 04.10.07 - 10:05 am | #
Just when I was planning to buy. Do you think house price will resume going up soon after I buy ?
damn, i will be in trouble if house prices keep soaring...
Speaking of foreclosures, the San Diego trustee deeds number for March is out. The drop in February to 408 (from 457 in January) was a statistical blip as we all expected. The March number is 509. March 2006 was 106, March 2005 was 28.
http://www.sddt.com/Finance/graphs/f24dfbf237ac4c339a5230af2ef.png
Notices of default show the same trend, now at 1517 for March 2007.
http://www.sddt.com/Finance/graphs/925c51f96d17f897d7cd5004520.png
economists' consumption-smoothing approach
That sounds soooo stupid...
Hmmm. Exponential or linear increase?
Burns and Kotlikoff (mr. smoothing software) co-bylined an article in 2006 about this very theory. I smell conflict of interest with my coffee:
http://people.bu.edu/kotlikoff/A%20Smoother%20Way%20to%20Save%20for%20Your%20Future,%20The%20Boston%20Globe%2004-16-2006.pdf
Of course, if you believe D.R. Horton, potential home buyers aren't exactly eager to jump in and grab up a bunch of "bargains." In the latest quarter ...
Just one data point, of course. But since Horton is the country's 2nd largest builders, it's worth noting the negative commentary out today
Yuck it gets worse - Burns has his hand in the ESPlanner he's promoting with this column-- he's Kotlikoff's co-author -- Dallas Morning News really needs to apologize to its readers for not vetting this -- and making him disclose -- And I quote from this piece about the book (link at bottom):
"Our goal here is not to sell you ESPlanner (although it's a good idea to buy it), but to convince you that taking traditional financial planning advice can be highly dangerous to your financial health". After this decorous disclaimer, perhaps driven by SEC requirements on financial promotions, they go on to make some rather obvious points about international diversification, the property market, and -- more controversially -- the value of gold as an inflation hedge. But the details, sadly, are not available unless you subscribe on the ESPlanner website."
Powell's Books - Review-a-Day - The Coming Generational Storm: What You Need to Know about America's Economic Future by Laurence Kotlikoff, reviewed by Times Literary Supplement
This article seems to assume that people need to either buy now or be renters for the rest of their lives. What if we assume that home prices will fall for the next few years and then will stabilize or even trend up sometime during the period of home ownership. Buying a home with a modest down payment is a very leveraged investment. At some point, it seems safe to assume that home prices are near or past a peak and will fall or at least be stagnant for a while.
He has some nice results there. No analysis, just results.
For example:
It's interesting that the people who pay an additional $26,000 a year (declining over time for increased rent) in cash for, say 30 years will at retirement have nearly the same value in their investments as those who don't.
It's also interesting that the only two options available to the couple is to buy today or rent forever.
While the column was plagued by jargon, the basic premise is reasonable. If you are comfortable and committed to your community and job, and if you take the long view (10-20 years) owning is much better than renting. Just get a fixed-rate amortizing loan, and make the payments and ignore home prices for a while. In 20 years you will look back over the roller coater ride and discover yourself much better off than you were renting.
That said, clearly it is better to buy low than high. In those markets where government land use controls have rigged the market and created the high home prices, the homeowner gets both the risks and rewards of the real estate market fluctuations. But on average and over time, the homebuyer will make more money in those markets than in "normal" markets. But note the caveat- like the man who drowned in the river that averaged two feet deep, the homeowner who loses his job and is forced to sell at a bad time will be worse off in a California-style market than in a Dallas-style market.
He's using an example of a guy making 4X the median income buying the median house. Also, the example guy would probably be in alternative minimum land anyway, so the income tax assumptions are probably way off.
Today's Washington Post has a front page article on mortgage scams. Nothing really new, but I find the details riveting. For example, 50 year old Phillip Hill's fraud in Atlanta involved "400 fraudulent loan applications; nearly $100 million in mortgages; and 120 closing attorneys, appraisers, mortgage brokers and others who prosecutors say were in on the scam."
Housing Boom Tied To Sham Mortgages - washingtonpost.com
We live in a world where risk and opportunity cost have no meaning, apparently.
I sold my house last year and chose to rent instead. I can already buy about 10% more house with that money, not counting the interest its been racking up. If prices fall further (they will) I can get even more house in the future.
Furthermore I face virtually no risk of losing a job and not being able to sell etc.
Having had a home and having dealt with the unexpected costs that frequently arise, I can say it's quite a valuable thing to know what your expenses will be each month.
Being able to make concrete plans is a valuable thing indeed.
You know, Burns has been pretty decent overall, but he's clearly selling something here.
There are obviously more assumptions here then can reasonably be made, not the least of which is renting this year, does not imply renting for the rest of your life.
Also, on a smaller scale, there is the simple notion that you would be willing to rent something for a year that you would not be willing to purchase, i.e. a much smaller place with it's much smaller rent. In that case the difference in the rent v. buy cost could easily be $10K more.
I know she's doing yeoman's work at the Dallas Fed, but I wish Danielle DiMartino was still writing for the general public.
Lindsey, was just going to mention DiMartino - she was one of the few voices in the wilderness seeing the bubble mania for what it was.
As for Burns "clearly selling something," it sure isn't clear in that column. It's a very serious ethical lapse as far as he and his paper are concerned not to clearly disclose his financial stake in the companies he is promoting.
Max makes a great point.
This is something that comes up a lot where I live (Monmouth County NJ) as well.
A big part of the problem in places where prices are just totally out of whack is that a guy who makes $150-200K per year really doesn't see himself in a 20- or 30-year-old three bedroom ranch house when there are McMansions down the block and all the other anesthesiologists live there.
I'm just glad I started smoothing my consumption before the market exploded.
Here's a little gem re yesterday's article:
Hardest-hit by the scheme were honest homebuyers. Mortgage fraud experts estimate that Hill's scam, and others like it, have put several thousand homes into foreclosure, driving down values.
Bill Cleary was one of the first to buy a condo in Deere Lofts, in a bustling area in downtown Atlanta. He was lured by the amenities -- hardwood floors, high ceilings -- as well as advertisements glamorizing the area. In 2001, he paid $213,000 for a two-bedroom unit.
Then Hill bought 40 units at a discount from the builder and started flipping them for about $400,000. The non-Hill condos left on the market were quickly snatched up.
But all of Hill's units ended up in foreclosure. Because Hill stopped paying homeowner dues, the condo association nearly went bankrupt and the building went downhill. Three years after Cleary bought his place, comparable two-bedroom units were selling for $130,000. "All of the promises they made went up in smoke," Cleary said of the developers.
And now the buyer wants her two favorite chairs
But buyers still hold the upper hand, she said. And she has seen that directly at one of her listings. The buyers want everything, she said. Sellers dont want to give up everything. In this house, the seller has reduced the price $50,000. In her mind, she has done all she could do. And now the buyer wants her two favorite chairs.
Normally, wed see two or three for-sale signs in a neighborhood (of ours). Now you can see six to eight, said Joe LaMendola, Centex Homes VP for sales and marketing. Weve always had resales as competition, but not to this extent. We find ourselves having to discount a little bit more to meet what the resales are asking.
Look for how many homes are empty. Theres lots of them, LaMendola says. We dont have that many people transferring out of Albuquerque to have that many houses empty.
When we see a whole bunch of (for-sale) signs on one street and run the ownership (through county records), very frequently well find that almost the whole street will be owned by California investors, said (broker) Kate Southard. I know thats whats happening because the tax bills are being mailed to out-of-state owners.
HBB
Reminds me of back in the late 80s I believe, tho my timing may be off. The jingles were on TV and radio: "Now's the time.... Now's the time to buy..."
Oh. Okay. I didn't realize that. Now I'll go out and buy a house. Thanks for telling me.
Maybe it's all the advertisers' fault.
Yeah, well, vader, if I were buying a house today I'd want two chairs myself. That increases one's odds of survival when the music stops.
But I remain most moved by the idea that that which is virtually impossible is nonetheless beneficial. It is virtually impossible that I will attend seminary and therefore gain the authority to excommunicate all you snotty little apostates, but I can see how that would benefit me anyway.
Oh! Look! It appears that someone put anesthesia in my coffee cup!
It's wonderful we have such modern and sophisticated ways of understanding money. It's no longer MONEY everybody - it's CONSUMPTION. MONEY = CONSUMPTION.
Therefore buying a McMansion for
$1M = More Consumption = a Better Life.
And renting a McMansion for
$2k = Less Consumption = Buying it later for $500k = a Horrible Life
Brilliant.
Scott Burns is usually sensible in his advice, but when I read the article, I must say I had the "huh?" reaction as well. Note there were lots of qualifiers and conditions in his example.
But look, we all know the real estate market is in a slow-mo implosion, but there will always be a baseline level of people who has some savings who want to live in a house.
Oh! Look! It appears that someone put anesthesia in my coffee cup!
That wasn't me. I had my DEA license pulled years ago.
effect of lower MEW??
China surplus takes surprise dive
Trade edge drops to $6.87 billion from $23.8 billion in February, but analysts ascribe change to tax law.
CNNMoney.com: 404 Page Not Found
That wasn't me. I had my DEA license pulled years ago.
Guess you won't be catching any falling knives. Tylenol just isn't enough for that.
What if the renter put the money he saved by not making that huge house payment in CD's at 5% for the next 30 years? How far ahead of the home buyer would he be?
$200k/year and barely able to make a median priced home?
Frankly, if you want to buy in the bay area (and LA and San Diego) market, you got to practice saying "Thats DOCTOR Trailer Trash to you".
And yeah, even in the inflated market, IF you can hang on for 10-20+ years with a 30 year fixed mortgage, it makes sense to buy, mostly because of the massive hedge against inflation and the wonderful drop in housing costs when you pay off the loan.
But almost nobody is in that situation, and if the knife is still falling, there is no reason not to rent for one more year...
Pardon my French, but what a load of shit....
You can be sure the software forgets about all the secondary costs of owning a home. It clearly assumes someone lives in the same house for more than 30 years and does no maintenance, remodeling, etc.
Oh, Bob, don't be silly. Nobody is ever going to have to repair or remodel these McMansions. They're brand-new! They have granite countertops that won't scratch if you use a chainsaw to slice pastrami on them. They have blown-in insulation that has a half-life of one million jillion billion years and can survive a nuclear winter. And everybody knows that the pool fairies come at night and dump chlorine when no one is looking.
The big problem is that with all that square footage, you have to buy so many darned chairs . . .
A leveraged investment is a leveraged investment.
With a "home" you get a tax break on interest, a roof over your head, and a high probability of price appreciation.
But it's still a leveraged investment.
Good luck, Arlo. I believe there are boxcars on "The City of New Orleans".
Ya Bob. You're a party pooper. Just try to sell your facts and numbers to someone who just received a slick marketing piece with smiling models on the cover standing in front of their nice house and new car.
calvert,
I just started to read that article but stopped as the first thing that came to mind was that the people who started the ball rolling are now trying to get out of its way and blame the fraudulent borrowers for their problems so they can get a bailout from the taxpayers.
There is a name for this type of story "journamalism"
I need a head banging pillow, stat!
"What if the renter put the money he saved by not making that huge house payment in CD's at 5% for the next 30 years? How far ahead of the home buyer would he be?"
It seems like a simple question, does it not? But it is a very complex question - you may see lots of handy-dandy formulas that purport to answer it, but the only real way is to lay out a spreadsheet and include adjustments for cost of living, tax breaks, estimated appreciation, rate of return on alternative investments, etc., etc. If you lay it out well you can look at various house prices, down payments, rental rates and investment returns... and, when you get older like me, what happens when work income stops.
It is an interesting thing to do because it gives you a much better feel for what matters and what does not - and how much.
An unmentioned cost is opportunity cost. A owned home ties a worker to a local area. Renting does not.
What really irritated me about this article when I stumbled across it was its sheer disingenuousness. Burns starts out saying that it's a great time to buy a home even when prices are falling, but not until the end of the article does he state that what he meant is that real prices are falling 2%, which means nominal prices (the ones everyone fears are falling) are actually rising. Heck, my cat even knows that real prices in CA are falling TODAY and not just a little.
Then he slips in this ESPlanner stuff, knowing that his catchy little deceptive article will rope in plenty of wanna-be CA homebuyers who he can then market his own product to. Ick.
Ok, ok. I gotta step in and defend Larry the Terrier. Bob, that counts as consumption. They don't say what you spend that money on.
The software is not as sophisticated as Burns makes it sound. Monte Carlo simulations give the most likely outcome, but I shouldn't have to spend $150 on a program to do that. Any 2nd year engineering or math undergrad should be able to do this type of simulation on an Excel sheet uning a few scripts and visual basic commands. But Burns is writing for a Dallas audience, so if it plugs into the wall and does more than burn toast, it must be high tech. (Sorry, shouldn't stereotype) It basically says that you should figure out what your lifetime income will be, and smooth consumption to match that. Ideally, you croak the second you get penniless. The software just does a time value of money calculation of savings, income, and consumption and creates a profile that will enable the highest overall uniform consumption over a lifetime. It then stress tests this assumption by varying the rates of return using Monte Carlo simulation, to arrive at some amount of money you can spend ($X) per year, with some confidence interval (Y%) that you won't outlive your money. I's sure it works great if we assume that the likeliness of economic outcomes follow a normal or exponential distribution, but I'm sure it grossly underestimates "fat tail effects", and it will probably fall to pieces if the distribution of returns used to model the expected returns going into the Monte Carlo simulation was pulled from actual performance in the last 30 years. But garbage data in yields garbage data out, albeit with great precision.
Burns is NOT an economist. Kotlikoff is, and the majority of his work is superb. "The Coming Generational Storm" should be required reading. But Burns chose Arlo's job as an anesthesiologist for a reason, and it's more than the good income. The key requirement is that he probably will never have to move unless he wants to. His wife isn't working, and he's in a profession that is largely independent of the economy.
In the earlier work, Burns and Kotlikoff took housing out of the equation entirely. Burns plays a dirty trick here, but Burns is right, it doesn't really matter a whit to Arlo when he buys, assuming he's happy with what he can afford, and can afford a house that he will want to live in for the next 30 years.
By nailing down the housing cost, we have eliminated one of the costs that would be simulated with a distribution in the Monte Carlo simulation. Remember the rule! Variability always hurts you in the long run. If we eliminate the variability, the confidence interval will get tighter. It does not necessarily mean that the most likely outcome has changed. Without giving us the mean outcome along with the standard deviation and confidence levels, Burns is only telling us part of the story.
From reading his previous work and attending a few of his lectures, it is cl
I'm at a loss for words, so I'm going to echo Simeon's, when Jesus was presented at the temple.
Lord, now lettest thou thy servant depart in peace, according to thy word: For mine eyes have seen thy salvation
brewster, in the One True and Universal Church of the Sacred Mortgage of Jesus I am about to form for tax purposes, what you have just quoted is known as the "nunc dimwittedness."
I love people who make decisions for someone else when they have no skin (money) in the game.
I also love people who love to tell other people how to invest (spend) their money when they themselves don't have any.
Thanks Alo and many others for seeing this article for what it is: a demonstration of our home economic muscles that we have developed here at CR (possibly a few other blogs too).
My estimate of Kotlikoff just took a dive with this heist...he must be struggling to pay off his mortgage to be associated with this $150 heist.
Oh my goodness!!
"This happens because they will benefit from declining real estate taxes"
I need a blowdryer for my keyboard.
The article assumes that the house is bought under traditional terms, which is impossible for many would-be buyers today. The real choice for many people is between:
- renting now
- buying with some funky I-O or teaser rate loan which will reset sharply higher a few years later.
Needless to say, for these would-be borrowers renting is a much better choice.
The article struck me as being very stupid. It assumes a situation in which homes are not overvalued to this extent. There are some people in some areas who will do better long-term by buying now, and they ARE buying. Prices in areas which aren't inflating are going up even while prices in all the inflated areas are dropping.
Sent the following email to Scott Burns:
Your column is drivel. Your analysis is totally flawed, even if you believe the soundness of the software for life consumption. If prices are dropping over the next few years, which they MOST certainly are, then you need to do your calculations not statically. In other words, how do the results look if I buy today, in one year and in two years (at ever lower purchase prices). A decrease of 4.5% (using your stated decline for San Diego, which will accelerate in the future IMHO) will more than offset the decrease in property taxes that you state (which by the way is flawed as well as CA has Prop 13, which holds property tax increases down). So even if a person is better off to buy in general, I guarantee you that they will always be better off financially if they pay less for a house, WHICH WILL BE THE CASE.
Haloscan ate the end of my comment!
From reading some of Kotlikoff's previous work and attending a few of his lectures, I know that Larry understands this. I'm not sure if his co-venture partners do, and I'm not sure if Scott does. Larry's an academic through and through, so I'm not sure if he's thought about the consequences that would happen if everyone strictly adhered to the ESPlanner guidelines. I'm also not sure if Larry has not made the classical "Merton mistake", where phi is simply characterized as a normal distribution to make the math easier, and because it was a nice lift from some of the Brownian motion equations. (look at the Black-Scholes option pricing equations to see what I'm talking about). These type of specific models consistently underestimate "fat tails" or "black swans".
Not to mention that I'm sure Dr and Mrs Anesthesiologist-First-Time-Home-Buyer will be perfectly happy to stay in their starter home for the next 30 years.
That's soooooo common, isn't it?
(And please, choosing an anesthesiologist with a starting salary of $200k a year as your case study? That's just insulting his readers.)
Semper,
I don't think he's trying to insult, rather he's trying to bifurcate the readers. Those who would finish the article and be satisfied with the content would also be willing to drop $150 for software that spits out unsubstantiated lies.
Um, oooookay. Even I think that argument in the article is ridiculous.
The software might well work...but if you let a monkey operate the controls and make the assumptions, you can fairly well guarantee that the "results" it spits out aren't worth the time invested in punching the keyboard.
Ha lama - that's surely it! I wonder what his response rate is?
I also sent Burns an email asking why he assumed the renter would never buy. Comparing Arlo to someone who waits another year or two and buys at a lower price would be more interesting.
Tanta,
This is the greatest miracle. No more do we live in fear of falling home prices, or living beyond our means, or under water in debt. Fear no more, for here is the joy foretold, the hope fulfilled.
Scott Burns himself, (one of the few who was warning about the bubble) believes now. The home with it's consumption-maximization utility, is the savior.
This title reminds me of the children's song... reworked a bit.
"Catch a falling knife and put it in your pocket - never let it fade away."
Scott Burns!
Surely, I must be confusing him with some other guy who writes for the DMN.
OK, I tried to read the article, but it makes absolutely no sense to me at all.
Is it all about increasing consumption now? (nevermind savings or even building wealth - whatever that may mean to you)
Although the cost of owning the house takes $55,942 of their income in the first year vs. $30,000 for renting they'll enjoy $95,560 of real annual consumption, over and above shelter expenses, for the rest of their lives. All other assumptions equal, they'd have $91,370 of consumption as renters.
WTF?
brewster
"Beware of the false prophets who come to you in sheep's clothing,
But inwardly are ravenous wolves. You will know them by their fruits.
Matthew 7:15
I believe this is more fitting if were talking about mortgages and re these days.
Continued from earlier:
More about the method. http://people.bu.edu/kotlikoff/CaseStudy7-2-02.pdf
More about the math and dynamic programming technique.
http://people.bu.edu/kotlikoff/New%20Kotlikoff%20Web%20Page/The%20AK%20OLG%20Model%20Its%20Past,%20Present%20and%20Future.pdf
Having met the guy, I'd say he definitely falls into the "Not a Quack" category. The links provide some nuance for somebody.
Hopefully, the links will provide some additional nuance for somebody. (Warning- dense academic language lies ahead)
Dense academic language! Why, he must be a genius! -- Let me get my checkbook and cough up that $150 post haste.
Lotta geniuses out there (no small number of them from Cato -like the Kotlikoffers) trying to shoehorn the real world into some dreamy ideal model or theory.
From the Article:
" Renters have another liability. To smooth their consumption, they need to save more because rent rises with inflation while the mortgage is fixed and shrinks in real value each year. The cash to balance that comes from other consumption."
The mortgage is fixed? Explain that to the people who have ARMs, which is lots of people in California. Maybe the analysis just doesn't apply to those people...
Alo,
Go back and read my earlier comments. It should give you an idea of what I think.
I did Glen, especially this part:
"I'm not sure if he's thought about the consequences that would happen if everyone strictly adhered to the ESPlanner guidelines."
Dead thread again, but fwiw I think dilbert upstairs might have read that wapo article too quickly. Fraudsters like Hill, the main subject of the article, are not the "subprime borrowers" buying over their heads that the original spin tried to make into the chief villains. Hill is a pro, who might or might not have been operating strictly on his own account:
The methodology is similar to what Milken, Keating, and that ring was convicted of in the S&L/junk bond matter in the early 1990s. The reason it worked for them, and for Hill and others these days, is that in a relatively small but growing market niche, like maybe the downtown condo market in one city, an initially small group of manipulators can have a critical effect on prices and timing. In talking about the housing market, and especially its financials, we often take a macro view from which perspective it seems impossible for an operator of Hill's size to have significant influence. But that national, macro market is a collection of stratified local ones.
(cont.)
(
(cont. from above)
There's direct social harm in these frauds and manipulations as in the articleand notice that the honest condo buyer suffered harm not apparently because he had overborrowed and expected to refi in a market that was probably spoiled in part by Hill; that buyer's loss is partly a real loss because of the financial trouble that Hill put the condo association in, per yesterday's post at CR. But there's also social cost in the pattern Hill's "business model" sets, until he gets caught at least, for less sophisticated people who imitate the "smart money, " or who listen to the shills that follow on after the Hills and their "smart money" have pumped the market. I don't yet know whether anyone has tried to estimate or illustrate how small a manipulation has to be to swing a local RE market, but some surveys of the S&L case, like the famous Akerlof-Romer (Brookings Papers, 1993) study called "Looting" seem to say that the jokers don't have to make up very much of the deck.
This kind of operator is not the only cause of the disaster that appears to be taking shape, as our hardworking expert hosts here have been documenting, but they are likely to have been a critical element in seeing to it that those bubbles get inflated. We will probably see them uncovered in many bubble markets, behind chains of what appear to be smaller frauds or simply unsuitable but naïve borrowers like Hill's college students.
$200k base salary as an "ass"umption in his analysis. Helpful to most of us? Not! How about using the San Diego median income of $58k with the rest of your "ass"umptions? Is foreclosure the end result.
This was fun:
Tanta writes:
Oh, Bob, don't be silly. Nobody is ever going to have to repair or remodel these McMansions. They're brand-new! They have granite countertops that won't scratch if you use a chainsaw to slice pastrami on them. They have blown-in insulation that has a half-life of one million jillion billion years and can survive a nuclear winter. And everybody knows that the pool fairies come at night and dump chlorine when no one is looking.
The big problem is that with all that square footage, you have to buy so many darned chairs . . .
Tanta | 04.10.07 - 10:05 am | #