The Real Estate Bubble: An Analysis

The key points covered in the below video are as follows:

1) A panic to buy has merged into a panic to sell.

2) Prices are coming down.

3) The greatest competition is being seen among builders of new homes.

Over the past 3  years, homebuyers have been buying at a frenzied pace, signing documents and wiring funds before even seeing a house.  If they didn’t, the house would be gone before morning.  The internet has transformed the real estate industry from “what is right for me” to “what looks good on a computer screen”.  My advice?  Never buy real estate sight unseen.  True, a good real estate deal won’t last more than a day, but if you can’t due your proper due diligence, you may get stuck with a nightmare.  And keep in mind, times are changing.  Don’t throw out a blind bid, because unlike a year ago, the house will most likely be there tomorrow… and the next day.

No doubt over the past year you’ve been asking yourself, “when is the price hike going to stop?”.  Depending on your location.  It may have already happened.  Do not be one of those hopeless romantic investors who believe that anything they buy will appreciate enough in a year to pay for itself, because it is not going to happen.  Everyone is accustomed to 15, 20, and 30% gains, and they don’t know anything but “boom-time-pricing”.  If you live in a place where home prices have grown at rates 5-10 times rents and wages, you’re in for a big correction.  However, there are still places like Seattle and Portland where job growth is strong and rents are pegged to jump.

The final key comment made in the video  is that the most heated competition has been seen between builders of new homes.  Why?  Because many new homes don’t close until they are actually completed, and buyers who put down deposits months before the market turn are walking away from the contracts.  Why?  Because they realize the house they bought is now worth much less than they paid for it.  This touches on my previous post on “investing in pre-constructed” homes.  You’re buying in today’s dollars something that will be delivered at a future date, at which time the true value might be completely different.

The Real Estate Bubble…

           ^ Just Click the Play Button. 

Still thinks it’s a good idea to put a deposit on a home that won’t be built for a year?  Analysis to come.

Adventures in Money Making Fights Back

Yesterday I posted a response to another bloggers praise of investing in pre-constructed homes. Within hours there were two responses to my comments (see comments attached to Target: Adventures… below). My responses were as follows:

Fist of all Mr. Adventure, thank you for modifying the post.

Second, you ask why I am so critical of blogs, and the answer is simple. In fact, it’s spelled out on the top of my page, to mitigate the damage caused by reckless financial bloggers. You may be asking yourself, “does this mean that I am a reckless financial blogger?”. Indeed it does, and your response epitomizes my point. You say “do you think people rush and invest based on what they read in someone’s blog? People spend thousands on seminars, books, lectures and mentorships and still never do anything.” Two words: ignorant and irresponsible. Your words clearly illustrate that you heed no care in the messages that you deliver. In reality, you have no idea who could be reading your page.

So do I think it possible for someone to find an investing concept on a blog and pursue it blindly? Absolutely. Why do you think investors (or potential investors) surf these financial blogs? To figure out what’s working for others. The problem is that reckless bloggers trying to boost site stats will rave hallelujahs about an investing technique, but completely forgo all mention of risks and pitfalls. That is what I am battling.

And finally, you wonder if I am one of those people who never do anything, and just sit around passing judgment? Let’s be clear, when I say that you are shortsighted and irresponsible, that is passing judgment. However, when I pick apart your strategies and techniques with sound arguments and experience, that is called analyzing. I have more experience with home builders than anyone reading your blog, so where is the harm in enlightening them as to where you come up short?

If you’re confident in what you say and do, then by all means, keep writing. Just try not to get too bent out of shape when I turn your follies into a textbook.

H&R Block: Let’s Talk Scam

As a jump-off for this discussion, does anyone currently use H&R Block for tax preparation or consulting? I’m wondering what their fees are like, and if they offer any other services. Your comments are appreciated.

Target: Adventures in Money Making – Topic: Speculative Investing

My passion is real estate.  Buying, selling, renting, or renovating.  I’ve read more books than I can recall, and spoken with more seasoned investors than I knew existed.  There are a few basic truths to real estate, a number of which are universal to all investing, the most important of which is as follows:

There is no free lunch.  In other words, if something seems too good to be true, it often is.  If you come across a reckless blogger like moneymaker.blogspot.com convinces you of a sure bet investment, odds are he hasn’t even researched it, rather he’s just picked it up from another unqualified adviser.

In his post How to Invest in Pre-Construction Flips, Moneymaker writes as follows (see my commentary in italics):

I recently tied up some SFHs in Boise, Idaho. The plan is to put down a small deposit, wait for six months until the homes are complete and then sell them for a profit. While it sounds very simple, there are some important rules to follow.

Essentially, he is buying a dirt lot, surrounded by other dirt lots, at some potentially arbitrary price determined by the builder.  There are no comparable sales to use for price analysis.  He is betting on the fact that by the time the homes are actually built, the market will have solidified a price somewhat higher than what he has agreed to pay.  The question then is this: how can this yield such good returns?  The answer is simple: the potential return of any investment will be directly correlated to the amount of risk assumed by the investor. 

The reason that the builders are selling the homes on what appear to be the low end of market value is because they don’t even know the true value, and they haven’t sold any units yet.   When these spec (speculative) communities are built (communities of homes built without having buyers pre-arranged), prices generally start low for the first buyers, and then grow as the builder gets a better idea for the demand of the homes.  This could be either really good, or really bad for an early buyer.  If you get in early and it turns out that there is little demand for the homes in that community, then prices will be lowered in order to continue with sales flow.  As a result, early buyers are immediately “upside down” in their homes.  In other words, they owe more to the bank than the house is worth.  In order to sell the home and pay off the bank, buyers have to come out of their pockets with the extra funds.  On the other hand if you buy into the community at $300K, and the final home is sold for $450, you’ve just built a quick $150K in equity.  

In the event that prices decrease, you have a few choices:  If you are living in the home as your primary residence, then there is no sense in selling.  Stick it out and wait for prices to bump up a little.  If you purchased the home for speculative/investing purposes, you can either try to sell it (in which case you’d end up owing more than you paid), or rent it out.  I’m sure however that you will find that new construction is not meant to be a rental property, and the house will operate at a significant loss (due to the gross overpayment).

1. Make sure you target an area where there is strong price increase.  After you subtract closing costs, real estate commissions and maybe holding costs, the property needs to have risen sufficiently enough to make a decent profit. example: I’ve tied up homes for $190k [included closing costs] and they’re already worth $250k even though they’re a few more months from build-out.

   Need this be said?  Whenever you’re buying a home, whether for investing or personal residence, make sure that it is in an area where prices have been historically strong and stable.  For example, a good bet is always something relatively near a body of water, or a busy, active city.  Look for the intangibles that will maintain demand even when demand in “cookie cutter” neighborhoods is lacking.
   

2. Make sure the area is experiencing actual population and job growth.

   A good comment.  Keep up to date with the population flow in your surrounding areas to determine where it is most desirable to live.  Many people make the mistake of only considering cheaper, low rent areas for investment because the prices are more affordable.  If you can achieve the same cap rate (gross annual rents divided by purchase price) in a $200k property as you can in a $100k property, and you can afford the $200k, buy it.  Eventually, your goal should be to manage as many asset dollars as possible, and which would you prefer:  1) manage 10 properties in a $1 million portfolio, or 5 properties in a $1million portfolio?  Half the tenants = half the headaches.  Also, more likely than not, prices in the nicer neighborhoods will rise or at least remain stable.
   

3. You want to ensure that the price growth isn’t just fueled by rampant investor speculation.  If so, when it comes time to sell, you won’t have any buyers.

   I couldn’t have said it better myself.  It’s very likely that you’ll have investors bidding up prices amongst themselves, creating a false demand, and then when it comes time to flip, they’re all in hot water, and the builder is on vacation in Tahiti.
   

4. Make sure you get in at the right time in the Cycle.  You don’t want to be left holding the bag at the tail end of a cycle like some Pulte home investors in Las Vegas.  After they closed, Pulte reduced the prices by as much as $100k.

   For such a “slam dunk” of an investment, it sure sounds risky, doesn’t it?  What scares me about investing in new construction, is that you buy something often times over a year before it will actually built.  In other words, you’re on pins and needles for a year hoping that the market doesn’t go south before your home is even standing.  How do you know what demand will be like in a year?  A market can flip overnight, and you’ll be left holding the bill.
   

5. Stick to bread and butter homes.  I’m buying between 1600-2000 sq ft homes in the sub 250k price range [depending on the market].  Don’t go for the super luxury homes.  That just increases your risk.  Instead go for several b&b homes.  That spreads your risk.

   Generally speaking, he’s fairly on track here.  Whether you buy new or existing construction, always position yourself such that you will have the greatest number of people competing for the home when it comes back on the market.  Although I don’t condone this investing philosophy, if you do chose to pursue it be sure not to stash all your eggs in one basket (one big house).  Why?  Although there may be some above average returns to be made, there is also an above average risk of failure.  Theoretically, if you have the guts to stay in it for a while, it should pan out in your favor .  Think of it as if you were the dealer in black jack.  There’s a good chance you’ll come out ahead if you keep sticking your money out there.  But how many times are you willing to lose before you call it quits?
   

6. Make sure you get a home inspection done.  Sometimes in a new home, the electrical won’t work or the plumbing is jacked up [because the contractor dumped plaster down the toilet].  Dont’ skimp on this $300 investment.

   A no brainer.  New or existing construction, always have an inspection.  If you are financing the purchase, it should be required by the lender.

7. Try to work out a deal with your agent.  If you use them to resell the property, ask if they’ll give you a discount on the listing fees.  Try and work out a deal with the builder.  Sometimes if you buy bulk, the builder will work out a deal with you. [difficult, but worth a shot].

   The quick answer is this: real estate agents are overpaid for the services they provide.  See my post “A Quick Shot at Real Estate Agents” for the reasoning and some negotiating hints.

8. Make sure you do your homework about taxes.  The last thing you want to do is be in the highest tax bracket or be labelled a dealer.  But thats a topic for another day.

   And more likely than not a topic that this author does not understand.  In the world of tax, there are what are called bright line cases, and then those that must be determined using facts and circumstances specific to that instance.  Whether or not you are to be considered a dealer for real estate purposes is almost always a facts and circumstances.  The confusing part is that you may be considered a dealer for some properties and an investor in others.  There are a number of different strategies that can be employed to minimize the tax dollars paid on real estate transactions, but make sure you consult a professional rather than a book or a blog, because there will be no clear answer.

Financial Advisers, and How to Handle Taxes

I want to be clear on this point, because I believe that some of my previous posts may have been a little misleading: CPA’s will save you  money.  When I say that 80% of the US doesn’t need financial advisers, what I mean to say is that 80% of the US doesn’t need someone selling them products and raking in commissions.  Your CPA should be an objective and independent service provider.  Don’t confuse a CPA with a commission driven salesman.  However, the moment that your CPA tries to sell you an investment product, you should immediately ask yourself: what’s in it for him?

Some of you will want to rely solely on a key income threshold to determine whether or not you should consult with a CPA.  Although it may seem counter intuitive, low income individuals may have more of a reason to at least briefly consult with a CPA.  Why?  Because most tax breaks are centered around low income households, and if you don’t have a comprehensive understanding of how the rules work, you may be missing out on literally thousands of dollars. 

Case #1: The Recently Married Student/Graduate

Only five minutes ago I prepared a tax estimate for my best friend who in 2006 graduated from college, and married his beautiful wife (still student throughout 2006).  Although their taxable income was only $16,000, they qualified for $2,800 in tax credits (Lifetime Learning education credits and the Saver’s credit for contributions to a retirement account).  Note: tax credits are not the same as tax deductions.  Whereas a deduction only serves to lower your taxable income, a credit is actually a dollar for dollar reduction in the amount of tax that you are required to pay.

Of course, since the newly married couple are friends of  mine, they were not charged for my advice, or return preparation time.  However, if I were to have charged them, the total bill would have amounted to $200 ($50 for the initial consultation, and $150 for the return preparation).  In other words, you must think of professional fees paid as investments: you pay $200 and earn $2,800.  That is a 1,400% return.

The Moral:  There is only so much you can do on your own (even with the help of the internet), because you can only do research once you’ve identified the issue.  A quick $50 consultation will be the best money you spend all year.  In that quick session, a CPA should be able to identify all of the issues and tax savings opportunities relevant to your situation.  If from there you choose to do your own research, then so be it, but make sure that you allow a professional to at least identify your issues.

An Answer to Your Search Terms: A New Approach

I recently realized that wordpress will provide me with the search terms used to find this forum.  As a result, I will begin using these search terms to specifically address your questions.  First up: Financial Advisers, and How to Handle Taxes.

The 5% Market Crash: A Good Time to Buy?

I feel as though Mr. Marshall was a little short changed after his last post. He asked for market advice, and I told him to steer clear. While I maintain that the market is not the place to make money, I will offer this little tid bit for those trying to decide what to do now. I’ll try to address the following two obvious groups: 1) You’re already in the market (company sponsored plans and/or post tax investment dollars), and your portfolio has taken a 5% hit over the past month, or 2) you’re not yet in the market, and you’re wondering if now is the right time.

1) If you’ve already take the hit, there’s nothing that you can do now, and selling would be the worst option. No matter how you invest, the idea is simple: buy low, sell high. We’ll, you’ve missed the boat on sell high, but don’t compound your mistake by selling low. Realize that stocks are assets, just like homes, and sometimes the market incorrectly estimates the value. When the over valuation becomes apparent, prices will correct themselves and then continue on their merry way. Don’t look at this as a 5% loss, because had the market now been going gang busters for the past 4 months, your portfolio never would have reached that value anyway. I know, you’re kicking yourself for not bailing out of the risky funds a month ago, but some of the best financial minds who ever lived are adamant that attempting to time a market is financial suicide. Buy and hold they say, but I come from a mixed school of thought. I believe that it is financially irresponsible to ignore obvious signs of pending market volatility. For example, through December and January, stock prices were hitting record highs day after day. To me, that screams top of the ladder, so I bailed into a much more conservative portfolio. Here’s what happened:

The above black line represents the value of my portfolio since the beginning of the year. The red line represents the growth (decline) in value of DJIA index portfolios (the DIJA is the Dow Jones Industrial Average and represents a diversified portfolio of stocks, like a snapshot of the entire market). You will notice that there does not appear to be a lot of upward movement in the value of the my portfolio, but the picture is deceptive. This line does not necessarily track the value of my portfolio, but rather the change in price per share over time. In other words, this line does not reflect the dividends and interest that are paid out to me and then later reinvested.

In an effort to avoid too much discussion about dividend paying funds vs. growth funds, I’ll leave you with the following: would you rather have an investment returning a consistent 6%, and be confident that your principal will be there when you need it, or would you rather shoot for an extra 5-6%, and release all grasp on certainty? What if you needed that money on 3/5 right after you lost 5%, leaving you no choice but to sell low?

2) If you’re a speculative investor, as I hope you’re not, you must be licking your chops right now. With a 5% average drop, I’m sure you’ve already identified some bargains. What you’re wondering now is this: will there be an even better bargain in a week? And that’s the million dollar question. Has the decline subsided? Will the housing and sub-prime lending debacle continue to influence stock prices? What will Bernanke do or say next? I’m not positive, but I can tell you one thing for sure: I’m not changing anything. In fact, I’ll still be pumping money into my IRA at the same rate as I was 2, 4, and 6 weeks ago. Why? Because my investments of choice aren’t so heavily influenced by the insanity of market fever.

How will you know it’s a good time to get in? Well, the way the market works, everyone else will know before you, and by that time, the bargains are gone, and you’re just an average Joe. If you want to step out on a limb, and try to ride the wave back up, you just may end up a hero; but you also may end up with a broken neck.

A Quick Shot At Real Estate Agents

I’ll preface this quick post with the following disclaimer: real estate agents can be extremely valuable in investment transactions.  They’re paid to ensure that the i’s are dotted and the t’s are crossed, and that you don’t make a rookie mistake that could drown your investment. 

Now for the roast.  In 2002, real estate professionals were charging between 5 and 6% of the final sales price to determine their commissions.  Since 2002, home prices in many places have increased more than 100%, and yet the agents are still charging 6%.  In other words, since 2002, agents have doubled their income on a per sale basis.  Did your salary double over the past 4 years?  Mine didn’t. 

Granted, with the housing boom the real estate profession saw a huge influx of new sales people, which should essentially make sales per person fewer and farther in between, but I’m not buying it.  With volumes and prices at record highs, the brokers have been cleaning up.

The Moral: Broker fees are always negotiable… Especially if you’re looking to buy a pricey property.  Typically broker fees will take the form of 3% to the listing agent, and 3% to the selling agent (which may be the same person).  Before you agree to allow an individual to represent you, ask if they would consider representing you for below the standard 3%.  If you plan on doing most of the leg work and research yourself, consider using a discount broker such as Redfin or Zip Realty who will refund as much as 2/3 of the total commissions.

A Quick Poll

There are thousands of finance blogs out there, and I want to be sure that I’m addressing relevant issues.  Are there any bloggers that you would like critiqued?  And which of  the following critiques are most helpful/interesting?

-Real Estate?

-Stock Market?

-Tax Strategies?

-IRA’s?

-Entity Structures?

-Accounting?

CapCritic