Should You Be Buying, Or Selling, Houses Today?


          With the stock market beginning to move up in value, and houses in some areas beginning to go down, investors who are serious about their financial futures can’t afford to rest on their laurels.  They have to continue to seek investments that offer high enough yields at a commensurate risk to pay them back for the time and money spent.  So in that spirit, let’s take a critical look at single family houses as an investment; given all the uncertainty about the market that rising energy, insurance, and interest costs create compared to other alternatives: 


          House prices are directly linked to availability of low cost financing.  Admittedly, the primary and secondary credit markets are a national market influenced by the Federal Reserve Board; but rather than being a national market, the single family house market is essentially a local market that is influenced by local demand for housing in different price ranges.  Despite the efforts of builders to construct what might appear to be more or less standard home models, no two houses are alike in every respect; sizes, shapes, floor-plans, interior decoration and exterior painting vary widely and appeal to completely different buyers. 


         There are many other variables that influence demand.  These include market-price, the cost of credit, desirability of the location within a city — which is heavily dependent upon the quality of local schools — proximity to jobs, shopping, recreational facilities, churches, libraries; and access to arterial traffic routes that can ease the daily commute to work.  All of these are reflected in the price and the amount of money that can be borrowed to pay for a house.


          Where a house is situated can also affect demand.  Houses on corners are priced differently than houses on interior lots.  This is also true of houses that are water-front versus water-view.  Houses situated on lots with mature shade trees are preferred to houses on bare lots.  Landscaped houses sell for more than un-landscaped houses.  Some houses offer upgraded interiors in contrast to bare-bones essentials.  And there are tremendous differences in the quality of houses.  Buyers  know what they want, and what they can afford and are willing to pay for.


          Ultimately, financing arrangements have as much to do with market value as any other factor.  Houses sell at different prices depending on down payment and monthly payments; or when financed with low versus high interest rate terms; or when     buyers can buy with nothing down.  The same holds true when a seller is willing to provide the financing for buyers with “bruised” credit.    


         Institutional lenders approve loans for a wide variety of buyers.  Lenders have a loan to fit just about everyone and loan terms can vary as much as houses.  Some are 100% of the value.  Some require payments of interest-only with a balloon payment after a period of time; which can also vary.  Each loan is tailored to the needs and qualifications of the individual buyer and to the appraised value of the house that will secure the loan.  An overall consideration of the cost of money is the credit rating of the borrower.  The F.I.C.O. system assigns values to a number of factors which generate a specific credit score for each borrower.  This score can control the down payment, interest rate, and terms of a mortgage loan. 


          When a house is bought for resale, price is more critical than terms; but because of the time required to put a house on the market, find a buyer, arrange financing, and close the deal, there is an element of risk that speculators have to contend with.  And then there’s the hassle factor:  Sophisticated buyers and sellers can strike creative bargains, but these often have to be approved by un-creative middlemen (lawyers, accountants, title officers, lenders, and brokers).  They often don’t close.  Still, when prices escalate, the combination of high leverage and appreciation can produce yields that stock market mavens can only drool over.



          There’s a simple answer to this question:  Look around you at all the people who have reaped fortunes over the past few years because they bought houses after investors had left the market and prices were low; then held them for a long time.  When the boat sails in the next cycle of price increases, the only way to be on it is to buy houses when there’s little market demand or appreciation, then to hold them for the production of income until the prices start to go up again.  When you chase an appreciating market, there’s a real chance that you’ll buy at the top of the market and lose your shirt.  In short, as the sale cycle slows, you’ve got to become an investor who makes money grow by reinvesting income it produces versus a speculator who “hopes“ that someone will pay him more for a property than he paid.


          A lot of people get confused over the term “investor”.  They confuse it with the word “speculator”.  A speculator makes his profit mainly by making an educated guess that market demand for the product he buys will increase, driving prices up with it.  By this definition, virtually everyone who buys stocks is a speculator.  Conversely, an investor is someone who puts his money to work to produce a predictable yield.  Those who buy bonds for income rather than stocks are more like investors than speculators.  This is particularly true if they either buy bonds with specified yields indexed to inflation such as I-Bonds, or they employ hedging strategies to off set the declining purchasing power of the dollar. 


          Real estate investors mostly create yield by buying property that can be leased out at a price that covers debt service, maintenance, property taxes, insurance, vacancy, and profit.  This is easily seen when commercial leased properties are priced to yield a certain amount based upon their current net rental income.  In every rental market there’s a “sweet spot” where the net rent received justifies the price and terms paid. 


          When houses are bought for long term income and appreciation, they enable the investor to realize a competitive yield when compared to other things he could have invested in.  Because the vast majority of houses are bought, not as investments, but for people to live in, houses in some cases command much higher prices because of the emotion involved in the buying decision; so the “income approach to value” rarely applies.  Instead, recent sales of comparable houses are used to establish fair market value; adjusted to current demand. 


          The great lament of people in areas where houses have appreciated is that a new investor can’t buy a house that makes sense as a long term rental.  All this means is that they may be in a hot sale market where rents haven’t kept up with prices; or that they are trying to buy houses to rent that are too up-scale; or that they aren’t using creative financing when buying.  This year is the 20th year that I’ve been teaching people how to lease and Option houses.  These enable a person to capture cash flow, mortgage amortization, and appreciation regardless of price.        


          Just because a property is returning positive cash flow doesn’t mean that it’s a good investment.  The cash flow may have been achieved by creative financing which allows a buyer to pay less than the amount required to pay interest and to amortize the loan.  Meanwhile, unpaid interest continues to compound, reducing the equity.  The accumulation of compounding debt is insidious.  It’s a cancer whose effects are often not seen until it’s too late to do anything about it. 

Sooner or later, this borrower is going to have to pay the piper, either by selling the property or by refinancing it.  He’s gambling that the market won’t have dried up when he has to do this; or that he will be able to refinance the accumulated debt on affordable terms; or that the value of the house hasn’t dropped below the amount needed to do either of the above.  In short, he’s a gambler even though he may be investing primarily for income than for a quick re-sale profit.  In the next 12 months we are likely to see the numbers of foreclosures rising to all-time highs as lenders refuse to refinance debt.  Like every other part of the business cycle, this offers benefits to those who prepare for it, and financial ruin to those who don’t.  The best way to get out of debt and raise cash is to sell while you can.



          If you dig deeply enough, you‘ll discover that stock market investors buy stocks for approximately the same reason that real estate investors buy houses; they want their money to make a lot of money for them.  For a number of reasons, the vast bulk of investors earn their income doing one thing, then invest their surplus income in something else that they hope will provide future security.  Just as a large mobile home park, apartment complex, or office block is beyond the reach of most real estate investors, owning a company is beyond the reach of stock market investors.  As a result, they settle for owning just a small piece of it.


          Houses can be bought with very little cash because of the availability of financing.  In contrast, stock market investors can only leverage 50% of their buying price; so, in its most basic form, the stock market enables those with money to spare – and limited financial skills – to buy shares of companies rather than trying to buy the whole company.  If they want to spread their risk, they can buy mutual funds or I-shares.  Mutual funds use their financial clout to buy shares in many companies, then they slice and dice these up into smaller packages and sell them to investors.  I-Shares are indexed to a broad array of other stocks, and they permit the little guy to hedge his bet by buying a portfolio of different I-Shares which represent different market segments; thereby more or less betting on every horse in the race.


          There are other fundamental differences between the house market and the stock market:  Houses are bought, sold, and rented in a disorganized market where financing and prices can vary with every deal.  They usually move fairly slowly in comparison to stocks; where a billion shares can change hands every day.  That’s because stocks are bought and sold in an orderly world market where their prices are posted continuously.  Except for large investors, most people pay the full retail price for stocks.  Many rely upon timing of purchases and sales to make their profit.  Orderly markets for stocks that can be found around the world make stocks a lot more liquid than real estate.  If we took a hard look at the amount of money made over the past decade, we’d find that stock market investors did about as well as real estate investors so long as they bought at the lows and sold at the highs.

Unfortunately, these make for interesting comparisons, but very few investors do it.


           Unlike real estate owners who can be held liable for just about everything that happens on their property, the owner of a share of stock is not liable for the actions of the company.  All he has at risk is the price he paid for his shares, which can go up and down in price just like houses.  Stock markets have been developing for over three centuries.  During that time, they have devised many different forms of investment.  The list of stock market derivatives can boggle the mind.  You can buy stock in one company, or in a company that owns hundreds of other companies.  Or, through the use of Options, you can use very high leverage to speculate in stocks.  Or you can buy warrants that will permit you to buy stocks.  You can buy stocks that guarantee a yield. You can buy corporate debt that’s convertible to shares.  When you buy and sell bonds, in contrast to selling Notes, profits can be taxed at low long term capital gain rates.   


          If investment in stocks is so easy and lucrative, why don’t real estate investors buy stocks instead of houses?  Many do; to create diversification and liquidity, and to “park” spare cash.  Stocks represent ownership of companies without much control over how they’re run; and for many, ownership amounts to an intangible book entry.  Because the market can move so fast, an investor can be trapped and lose a fortune in a day.  For this reason, stocks are often bought with “trailing stop loss orders” which instruct the broker to sell them when they fall a specified percentage, or to a specified price; but sometimes these orders can be overlooked.  When you buy a house, you can kick the bricks every day, and except for various government minions, you’re in control of it.  You can decide how to improve it, how much rent to charge, whether or not to refinance or sell it.  Stockholders derive little satisfaction other than in the increase in their share prices.  Despite all this, for years I’ve invested in stocks to capture profits on up-swings.


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          We are living in unsettling times. North Korea is rattling its nukes while Iran continue to refine bomb-grade plutonium.  Thousands of Americans are stationed in Afghanistan, Iraq, and Korea.  For the next two years we’ll have a lame-duck President trying to get his programs through a non-cooperative Congress.  Energy prices, insurance (both medical and property), and local taxes are making massive raids on the buying power of the American worker at the same time as large numbers of retirees are seeing their retirement expectations fall through the pension gap. 


          Today looks like the early years of the Reagan Administration:  Commodity prices are running away.  The FED continues to raise interest rates and house sales in many areas are cooling off.  Stock market prices are waffling as nervous investors try to gauge future price moves.  The price for gold bullion coins has recently tested 25 year highs.  This could signal a paradigm shift in the market from a period of low inflation to high inflation; and the FED has no Alan Greenspan to kill off inflation without killing long term bond holders too.


           Pressure is being put on China to raise the value of its currency, which will make things even more expensive for consumers.  This could reduce bottom line profits of retailers and lenders at the same time as bankruptcies and defaulted loans keep rising at record rates.  Despite this, Americans continue to run up debt in record amounts.  You should try to position yourself to be able to out run potential financial disasters while getting into a cash position to exploit the opportunities they might present.  At one time or another over the past decade, an investment in real estate, stocks, commodities, or currency would have both made a lot of money lot of money for those who adapted their investments to market cycles.  The lesson: There’s no single strategy that is going to work all the time. 


          Real estate investors are already inflation-hedged.  For well heeled investors, except for special situations, it’s probably too late to invest in gold and silver; and maybe for many stocks too.  If you can invest in a small service business, such as a property management firm, that is more or less immune to inflation, or if you can lend money secured by first mortgages at variable interest rates pegged to inflation, those are good choices for now.  If the market returns, you’ll most likely be paid off.  If things get tight, you could wind up with the collateral at a discounted price.


         Warren Buffet once said that diversification is for those who don’t know what to invest in.  That pretty well describes my situation at this point of time.  I don’t want to bet a lot of money on either an inflationary or deflationary scenario.  Putting about 20% of disposable cash into a liquid holding position would be prudent.  A good choice would be 90-day T-Bills.  They pay interest in advance, are immune from State income taxes, and are self-liquidating every 90 days.  If you choose to roll them over, the interest they pay is tied to inflation and they’re super safe.  They’re well within the reach of even a beginner’s IRA.  You can buy T-Bills through banks, brokers, or from the U.S. Treasury.  I’ve made and lost a few dollars here and there in the stock market, but don’t know why; so I’ve finally decided to buy I-Shares in various market sectors.  Both T-Bills and I-shares can be liquidated easily; it but it remains for you to decide which mix is best for you. 


         For those who are just starting out as investors with little cash – and  those speculators caught by the market – the single family house rental held for the long term is going to be about the only game in town.  No doubt you’ll do well over time, but easy money is going to have to return before you will be able to liquidate your houses.  Putting all your remaining investment funds solely into one asset class, whether houses, or stocks, or commodities isn’t a prudent course of action in view of the unsettled future.  Diversify and spread the risk if you can.   


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Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.

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