There have been many calls from “experts” that the time is right to buy real estate. Don’t believe their objectivity as many are funded by major national residential and commercial real estate companies. Surveys across the country do not indicate that the bottom of the real estate markets have occurred, even with significantly lower prices than 2 years ago.
“Location, location, location” is the moronic shibboleth perpetually spouted by real estate agents and brokers. To a very limited extent, that has, still does, and will hold true for certain properties. Real estate located in great neighborhoods with well-built properties, good schools and transportation, visually attractive streets, close-by amenities, low crime, and principally inhabited by their owners will always command better prices than other areas. However, the higher median income in those neighborhoods will justify and support the higher prices.
Nationwide during the past 2 years, median incomes have fallen and income/wealth disparity has grown – as a result of the deep recession with high unemployment and underemployment across the country. Those who had modest or few assets are losing what little they have. Those who were wealthy are now picking up assets as great discounts adding to the income/wealth disparity. The trickle-down economic and tax policies of the past decade, coupled with the trickle-up socialized bailouts of the past year have greatly exacerbated U.S. income/wealth disparity as well.
The variable interest rate, no-money-down, ballon-payment after 5 years subprime mortgage model is shot and will never return. Even using reasonable lending standards, a household can only afford a home that is worth about 3 times its gross annual income. This assumes a fixed-rate interest rate, a mortgage term from 20 to 30 years, a 10% down payment in cash, and a desire by the household to live in that home for longer than 5 years.
Investing in commercial or residential real estate will require that market rentals pay for the mortgage, taxes, maintenance costs, and a reasonable annual rate of return of between 5 and 10%. In any case will significantly rising real estate prices be a major factor. At most we can anticipate slow to moderate appreciation in real estate prices of 1 to 5% annually – not the bubble-like increases that went far beyond the annual rates of increase in personal incomes and inflation.
If the U.S. median annual gross family income is around $50,000, then the median U.S. home price should be around $150,000 to $175,000 – depending upon the cash deposit. A monthly mortgage payment should not exceed 1/3 of the family’s monthly net income. If a city or region shows median incomes higher or lower, that range of real estate home prices should also be adjusted up or down accordingly. This is not to say there cannot be homes worth over $500,000. However, their total number has to be proportionate to the actual population of people in an area that can afford them.
If less than 5% of American households make $250,000 or more a year, then only 5% of the American homes can be reasonably priced over $750,000. Even if certain cities have reached that 3:1 ratio of median home prices to median household incomes, any future real estate appreciation will be directly tied to future increases in overall household incomes. After more than 6 years of stagnant income growth, and 2 years of income declines, the value of real estate will likely remain unchanged for quite some time during any economic recovery from this deep recession.
Until this country has near full employment in well-paying jobs, we will not see an end to our decades-long decline in household purchasing power and global competitiveness, and be able to ameliorate (1) the decline in real estate prices, (2) excessive public and private debt, and (3) wealth disparity in the U.S. Real estate generally prices reflect supply and demand but ultimately supply and demand are dictated by overall employment and median incomes.
What we created during the housing bubble were too many homes that were simply unaffordable by any reasonable criteria. Of course rationality is always abandoned in any bubble and the painful readjustment takes time to reach a new and sustainable reality.
In light of all the competing and selfish players in this market, the only likely resolutions for most pending and possible foreclosures are to just let them happen – and possibly the faster the better. If banks and the investors of bundled mortgages can not or will not renegotiate new terms, let them waste money on lawyers and take their losses in sheriffs’ sales. For those individuals and families who cannot afford their mortgages due to (1) increases in variable interest rates that created higher monthly payments, or (2) job losses that make any mortgages unaffordable, or (3) being woefully under-water (the current home value is more than 20% less than the face value of the mortgage), they simply have to walk away and start anew elsewhere in something they can afford, generally a modest rental unit.
For those people today with money and still interested in buying real estate, these are the three possible options:
(1) If it is for a personal residence, that should be the only rationale for owning the real estate. This is a long-term commitment to a community and neightborhood, someplace where you plan to put in roots and be willing to pay taxes and support local schools and be concerned about the welfare of your neighbors. Homes are not for short-term “flipping” and reselling because they may only appreciate in value after 20 years of continuous occupancy and upkeep. If you are not interested in making such a major commitment, then rent and put your money elsewhere. You do not need to own a home to start a family or enjoy living in any neighborhood.
(2) For those who want to make a real estate investment, ensure that the monthly stream of income (from business or household tenants) safely exceeds the monthly mortgage payments, taxes and maintenance costs. If your accountant, lawyer and financial planner cannot confirm this basic profitability requirement, then put your money elsewhere.
(3) For people with excess money to invest, there are a few good options: (A) One could participate in investment clubs that fund a variety of new or expanding small businesses – the engines that drive the U.S. economy. (B) One could also wait and buy bonds issued by the U.S. infrastructure bank to be created by 2010 in addition to buying U.S. Treasury Bonds. (It’s a patriotic duty to help pay off the massive U.S. debt and rebuild our nation’s infrastructure.) (C) One could also start a new business, go back to school, or take a few good vacations – all worthwhile future investments in one’s family and oneself that may not show immediate economic returns but will definitely enrich one’s soul.
These straightforward principles used to guide our real estate and general investing for decades. Somehow we forgot our old principles during the past 10 years and fell in love with debt. Getting a handle on our massive household, business and public debts will be another parallel challenge for this country. Relearning these attitudes will be a painful process, but ultimately the truth will set us free and greatly improve this country for our children.
By Marc Pascal in Phoenix, AZ