Piggington Jumps the Shark

Submitted by Rich Toscano on January 29, 2012 - 11:39pm
I have bought a house in San Diego.  I'm also going to start putting up guest posts by Ted McGinley.

This (the house buying part) shouldn't be a huge shock for people who've been reading the site of late, because I've talked a lot about how it makes sense to buy in certain situations.  That said, I will briefly outline my thought process here.

After the recent leg down in interest rates, monthly payments are the lowest compared to incomes and rents than they've been in the history of the data, and are quite dramatically below their median historical levels:

I frequently point out that when it comes to determining whether homes are overvalued or undervalued, the price-based ratios are far more important than payment-based ratios.  However, as I discussed in this article, an individual buyer should be more interested in the expensiveness of the monthly payment, rather than the purchase price, if he or she is financing most of the purchase and intends to (or is at least able to) keep the home indefinitely.

A buyer in these circumstances is not only locking in rock-bottom monthly payments, but, crucially, is doing so ahead of what I believe will be a period of unusually high inflation.

Now, I don't want to turn this into a big discussion on the something-flation debate, because that topic been thoroughly beaten to death elsewhere on this site as well as on my "day job" site, and it is beside the central point of this article.  Suffice it to say that I consider it a high-confidence forecast that the dollar is going to lose a lot of purchasing power in the years ahead, because nominal incomes -- and thus prices, including those of rents and maybe even houses, a little -- must be made to rise (in excess of any plausible level of economic growth, i.e., via inflation) if the country is to be able to continue servicing its tremendous and growing debt.

If this outlook is correct, as I believe it is, then today's ultra-low rates make this an ideal time to take out a chunky 30-year fixed mortgage, and to sit back and let inflation hew away at the real value of the mortgage and the monthly payments over the years to come.

So, the missus and I went out looking for homes.  We only found one in our price range, a single family house in Bay Park, that we thought was awesome enough to be a long-term home.  So we made an offer, got a loan with as low a down payment as we could get away with, and have now re-joined the ranks of the titular Landed Poor.

And now I will attempt to anticipate some questions:

Q: Does this mean you think this is the bottom for home prices?

A. Not really.  I don't know when the bottom will be, but it really doesn't matter all that much as I've financed most of the property and I'm more interested in minimizing monthly payments than the purchase price.  For what it's worth, my (not very high-confidence) prediction on home prices is that valuations will continue to slowly decline for a while, but nominal prices will kind of bounce along and not do anything too dramatic in either direction any time soon (barring an interest rate spike... see 3 questions down).

Q: OK, does this mean you think this is the bottom for monthly payments?

A. I suspect that it's awfully close, at least in terms of level (I have less of an opinion on duration).  But my investing philosophy is that you shouldn't get too caught up on catching the exact top or bottom, because it's impossible to do so with any reliability.  If something is a great deal, you can be greedy and wait for it to become a super-great deal -- but there's a good chance that's not going to happen, leaving the possibility that the train will leave the station without you.  I believe that long-term investing success (and far lower stress levels) will come from being disciplined about buying things that are cheap and selling things that are expensive, not by getting overly worked up about whether you caught the exact peak or trough.

I sat out an inflation-adjusted home price decline of almost 50%, and now I'm buying at a time when prices are cheaper than normal and monthly payments at 45% below their historical median.  That's close enough for me.

Q: Monthly payments may be cheap, but homes are still overpriced.

A. Not so.  Not in the aggregate, anyway:

As of November, San Diego homes were 10% undervalued based on the historical ratio of home prices to San Diego incomes.   Of course, individual markets may vary from this aggregate figure, and there are always issues with even the best price indicators, so buyers should (and we did) verify that their target homes are reasonably priced compared to area rents.  On the whole, however, the argument that San Diego homes are overpriced is not supported by the data.

Q: Won't interest rates go up a lot, and won't that push down home prices?

A. Yes, it's certainly possible that rates could rise a lot, possibly to a shocking degree.  And this could indeed put downward pressure on home prices.  There's actually very little correlation between interest rates and home valuations, and if anything, homes have tended to get more expensive in rising rate environments (due to rising rates typically being accompanied by rising wages, as well as other external factors).  However, I think that a sufficiently steep and abrupt rate rise could really hurt home prices.

But recall that I am more concerned with minimizing monthly payments than the purchase price.  If rates rose enough to really impact prices, it's likely that those higher rates would have affected monthly payments even more.  So for a long-term, heavily leveraged purchase, the threat of rising rates is a reason to act sooner rather than later.

Q: Ted McGinley was president of the Alpha Betas.  Don't you think you're more Tri-Lamb material?  Consider the following:

A. That's just mean.

(category: )

Submitted by creative_cpa on February 17, 2012 - 8:43pm.

sdrealtor wrote:
Ironically I did a short in Yorba Linda a year or so ago. I think the same thing is going on up there as down here. Lots of buyers want in on great houses at today's prices but they wont overpay based upon comps. Its a bit of a stand off. Dont see any signs that prices are gonna take off but good luck finding a house you like at current prices. Discretionary sellers are emboldened to stick to their inflated asking prices because inventory is down...

Yet, amazingly, the Los Angeles Times reports house prices dropped 11% in Yorba Linda in 2011. I wonder how that could happen if sellers won't drop prices and buyers won't overpay? Greater minds would wonder.

Submitted by sdrealtor on February 17, 2012 - 10:27pm.

Because greater minds need to open their minds and listen to what I wrote. Discretionary sellers with the better properties are holding. Distressed sellers are selling what are typically the inferior properties. The sales mix shifts more toward inferior properties with sales volumes dropping. The statistics say lower prices but the quality is down so the stats skew reality. Use that CPA and what it taught you about statistics just like I use mine

Submitted by creative_cpa on February 18, 2012 - 1:47am.

sdrealtor wrote:
Distressed sellers are selling what are typically the inferior properties. The sales mix shifts more toward inferior properties with sales volumes dropping.

Since you seem to be a realtor. What evidence do you have to present to us that more "inferior" houses are in the sales mix? While you are at it, perhaps you can also show us that distressed sellers are in inferior properties while non-distressed sellers are in superior properties. And since sales prices have been dropping for over 6 years now, are you telling us that each year an even greater proportion of distressed/inferior properties are being sold and for ever-lower prices?

Meanwhile, prices are dropping and defying your original statement that sellers are sitting tight and not dropping prices and buyers are not willing to buy based on the comps. You have offered up a deus ex machina explanation of the phenomenon without presenting any evidence.

Submitted by sdrealtor on February 18, 2012 - 2:45pm.

Actually I'm a realtor and also have an inactive CPA certificate in NY and Nj. If you would like to pay me to do that research for you I would be happy to but am just to busy to do it now. The evidence I have comes from being on the streets and looking at the houses. Statistics are nice but when every unit of measure is unique as in housing you can only get so much from them. In general distressed properties are inferior. They skew heavily towards deferred maintenance. Sure there are some really nice distressed properties. I am sitting in open house for one now but that is more the exception that the rule.

Non distressed sellers with the nicest homes are getting lots of showings even when they are over priced. What they aren't getting is offers at their inflated prices. So they keep listening to all the comments of how nice their home is, see a big stream of lookers and hold onto their fantasy that their home is somehow special enough to warrant a price it does not. In the same situation a distressed property takes the offer that comes along and meets the market. The discretionary sellers just fall back on the i'll just rent it out if someone won't meet my price. I seethis happen all the time. Are you actively home shopping or just pretending to from cyberspace. If you actually head out there you will see what I am talking about.

Fwiw, I have been on the prices will fall wagon since 2004/2005. But I also told people that once they did volume would dry up and competition would be steep for quality homes priced at or below comps. Last week I submitted one of twenty offers submitted in a single day on short sale in Mira Mesa that was attractively priced. Submitted full price all cash offer and wasn't even close. Yesterday I submitted an offer on an attractively priced condo again full price and all cash the first day. The agent stopped counting at 20 offers. There are no stats and no way of collecting this kind of databut I seeit everyday. Feel free to ignore me. Posters who have been around here for years know that I tell it like it island in nearly every if not every case am proven correct in time on what I see happening on the leading edge of the market.

Sorry typing is even worse when on my ipad

Submitted by scaredyclassic on February 18, 2012 - 6:41pm.

Reality is weird.

Submitted by mediaguru on March 20, 2012 - 4:32pm.


Sounds very similar to my situation. I refused to buy during the "idiot years", as I like to call them (essentially, the entire last decade)... so we continued to rent and rent. But we wanted a space of our own, a little more privacy; I'd like to be able to play my guitar or watch a DVD without hearing or being harassed by the neighbors.

Anyway, we finally found a place in Napa Valley, closer to my work (in Calistoga), and even though we DID end up paying about 100% more than what we were paying for rent (about $2600/mo, like you mention), we're okay with it because it's a house that would have been impossible 5 years ago (valued at over $1 mil) or even 12 years ago (it sold for 40% higher than we paid, back in 2000)... and it gives us a lot more space. 80% more square feet, plus a one car garage, plus 0.5 acres of land.

So, even though I'm not bullish about real estate (I don't see it dropping much, but I do see it staying flat for a while), we plan to stay here forever and I felt okay about it even though there's a little work to be done (but it's livable in the meantime), and will cost us more, and we got 3.25% interest rate (15 year fixed) It just all adds up sometimes.

Submitted by mediaguru on March 20, 2012 - 4:48pm.

You know, I'm right there with you on your logic... for the most part. We have been hold-outs for several years (even my father was saying we should buy back in 2005. I just responded "Have you looked at a chart of home prices and a compared it to a chart of average salaries any time recently?")

We just bought a place in Napa Valley... it last sold for ~$850k in 2004, $650k before that in 2000, and was valued up to $1 mil+ at boom time (2006), but the owners made out with pretty much nothing and paid $400k in interest, still had to do a short sale.

Which brings me to my point: I'm not sure I agree with your assessment that (a) monthly payments are what matter more than total cost; and (b) that 30-year is the way to go.

Personally, we decided to do a 15 year fixed (@3.25% interest). We debated on a 30 year, because it doesn't get much better than getting practically "free money" at 4% interest; that beats the heck out of any personal or business loan you can get. So in that sense, I understand.

But on the other hand, there are a few important risky factors to consider:

1) If rampant inflation doesn't arrive (I'm still iffy on if or when that is going to happen), then you don't make out nearly as well.

2) Even more concerning, what if you DON'T stay there "forever"? We found a house we absolutely knew we could be satisfied in until we retire, and beyond. But we always have to consider the WORST CASE scenario. What if something happens in the meantime? I mean, we can scrape by if one of us loses our job... but what if somehow we both do? Or we really have to move for some reason? I'd much rather have equity built up 6-7 years down the road (we'll be at about 50% equity in 6 years), so that if I do sell, I actually get some of that money back.

3) You can always make extra payments to pay down principal to make that happen, if you are strong-willed and have the money to do so. But you still probably end up paying about TWICE the interest than you would with the 15-year (and if you don't pay down the principal, you end up paying even more... like 4-5x as much). It would take a RIDICULOUS amount of inflation to balance that out. CPI has only gone up about 28% in the last decade, so I doubt inflation will go up 300-400% over the course of 30 years (and yes, I know interest is deductible, so I'm factoring that in, too.) We're talking maybe 150%... and that's IF there actually is inflation, and not deflation like some people have actually predicted (myself, I can see certain signs of it going either way, but my guess is slow and steady inflation for many years to come; however, salaries haven't been playing that catch-up game to CPI like they normally do in inflationary periods, so something's gotta give; we're either going to hit a wall where people simply can't afford higher prices because their incomes aren't rising, or incomes are going to have to go up and inflation will arrive for sure.)

4) Prop 13 limits your tax assessments based on initial purchase price, so that purchase price absolutely IS an important factor to consider. Principal can be paid down, but taxes are forever.

Submitted by Rich Toscano on March 20, 2012 - 5:55pm.

Everyone is different, and different things matter in different situations. FWIW you appear new to the site so perhaps you don't realize that I have been an outspoken proponent of the idea that price matters far more than monthly payment when it comes to determining whether the market is, as a whole, overvalued and undervalued. More importantly, I absolutely never said that monthly payments are generically more important than price, as you've implied above.

That said, in my specific case, it absolutely was the monthly payment that mattered more.

To your points:

1. I am not "iffy" on whether high inflation will happen. That is my own view, and one that I do not expect other people to necessarily share... but it is in fact my view and have acted on it accordingly.

2. The possibility of my being forced to get rid of the house (not just move out and rent it out, but to actually have to sell it) is remote enough that the monthly payment is a much more important factor than the price (again -- in my case). Fortunately, even if I were forced to leave, it wouldn't be a big deal because home prices are somewhat undervalued -- just not to the extent that payments are.

3. You are only looking at one side of the equation... you are looking at the interest you'd pay, but not at the opportunity cost of the higher monthly payment with the 15 year loan.

4. Of course purchase price is an important factor to consider... I never said otherwise. And I did in fact consider it, and discussed it in the article, both when citing aggregate countywide housing valuations as well as my own rent-vs-buy analysis on the house I bought. I said (and stand by this) that the monthly payment was the more important factor in my case, not the only one.

Submitted by mediaguru on March 23, 2012 - 12:25am.

Sorry, yes, I am new here. Like the site (then again, I always tend to enjoy sites talking about the logic -- or lack thereof -- in real estate, backed with lots of graphs and data)

You may be right that 15 yr vs 30 yr is a wash... at least as these interest rates. There certainly is an opportunity cost to paying extra every month. But the difference in PITI is like $3000 instead of $2200/mo. Significant, for sure... but on the other hand... I don't know your age, but I am entering my mid-thirties and this would let me own a house free and clear and pay only taxes by the time I turn 50 (on that same token, since I will still have to be paying taxes, potentially for a while after that -- and since Prop 13 caps them at 2% annual from my currently assessed price -- that initial sale price for assessment is important.)

I'm with you in the sense that we are very much secure that we can afford this place even if something goes south (like one of our incomes disappears), but I guess one thing I couldn't stop thinking about was if something happened to me (ie. I died in a car accident or something), I wouldn't want my wife to be stuck with low equity in the property; she may decide she wants to sell it and move on, in which case the best thing I could have done for her in my final years would have been to build equity in the house.

On the other hand, this comes at a cost of sticking her with larger, less manageable payments if this happens sometime very soon, but she could always rent it, etc. (rent for this place is not quite equal to PITI, but close)

It's also because I agree with you re: inflation being more than likely what will happen. Because of that, I figure what seems significant now ($800) will probably be less so (in real/adjusted dollars) every year from here on out.

Additionally, the low interest rates, overpriced commodities, and too much volatility in the markets negates any opportunity factor I can see for using that saved money for any other sort of investments (short of my own leisure / quality of life or maybe starting a business)... sure, the markets and commodities will likely rise with that inflation, but for that matter so will the house value most likely (and maybe even more rapidly if RE is currently undervalued, which it seems to be in my case, and it sounds like in yours as well). So I guess what I'm saying is I am banking on inflation, too (just not as much as you), and figuring that putting that money into equity will thus give me a better return than putting it into stocks... or bonds... or mortgage interest. Even if deductible, what am I going to do with the savings? If rates stay low and stock markets stay volatile, flat, or rise at the pace of inflation, or slower -- as has more or less been the case for the past decade -- then I might as well stick the money into housing, as long as I don't have to suffer or sacrifice my quality of life to do so...

Submitted by Rich Toscano on March 23, 2012 - 9:21am.

Hi mediaguru -- Given your set of forecasts/beliefs, your approach makes perfect sense sense. We just have different forecasts, is all.

On the inflation thing, you may be leaning towards inflation, whereas I am very, very confident that whatever I am paying on my mortgage in those last 15 years will be a trivial amount of money in purchasing power terms at the time.

Also, I don't share your view on investment opportunities. For this arbitrage (as it were) to pay off, you have to make good returns over a 30 year period. Thus, volatility is not in an impediment to good returns over that period -- in fact, imho, volatility (while nerve wracking) is an advantage because it provides value-minded investors more opportunities to buy undervalued assets. And due to the long time period, the current level of valuations is really not an issue... for you to believe that you won't do well over 30 years, you have to believe both that there are no good values now (I don't actually agree with that) and that there will not be any good values at any point in the coming decades (I strenuously disagree with that one). Add to all this that, given current rates, the bar is exceedingly low for what kind of returns one has to make over 30 years in order to come out ahead.

So, as I said, this all comes down to a different set of forecasts/outlooks/etc. I'm not trying to win you over to my outlook, I'm just trying to explain my own outlook, so that hopefully my decisions make a bit more sense in that context.

Submitted by greekfire on March 27, 2012 - 10:29am.

Congratulations Rich! Most of us got into this site because we wanted to buy a home but realized things were out of whack. You've obviously done your homework and have taken a shot and that should be applauded on many levels regardless what happens.

Word on the street is that the BRICS nations (Brazil, Russia, India, China, and South America) are looking to replace the dollar with the renminbi. I'd be interested in hearing your take on this and if it plays any role in your long-term calculus.

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