Tuesday, February 14, 2006

My REBUTTAL to "the Automatic Millionaire"

I have had the following article e-mailed to me no less than 10 times already today. The article in question made the front page of Yahoo Finance. Here is the article, written by David Bach, titled "Why Homeowners Get Rich and Renters Stay Poor".

Now that you have read the article and seen one side of the story, it is time for me to get to work and pick off the main points in this article one by one. This is probably going to be a long one...so grab a drink, get comfortable, and get ready to look at things mathematically and logically using REALISTIC numbers from areas that have had lots of appreciation the past few years.

Now let's get started...

First off, I am not against home ownership one bit! I am all for home ownership if it makes mathematical and financial sense. The problem is that in many areas of this country, it doesn't make financial sense. I have demonstrated this in several previous posts (post one, post two, post three). I have no problem with trying to get 10 million people to own a home...as long as it is a good financial move based on TODAY's numbers, not the numbers of 5, 10, or 50 years ago.

The article says it is going to "provide you with a common-sense way of looking at a real estate market that often seems crazy...". Well, let's just see about that!

"From 2001 to 2005, the average homeowner saw the value of his or her house jump by more than 50%. Many homeowners doubled, tripled, and in some cases even quadrupled their wealth in just five years because of exploding real estate values.

Imagine that. Buy a home, live in it, build your wealth, get great tax deductions -- and then retire rich. It may sound too good to be true.

Indeed, plenty of experts will tell you that the housing boom never happened. According to them, what we've experienced over the last few years was just a "bubble" that's going to pop any minute now. Others insist that whether it was a boom or a bubble, it's over. According to them, it's now too late to get in on the party.

The American Dream Is No Fantasy

I think both these positions are wrong. My view is that the American dream of building a nest egg by owning a home is no fantasy. Homeowners have been getting rich off their real estate for years, and they will continue to do so in the future."


So this guy doesn't think that we are in a boom, or that it's over?!?!? Good, at least we know where he 'stands' on things. Let's see if he has the DATA to back up his position.

He gives this first piece of data and then 5 more reasons. "How can I be so confident about the real estate road to riches? Well, U.S. real estate values have been going up steadily for nearly four decades -- an average of 6.3% a year since 1968, which is when the National Association of Realtors first started keeping track. According to Freddie Mac (a.k.a., the Federal Home Loan Mortgage Corporation), since 1950 U.S. house prices have never experienced a year-to-year decline nationally."

I seem to remember another country that said the exact same thing...Japan. Again, past performance is no guarantee of future results. They didn't have widespread use of interest only loans, neg-am's, option ARM's, stated income, or 100% financing back in the the 1950's. These loans started becoming popular in the 2002 time frame. We don't have enough data to accurately analyze the impact of there exotic loans. We do have data that shows that interest only loans were last popular in the 1920's. I wonder why it took about 70 years for them to become 'popular' again?

Let's look at the 5 points the author has outlined. Hang on, it's about to get fun!! Here is the first one:

1. Owning Is Cheaper Than Renting oh really?!?!?

People who say it's cheaper to rent than to own are simply wrong. It gets better...trust me! Under certain circumstances in certain markets (where real estate values are overheated and rents are low), there may be some short-term advantages to renting. But over the long haul, renting simply isn't a good deal. If you don't own your own home, you can easily wind up spending more than half a million dollars on rent during the course of a lifetime -- and probably a lot more.

Assume you're renting a house for $1,500 a month. Now let's say you stay put for 30 years, during which the landlord increases the rent by 5% a year. Over those 30 years, you will hand over a total of nearly $1.2 million in rent payments -- and at the end, you'll have nothing to show for it except a bunch of cancelled checks. To add insult to injury, you'll now be paying $6,174 a month in rent!

Now let's imagine that instead of continuing to rent, you buy the same home for $200,000. Initially, your costs as a homeowner are likely to total around the same $1,500 a month you would've paid in rent. But these costs won't balloon over the years the way rent would. That's because your regular mortgage payment, which represents the lion's share of your monthly outlay, is fixed (or, if you have an adjustable-rate mortgage, at least capped).

What will balloon over the years is the value of your house. Say it goes up by 6% a year, which is actually slightly lower than the national average. After 30 years, you will own a home that's worth just under $1.1 million.


Oh jeez...where to start?!?!? First off, you can't make the statement that renting is cheaper than owning...and then use a pretty unrealistic example to prove your point. I don't know of very many places where the rent is $1500 month, and you could buy the property TODAY for $200k. I'm not talking about paying $1500 for rent on a place the landlord bought for 200k years ago, you have to talk about today's numbers. I pay about $1500 a month, and the property is about 500k.

Where does he get the 5% a year increase in rents? I have rented the same place for over 3 years now. I have had 1 rent increase of about $50 which equates to about 3%...over a 3 year period of time. I'm not saying that applies to every situation, but I can say that I have not seen 5% increases in rents each and every year. To say that rents will go up 5% a year forever is not a realistic statement.

I agree that $1500 a month is about right to 'own' a 200k home. If you put down 20%, had good credit, and got a fixed rate at 6.25%, your payment would be $985 a month. Add in $200-300 bucks in taxes, some insurance and maintenance, and you are close to that $1500 mark (assuming you put 40k down). What I don't get is how you can make the statement that property will go up 6% every year from now on. I know that nationally, prices have 'never gone down', but Japan said the same thing. If that is the case, that means that the median price of a home in this country, about $238,000 today, will be over 1.1 million dollars in 30 years. I know a million dollars isn't what it used to be, but I have a hard time believing that the median priced home in this country will be over 1.1 million dollars in 30 years. Sounds good on paper, when you assume his scenario, but we all know what happens when you ASS-U-ME!

Let's get to his next point.

2. Homeowners Get Leverage

Leverage is what you get when you use what is called "OPM," which stands for "other people's money" -- the other person in this case being your bank or mortgage lender.

Here's how it works. Let's say you buy a home for $200,000. With standard 80% financing, you make a cash down payment of $40,000 and cover the rest of the cost with a $160,000 mortgage from the bank.

Now let's say over the next year or two the value of your house rises by 10%. So now it's worth $20,000 more than you paid for it. If you were to sell the house at this point for $220,000, what kind of return would you have made?

If your answer is 10%, you're mistaken. You take the $220,000 you got for the house and repay the bank its $160,000. That leaves you with $60,000 -- or $20,000 more than the $40,000 original down payment. In other words, you made a $20,000 profit on a $40,000 investment -- which amounts to a 50% return.

As much as I like stocks, bonds, and mutual funds, there's little chance any of them will produce anything close to that return in such a short amount of time.


I don't disagree with his math, and that it 'looks good on paper'. Again, the PROBLEM with ALL of these arguments is that they ASSUME APPRECIATION!!!!!!!!! We have just experienced the largest expansion in Real Estate the world has ever seen. According to estimates by The Economist, "...the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries' combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America's stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history." I know this is worldwide, but you get the point. Just because something hasn't happened in the past, doesn't mean it won't happen. But while we are on the topic of leverage, don't forget to look at the post on leverage I did a while ago. It talks about the 'other side' leverage. Leverage is great when things go up, but it will crush you even faster on the way down.

I'll lump number 3 and 4 together. Three talks about a tax break, and four talks about capital gains tax. I'm not disagreeing with these points too much. I'm not a tax expert, but I know there is a tax benefit, especially if you are talking about a 200k home. I have also read information that many 'high income' earners are hit with a little thing called the alternative minimum tax (AMT), which limits the amount of deductions they can make...mortgage interest deduction is included in this. I'm also aware that after 2 years of primary residence, you don't have to pay capital gains taxes up to the first $250k in profits.

The final reason why buying is better than renting is:

5. Homeowners Become Savers

Each time you make a mortgage payment, you're saving money. That's because with each payment you're reducing your loan balance a little -- and that, in turn, is building your equity. (This assumes you don't have an interest-only loan.) The longer you're in your home, the more equity you build, the more you save -- and the richer you get.


Again, on face value that is a true statement, but it is not realistic of what we are seeing in this market place. Take a look at this article from Forbes that tracks the amount of equity extracted from homes. In 2004 alone, they peg the number at about 569 BILLION dollars. Looks like a lot of homeowners are spending, not saving. Add up the past few years of 'equity extraction' and you are into the TRILLIONS of dollars. Again, interesting how he 'assumes' people don't have interest only mortgages. The reality of the situation is that many people ARE having to use interest only mortgages to afford their homes in many of the high cost areas of this country.

Let's look at his conclusion before I make my own. If You Want to Be Rich, Don't Rent

According to statistics compiled by the Federal Reserve, the average homeowner is 34 times richer than the average renter. If you're not a homeowner, this may depress you. But it shouldn't. Why? Because -- and this I can't emphasize this enough -- it's never too late to catch the real estate wave.

Everybody has to live somewhere, and someone owns every place where someone lives. Why shouldn't that someone be you?

Obviously, no investment -- not stocks, bonds, or real estate -- goes up in a straight line forever. But over the long term in America (which is to say, 10 years or more), most experts believe that homeownership is an exceptionally smart way to invest your money.

Remember -- as long as you're alive, you have to live somewhere. So does everyone else you know. And because of that, homeownership will continue to be a great investment.


I don't doubt that as a whole, homeowners are 'richer' than renters. Again, that statistic is probably before this massive run-up in prices. What bothers me is that "it's never too late to catch the real estate wave." What exactly does that mean? I have never seen a wave that eventually didn't 'crash'. Who are these 'experts' that say real estate is going to go up for the next 10 years? Who else is tired of the 'you have to live somewhere' line? I do live somewhere...at 1/2 to 1/3 of the cost of owning.

I think this guys statements are pretty far off base for a large part of the population. The median priced home in this country is about 238k, and he is using 200k homes with unrealistic rental prices and appreciations to make his point. He is writing this article to push his books and the "Homeowner Challenge". Take a look at the cities they are doing these seminars. Here is a quick list...

NYC, New York
Seattle, Washington
San Francisco, California
Los Angeles, California
Phoenix, Arizona
Houston, Texas
Dallas, Texas
Boston, Massachusetts
Baltimore, Maryland
Philadelphia, Pennsylvania
Chicago, Illinois
Denver, Colorado
Atlanta, Georgia
Orlando, Florida

Now tell me, in how many of these areas you can buy a decent home for 200k?!?!? I'd love to see the San Francisco and Los Angeles seminars where this guy tells people it is better to buy TODAY, than rent. Tell the San Fran crowd how they will be better off buying 700k starter homes, instead of renting. Tell them how their 700k starter home will be worth millions in a few years. I look at that list of cities where they are doing seminars, and I think it is safe to say that most of those cities have had pretty big appreciation the past few years, and that the median income in most of those cities will not be able to afford the median priced home without resorting to creative financing and mortgages.

I have said it before and I will say it again. If you find a home you like, can put money down, get a fixed rate mortgage that you can afford, plan to stay a while, realize that property values might go down, and you are comfortable with all of those things, then go ahead and buy. The problem is that in most of the metropolitan areas and along both coasts, it is hard for most people to afford the price of homes without using interest only, 100% financing, stated income, option-ARMs, or other creative mortgage products.

It is also pretty amazing to me how these people seem to ignore the data out there, and keep saying that real estate only goes up! Every one of their calculations and arguments is based on things continuing to appreciate. I think the info is good, general, basic information if you were introducing 4th graders to real estate. I think it is incomplete and terrible advice for people that are looking to buy homes at TODAY's prices in many areas that have seen massive appreciation. I think the article needs a lot more clarification before it is put on the front page of Yahoo Finance.

Don't forget, I'm talking about buying TODAY!!! Hindsight is 20/20. Nobody can go back to 1997 and buy a bunch of property. You have to make decisions based on TODAY's prices with your personal economic situation in mind. I think buying real estate in many areas today will make you "automatically upside down", not a millionaire. Again, I'm not talking to people who already own, and I'm not telling people to sell. I'm trying to educate the person who wants to buy a home by any means necessary in any of the areas that have seen abnormal appreciation the past few years.

So, who do you think is right?!?!?

I look forward to the comments and feedback!
---
I am going to keep making my posts over here, but most of the comments are happening at the new site. Go to...
www.housingbubblecasualty.com
or
www.anotherf@ckedborrower.com

...if you would like to see more comments and activity. Don't forgot to check out the activity in the FORUMS!

SoCalMtgGuy

15 Comments:

Anonymous Anonymous said...

There is great power in saying nothing in response. ps: your right.

2/14/2006 10:27 PM  
Anonymous Anonymous said...

He-he...I love the statement that homeowners are 30 times richer than renters. Well, my scientific study says that those wearing Rolex watches are 300 times richer than those who don't. Before you rush to your local jeweler to become a zillionaire, you should remember statistics 101: just because two things correlate doesn't mean one causes the other. Buying a Rolex won't make you any richer, and buying a house today in one of the hot spots isn't such a great idea, either.

2/15/2006 12:31 AM  
Blogger grim said...

Why even waste your breath with that rebuttal?

A quick look at the source of this B.S. is all anyone should need to question it's validity?

Wells Fargo? An author with accompanying books to sell? A speaking tour? Seems like a lucrative proposition for both parties involved. A win-win for everyone.. Well.. Except the bagholder.

The whole thing reaks of desperation, especially considering the declining market.

Bias? Most certainly.. The bias overfloweth.

grim

2/15/2006 7:01 AM  
Blogger Privatebanker said...

I think you did a great job here. I'm tired of reading articles put out by biased real estate wannabees. They have no true understanding of investments and building wealth. One thing I'd point out is he stated that no stock/bond/mutual fund can produce a return such as his example. Entirely false, to compare apples to apples, if you have a concentrated investment in a single security i.e. stocks can certainly go up 50% in a short time frame. Options can go far beyond that. What kind of naive statement was that?!! And as stocks/options can go down just as fast, a homes value can drop significantly as well. Example, a home is in an area where there are multiple foreclosures and sales for losses occuring. That will affect the comps in the area and certainly drop the home's value.

2/15/2006 7:40 AM  
Blogger SoCalMtgGuy said...

Grim,

Unfortunately, not everybody out there is informed about housing/mortgages.

Tens of thousands of people will see that headline on Yahoo Finance, and many will believe what it says.

Lots of people still have no clue that the market is 'declining'.

Hopefully the post will reach a few people before they make any quick decisions.

SoCalMtgGuy

2/15/2006 10:04 AM  
Anonymous Anonymous said...

It's weird that there's an article with a theme like that on Yahoo finance frontpage. It looks like a paid advertise to me. Remember those late night paid programs on TV? How many of them are flat lies? It's hard to believe that this type of business practice is not even regulated. Some poor people would just become a little poorer to make the owner of these programs, and the author of this article, a lot of richer.

The examples in the articles are just not realistic. Most of the people who are looking for or buying a house know that. Look at those half million to million dollar shacks in southern california. Real Estate agents call them "shit hole" behind their customers. Those are the ones they show to the customers first to give them a shock in order to set their expectations at the "right" level. Those shacks will go up in price 6.3% every year? People will get sick by living in those shacks in a few years. Forget about they will be becoming richer and richer and richer in the coming 30 years. They will be living a healthy life renting a nice small apartment for less than $1500 a month in the same area. I think most of the people who'd ever crunched some numbers know that a $500k, 6%, 30-year fixed mortgage costs $3000 a month, plus property tax on $500k, insurance, maintenance, that's easily another $2000 a month (24k a year), on that $500k shack.

Anyway, it's a waste of time rebutting this guy...

2/15/2006 1:38 PM  
Blogger Out at the peak said...

There needs to be another guy following him on his book tour. The other guy should have a book entitled, "Why new home buyers are going to lose their @ss", and his seminars are five minutes after the original.

Although all readers of this blog know it is obvious that the Automatic Millionaire is a joke in this day, I think there are a handful of suckers left, unfortunately.

Will he adjust SF numbers for $700K -> $4M (6% over 30 years)?

2/15/2006 5:02 PM  
Anonymous Anonymous said...

I dunno.

Yet you people act as if it's already happened. Disconnect w/ reality.
MAJOR Cognitive Flaw.
I don't see prices down at all.

More importantly, perhaps you should step back and think of ahy you're obsessed with the idea of housing prices going down.
I think there is a LOT of "see what u want to see" going on here.
Bitter renters who think "they knew better" just hoping, praying, anything...
I bet most of you have no stock investments either?
Prob. sitting in cash during a 20 year bull market. (while thinking you're right all along)


I don't see how buyers will ne "f*cked" either.
People just walk away, if they're upside down, and buy the house down the road at the lower price.
So you lose your downpayment. Wait, there was no downpayment. LOL

Yea, the only person who loses seems to be the renter.
Prices go up = buyer wins
Prices stabilize = buyer wins (still has paper profits)
Prices drop = buyer loses paper profit that renter never had anyways
Prices crash = buyer just bails. Tie with renter.



Just a counter -viewpoint.
Feedback welcome.

2/15/2006 6:12 PM  
Anonymous Anonymous said...

Go f@ck yourself stupid.

2/15/2006 7:21 PM  
Blogger tika said...

To Moderator of this Blog
I fully understand the freedom of speech in this country but people posting shill comments should be remove from this blog. It's about bubble. If you want buy at the inflated price , do it. Please don't post your flawed logics on this blog."Prices go up = buyer wins
Prices stabilize = buyer wins (still has paper profits)
Prices drop = buyer loses paper profit that renter never had anyways
Prices crash = buyer just bails. Tie with renter."
What a horse shit. Anon go fuck yourself. I'd like to here the sound of the alum baseball hiting your skull. Probably is not hollow sound. It's dumped by a shit inside.

2/15/2006 7:28 PM  
Anonymous IMarvinTPA said...

This bubble is an middle sign of inflation. You have two choices coming up if you already own.
1) Buy something expensive on 100% financing and invest your existing equity in something precious, like gold. Then get an home equity loan and as your property appreciates, keep increasing that until the bank says no, and buy more precious metal. (Buy actual metal you can hold so you can't loose it.) When the bubble bursts, don't try to keep up with the house payments, just foreclose. Use the gold to buy a new home somewhere else. Don't worry about your credit, everybody else won't have any either.
2) Buy a home outright with your existing equity. When the buble bursts, you have no mortgage, so you still own your home, and your property taxes just went down.

Interesting article on money:
http://www.galmarley.com/framesets/fs_deflation_and_hyperinflation.htm

IMarv

2/16/2006 1:02 PM  
Blogger Rob Ryley said...

Anonomous 6:12 PM wrote
"Yea, the only person who loses seems to be the renter.
Prices go up = buyer wins
Prices stabilize = buyer wins (still has paper profits)
Prices drop = buyer loses paper profit that renter never had anyways
Prices crash = buyer just bails. Tie with renter.

Just a counter -viewpoint.
Feedback welcome"

First,
The problem with that POV is that you are forgetting about the new bankrupcy law that makes "walking away" more difficult.

Second, it is just dishonest to make an obligation you have no intention of doing your best to meet.

A market where people take on debt, but fail to repay, makes people less willing to extend credit. Fewer businesses get capital, and more people are unemployed.

This idea you can "walk away" from a promise when your speculation doesn't pan out is something that needs to be eradicated. Yet, it is a belief that is common at bubble tops.

You are also forgetting that a renter can save more, on a cash flow basis. Home equity is NOT savings, despite what the pundits constantly refrain.

To tap home equity, you need for prices to rise. Next, you either need to add to your liabilities by taking out a HELOC, or, you have to disrupt your life by selling your home, and finding a new one, or renting.

2/16/2006 2:17 PM  
Anonymous IMarvinTPA said...

We're approaching a triple disaster.
1) Peak Oil, some say it passed us in December, others say it isn't more than a year or two away. In either case, the price of oil will go up just due to market demands.
2) Real inflation of the money supply. The dollar itself is poised for a bad fall, oil for Euros isn't going to help either.
3) Housing bubble.

What would you do if you knew the Great Depression was nigh? I can't wait to find out what we call the 1930s in the 2020s.

What happens if your mortgage company goes belly up, you've made every payment, and there are no other viable mortgage companies around?

IMarv

2/16/2006 3:17 PM  
Anonymous Anonymous said...

During the past 100 years every asset class including stocks, bonds, precious metals, real estate, collectible art all of that went up in price. The primary reason for appreciation of these assets is monetary inflation. The other reason is the constant growth of human population. The US population grew in the last 100 years 3 fold increasing from barely 100 million to almost 300 million presently. This growth of money and demand for assets created this phenomenal appreciation of stocks as well as of real estate. Regarding the question buying versus renting the answer depends on relative prices. When buying a house, you pay property taxes, interest on the mortgage and maintance cost. That can add up to a significant monthly payment. If the rent is only a fraction of that cost, clearly it is more advantageous to rent than to own. There are many places in the US where rents of apartments are regulated and kept way below market rates. If you live in such a place keep renting and forget about buying. It's not worth the trouble. On the other hand if you plan to have 4 children, you have no choice: You must buy regardless of cost.

2/16/2006 4:16 PM  
Blogger ed said...

Another problem with his argument:

It's mathematically impossible for home prices or rents to rise faster than wages forever. If homes go up at 6% and wages go up at 3%, after a while housing would cost more than 100% of wages. It is possible for rates of increase in housing costs to outpace wage growth for a while, but not in the long run.

Productivity (and hence wages) is only growing 2-3%. The recent run-up has pushed the price/wage ratio much higher, and it probably can't continue rising much...in fact, rising interest rates should make the price/wage ratio decline. So it doesn't make sense to assume that prices will go up faster than wages in the short term, either.

A similar argument can be made for the increase in the ratio between rents and home values. Rents are at historically low fractions of home values, so it doesn't make sense that values will continue to climb faster than rents.

2/23/2006 1:42 PM  

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