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!
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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