by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
My hands were sweaty as I nervously darted my eyes around the craps table . I was the pariah because I was “betting on the don’t line”. This particular strategy can be extraordinarily frustrating when a table gets hot. It requires a bettor to double up his stake each time he is incorrect. It takes incredible faith in the mathematical probability of a negative result.
“Seven Out!” yelled the croupier.
Victory, while inevitable, doesn’t really feel that sweet. I risked $2500 to win five bucks. I proved my strategy to the reckless gamblers betting the other way. I yelped exuberantly, not for my intellectual superiority, but in relief that my bet, the family vacation money, hadn’t disappeared. While I was yelping, the players at my table were pocketing pink and black chips and cheering raucously. Confused, I learned that they were collecting chips every time those dice hit various numbers on the way to making ten straight points .
Now craps may seem like a poor analogy to the real estate market. It really isn’t. I know that craps, a loaded game of chance, always favors the house no matter what strategy you employ. Real estate is a loaded game of chance; the best thing about it is that it is loaded in the owner’s favor. The “MySpace Generation” and the immigrant population are entering the housing market in the next 10 years. The demographics are astoundingly favorable, especially for the sunbelt states.
I think all the bubbleheads and doom pundits should yelp. You were absolutely correct this year. 2006, perhaps part of 2007, will be the year (s) of the bubbleheads. Gloat! Wipe your brow with confidence in your marked intelligence. I commend you for your prowess. You had to be correct one of these years; you had mathematics on your side.
Take a look around. Your neighbor sold that rental property in Anaheim and lost $30,000. So why, like the gamblers betting on the come line, is he cheering ?. He is cheering because he still has rental properties in Albuquerque, Salt Lake City, and Bakersfield.
Now that I’ve commended you, I must warn you of something. You really don’t want a 30% decline in housing prices because every financial asset you have will be devalued . If you’re stashing your cash in the local bank, it will be gone because the bank will collapse. The FDIC will not weather a bailout without significant tax increases. Stocks will sink and mortgage-backed securities will be worthless setting your well-diversified, employer-sponsored 401(k) account back to it’s 1984 value. Think of the big picture bubbleheads. Isn’t that a huge price to pay for bragging rights?
2007 should be the year you stop gloating and start asking the tough questions about how YOU can profit off the changing markets. It is far more courageous to ask those questions than to post argumentum ad hominum under a pseudonym (although I secretly enjoy the mindless banter). The real estate market, like a cold craps table, will quickly get hot.. History and demographics dictate that this table will have a lot of winners on it.
I hope you’ll get prepared for the big roll.
Happy Anniversary Bloodhound Blog !
Happy New Year to All !
mike says:
2007 should be the year you stop gloating and start asking the tough questions about how YOU can profit off the changing markets.
Of course, I disgree with your doomsday if-housing-falls-by-30% – then – the-entire-economy-will-fail scenario… but I do agree with the statement above.
Yes, absolutely, let’s make money from the current situation … what do you see as ways to profit off the changing markets?
December 30, 2006 — 1:54 pm
carole cohen says:
I always contend that even in an ‘off’ market, you buy a house to live in, if you sell it 5 years later for the same amount, you’ve paid no rent in that time. I couldn’t agree with you more, Brian, I think when the market is level or ‘down,’ you should seriously consider some investment property. Real estate, historically, holds up very well compared to stocks. I’m not sure about the 30% figure, but the philosophy is the same, if the housing market crashes completely, so will everything else. There is no indication that we are on any path in that direction! Too many people want instant gratification. Buy something the way people used to buy stock, hold it, make money! Hi Brian and Happy New Year
December 30, 2006 — 2:39 pm
mike says:
I always contend that even in an ‘off’ market, you buy a house to live in, if you sell it 5 years later for the same amount, you’ve paid no rent in that time.
I contend that in this down market, with price:rent ratios in the 150/160/170 (and even higher!) range, it’s far better to rent, invest the savings in appreciating assets and wait out the correction than to buy that depreciating asset now and lose equity every year.
In ordinary times (stable markets), it’s better to buy than to rent.
But this is a very unique market – distorted horribly by the unscrupulous lending practices and the Fed’s interest rate decisions between 2001 and 2005 – the most unaffordable market since 1890 and prices have a long way to go before they come back down to where they need to be.
December 30, 2006 — 2:53 pm
Joe says:
I always contend that even in an ‘off’ market, you buy a house to live in, if you sell it 5 years later for the same amount, you’ve paid no rent in that time.
Right, except that you did pay for:
* taxes
* maintenance
* selling costs to the agents
* whatever “upgrades” you did to the house
* HOA fees (if you have them)
In the meantime, the “poor schmuck” who was renting took the 25%-50% difference from what a comparable dwelling would have cost to buy (depending on the market) and invested it, making money whereas the house ended up costing you.
Is this true of all cities? No, of course not. But there are plenty of cities where this is the case.
December 30, 2006 — 3:33 pm
Jeff Brown says:
I’m buying Tuesday.
December 30, 2006 — 3:33 pm
Joe says:
Victory, while inevitable, doesn’t really feel that sweet. I risked $2500 to win five bucks.
Then you’re not a very good craps player.
Confused, I learned that they were collecting chips every time those dice hit various numbers on the way to making ten straight points.
Yeah, I bet you were confused. Hey Brian, go do the math and figure out how likely it is that a craps player makes 10 straight points. Go ahead. I’ll wait. Here’s a hint: it’s significantly less often than you make it sound like.
The don’t pass line actually has better odds for the player than the pass line does – not by much (pass line is 1.41% house edge, don’t pass is 1.4%. Not much, but hey, better is better).
There’s a reason why casinos don’t teach people to play the Don’t Pass line, Brian. See if you can guess what it is.
Your neighbor sold that rental property in Anaheim and lost $30,000. So why, like the gamblers betting on the come line, is he cheering ?. He is cheering because he still has rental properties in Albuquerque, Salt Lake City, and Bakersfield.
Um, yeah, OK. As if that’s somehow the norm. Right, everybody owns rental properties, Brian.
What about the 40% of California borrowers in 2006 who Option ARM-ed themselves into a house they couldn’t afford, Brian? Are they going to be “cheering” when they have to sell and take that 30K bath? The story repeats itself in Vegas, in Southern Florida, in Boston.
You really don’t want a 30% decline in housing prices because every financial asset you have will be devalued… Think of the big picture bubbleheads. Isn’t that a huge price to pay for bragging rights?
Wow, that statement is so unbelievably wrong I don’t even know where to start.
It would only be true if they’re as poor investors as you are a craps player.
People who are smart enough to diversify their assets out of riskier classes and into ones that are more defensive won’t have those problems. That’s the big picture.
Let me give you an example: last year I bought stock in ING, the Netherlands-based banking giant. It’s only up about 28% on its home exchange, but I’m sitting on a 53% gain. Why? Because the dollar declined, and all that extra money was just gravy thanks solely to currency movement and dividends. Same story with the Dutch phone company I bought (KPN), same story with my position in the European ETF I bought (EFA).
I also bought the Canadian Oil Sands trust. Got myself a 40% gain so far, and oil is just headed higher again in 2007. Same story with my gold position in the Gold ETF (IAU) – only up about 42% on that one.
And please don’t give me this “the Fed will cut rates in order to save the housing market” BS. The Fed is in a box – lower rates and you cause a run on the dollar as every foreign govt dumps their treasuries, raise rates and you risk recession. Do nothing and they risk inflation. Sure will be interesting to see which one the Fed chooses.
To be fair, my commercial real estate holdings also did well for the year, but I’m bracing for a downturn in that market. The whole “commercial will make up for residential” argument is just fantasy.
What I don’t understand is – why can’t anyone on this blog just come out and admit that real estate is a riskier investment at the current moment than other asset classes? What do you have to lose by being honest?
December 30, 2006 — 4:00 pm
UrbanDigs says:
“I always contend that even in an ‘off’ market, you buy a house to live in, if you sell it 5 years later for the same amount, you’ve paid no rent in that time.”
AGREED with Jeff Brown. You have NOT taken into account transaction costs to both BUY & SELL the property, the LOSS of interest income that was eliminated as a result of down payment, and the fact that owning will cost you about twice as much as renting a comparable unit in most areas.
I just sold in NYC after owning for 5 years. Now Im renting for $2900/mth. To buy this same apartment, would cost at least $600,000 + transaction fees to both buy and sell + loss of interest income from money needed to do the deal. When you look at a REAL ANAYLSIS of this, renting all of a sudden makes sense!
If you are going to talk about this, lets do it the right way. No homeowner makes as much as they say after ALL expenses are counted. But people don’t ever talk about that part of the real estate process.
To buy a $500K CONDO in NYC you are looking at $22,000 or so in buyer closing costs and 7-8% of your purchase price in seller closing costs when you ultimately sell. Plus eliminate the $100,000 that was used for down payment that could have been invested elsewhere making 5-7%, hopefully more.
Hmmmmmmmmmmmmmmmmmmmmmmmmmmmmmm….Buyers should be more educated on their decisions, especially if timeline to own is under 5 years!
December 30, 2006 — 8:06 pm
UrbanDigs says:
Sorry, meant to say I agree with JOE. Jeff should wait to buy until Friday. Housing should be down 30% by then and be a much better deal. Happy New Year all!
December 30, 2006 — 8:09 pm
Brian Brady says:
I don’t know where to begin. How about…
Joe: I appreciate the good comments. I’m not a good craps player; nobody is. The point of the $2500 for $5 was that I was doubling down in a ten straight pass scenario…which is highly unlikely,,,which is why it’s unnerving to have to stick to the “system” of doubling down when you lose on the don’t pass. You already knew that but wanted to have a little fun with me…I’m down with the banter, Joe.
The braggadocio about your odd-lot securities trades might be hit with the ladies, stud but it ain’t impressing me.
How about I go out on a limb here, Joe?
Residential real estate, as an asset class for the sophisticated investor, is an inferior choice to other asset classes at this particular moment…now…when you cut and paste my comments, be sure to include this:
Residential real estate will offer tremendous upside over a ten year period for the homeowner or starting investor. That person can benefit tremendously from the advice offered by the real estate professionals here.
I won’t comment on the Fed because you and I both know that the Fed is a wild card right now.
I have a serious question for you, Joe. How did you benefit from the currency devaluation with the ING trade. Did you own ADR’s or the actual security?
December 30, 2006 — 8:15 pm
carole cohen says:
In my market I can sell someone a 79k home in move in condition, three bedrooms with a small low maintenance yard. They can pay what, 500 or 600 a month on a mortgage; or, door number two, they can rent the upstairs of a double house for $650 to $750. I think that makes up the difference in closing costs. Which in my market are around 2500 to 3000 (yes we are not a high end market).
I do agree though, some people should not buy, the ones who are not looking for investments; they should keep their money and use it at the casino. Or for that big screen entertainment center. I’m right with ya!
December 30, 2006 — 8:16 pm
Brian Brady says:
Noah:
“Buyers should be more educated on their decisions, especially if timeline to own is under 5 years!”
I don’t think I ever suggested that real estate was anything but a long-term hold but I get your point. However, there are undervalued markets in residential real estate on a relative basis. Historically, Carole is correct when she cites 5 years. Maybe the current environment is 6 or 7, maybe it’s five but you get the idea.
Thanks for visiting.
December 30, 2006 — 8:22 pm
Brian Brady says:
I don’t know where to begin. How about…
Mike:
Are we still back on the unscrupulous lenders rant? I thought we diffused that at Active Rain when you went by Mikey. I imagine you’ll point me to an obscure consumer watchdog group study now.
December 30, 2006 — 8:29 pm
carole cohen says:
It’s kind of a puzzle though,no? Because now 5 years is a long time for someone to stay in a home, when in the past in my market, it was longer. True, I don’t know if five years is long enough anymore; the rental market is also better for people who have financial issues and can’t buy right now. That part is good. And these rental house make good investment purchases for people who can start buying multiple properties. Why would you guys say that buying low and selling high is bad?
December 30, 2006 — 8:33 pm
UrbanDigs says:
Brian – Yes I agree, and I also agree that deals could be found even in the bubble markets (Miami, Los Angeles, Phoenix, and to much lesser extend NYC) if buyer is properly educated on what to spend their hard earned money on; mainly permanent features such as location, light, views, raw space.
Buying + Selling real estate isn’t cheap or easy and that should just be considered much more closely by would be buyers. Most people don’t live in their home for 10+ years, even 7 is a stretch I think. I wonder what the average is, possibly 4 or 5 years, and in this environment buyers should really negotiate a good deal in the current ‘buyers markets’ that most markets are experiencing right now so that after all costs are done the investment was still the right one at the end of the day. Fundamentally, we still have some bumps in the road ahead of us to work through as housing is not a liquid asset and when the market turns, it could take time to reverse course. The next few years could very well be flat to down. My worry is jobs and lenders tightening ease of borrowing that so many have taken advantage of over the past few years. Should jobs data get weak or banks make it harder to borrow, we could have some issues to get through.
BTW, Im lovin this blog. Content is great and came along way in a short period of time! Keep it up!!
December 30, 2006 — 8:34 pm
Brian Brady says:
Noah:
Your continued comments are what will make Bloodhound the must place to visit for real estate professionals. Keep coming back.
December 30, 2006 — 8:45 pm
john harper says:
Brian – Having recently “retired” from Delta airlines after seeing my paycheck lose 30% and my 401K disappear faster than a Realtor’s buffet, I am want to point out that the US Taxpayer has a very hefty bill coming his way compliments of US Bankruptcy Judges who have allowed companies to dump their pension plans as a business strategy.
December 30, 2006 — 8:51 pm
Joe says:
Brian:
Joe: I appreciate the good comments. I’m not a good craps player; nobody is. The point of the $2500 for $5 was that I was doubling down in a ten straight pass scenario…which is highly unlikely,,,which is why it’s unnerving to have to stick to the “system” of doubling down when you lose on the don’t pass. You already knew that but wanted to have a little fun with me…I’m down with the banter, Joe.
Fair enough, but when I play the Don’t Pass I certainly never “double down” after a loss. Dude, that’s rule #1. And I certainly don’t go in expecting to win! 🙂
The braggadocio about your odd-lot securities trades might be hit with the ladies, stud but it ain’t impressing me.
OK, so, I wasn’t trying to impress you or anyone else; the whole point was to illustrate that your comment about how a 30% haircut in real estate would destroy the value of all other asset classes was inaccurate. It’s entirely possible to find places that will benefit while others suffer.
Residential real estate, as an asset class for the sophisticated investor, is an inferior choice to other asset classes at this particular moment
Thank You!
now…when you cut and paste my comments, be sure to include this:
Sure, no problem:
Residential real estate will offer tremendous upside over a ten year period for the homeowner or starting investor. That person can benefit tremendously from the advice offered by the real estate professionals here.
I guess my response would be that residential real estate will offer tremendous upside potential (you left that out) over the next ten years, with the following caveat: depending on the price paid for the asset.
This is the part that most people seem to get wrong: the single most important determinant of return is the initial price you pay. You don’t just plunk down cash and make mega bucks. 2002-05 was an anomaly, not the norm.
I don’t disagree with all of the people who keep talking about demographics, about population growth, yada yada. Yes. Fine. It’s all true.
But, it doesn’t matter how many people move to a place if they can’t really afford to buy, if the jobs don’t support the prices, if the lending rates move up. That’s the part of the demographics equation that nobody ever wants to talk about. Prices are eventually justified by income. Check out john harper’s comment above – we’re going to be seeing more of this as 2007 progresses.
It becomes a house-picker’s game at that point, which involves a whole lot more legwork than just buying a place and watching it shoot up in value.
I have a serious question for you, Joe. How did you benefit from the currency devaluation with the ING trade. Did you own ADR’s or the actual security?
The ADRs. You can also open a foreign trading account, but why? ADRs make the process easy, and it’s a lot easier at tax time when everything is denominated in dollars.
Peace.
December 30, 2006 — 10:19 pm
mike says:
I don’t know where to begin. How about…
Well, Brian, how about beginning here:
Yes, absolutely, let’s make money from the current situation … what do you see as ways to profit off the changing markets?.
Well?
December 31, 2006 — 12:23 am
Brian Brady says:
I think we see eye to eye, Joe vis a vis real estate.
Mike. I’m going to defer to Jeff Brown for your pointed question although I have some ideas about trust deed investing. Please contact me for those ideas.
Joe: That was actually a dumb question I asked about the ADRs. They are just receipts (the R in ADR) and as such aren’t hedged back to dollars, correct? It’s a “pure” play on the foreign security(without a currency hedge), correct?
December 31, 2006 — 1:27 am
Brian Brady says:
Joe:
I had no intention of going here because of the nature of this being a real estate rather than gambling post. BUT…why won’t you double down after the initial loss on the don’t? If a bettor has the resources, isn’t it always the strategy to double down on the don’t to recover the initial loss? Mathematically, it’s perfect.
December 31, 2006 — 1:35 am
Joe says:
Brian:
We probably do see things mostly the same. I’m not sure I’m comfortable with your assertion that the odds are stacked in the owner’s favor when it comes to real estate investing – there are a lot of variables outside your control. Not to say it’s too hard, or that stocks are always better, but it’s not an easy game either, and I’ve been at this for a while.
I’m also still waiting for the meaty advice that you refer to this blog providing. I guess I’ll have to keep reading.
RE: your previous questions, yes, the ADRs are not actually hedged into dollars, they’re just priced that way based on the exchange rate. Of course, it works in reverse as well, so when the dollar rises you don’t make as much as a home-exchange buyer. Luckily, I don’t see the dollar rising meaningfully any time soon – there will be ups and downs, but the trend is for the moment still down. And that’s how the Treasury wants it for the moment.
For your other question, the simple answer is an old Wall Street saw: “markets can remain irrational longer than you can remain solvent.”
The longer answer is that doubling down each time doesn’t actually reduce any risk in craps. You have to remember that each time the dice is thrown, the chances of rolling any given number is exactly what it was on the previous roll. It doesn’t matter if the shooter rolled 46 sevens in row – the chances of rolling another seven is exactly what it was on each of the previous 46. You’re playing the current roll, not a succession of each roll. Note that this is inherently different than blackjack – when 2 jacks are gone, for example, that affects future outcomes that you can then act on. Craps has “no memory”.
Thus, in theory, you could lose each and every time. Now, in practice, that obviously won’t happen, but I prefer to play craps less aggressively than that. For me it’s about entertainment, not the $. To reduce risk, I always take odds on my bets, especially the don’t pass/don’t come ones. No house edge on those.
December 31, 2006 — 3:46 pm