Tuesday, January 24, 2006

"The Dumbest Reason to Buy is When Prices Are Going Up"

I originally found this article posted on today's Housing Bubble 2 blog. I try not to post articles that other blogs are posting unless the article makes some really good points (at least in my opinion) and is applicable to Marin. This article is just such a one as it addresses the meaning of value in the RE market and investor psychology.

First some quotes from the article:
Warren Buffett said: "For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for someone else....The dumbest reason in the world to buy a stock is because it's going up."

Personally, I would say, "The dumbest reason to buy anything is because the price is going up." Yet that's what people do when they invest. They generally don't buy high-priced things when they shop.

For example, if Safeway had a sale -- 25% off everything in the store -- the supermarket would be swamped. Yet, when the stock market or real estate market has big discounts (often called a crash or a burst bubble), that same shopper runs away from an asset sale. Instead, they wait until prices are high and other fools are bidding them up further to finally buy.

I estimate that 90% of all investors invest for price movement, not value. If prices begin to escalate, as they did in real estate from 2000 to 2004, amateurs turn pro and begin buying real estate to flip...

Most stock market investors do the same thing. In investor language, flipping is known as "the greater fool theory of investing" -- you're buying something not to own, but in the hope of selling it to someone who's a greater fool than you.

But such rumors [of an impending decline in housing prices] only affect those investors who, as Buffett says, "take their cues from price action rather than from values." During such periods of high prices and volatility, it's even more important to pay attention to value, more than price.
The fact that the author of this Yahoo article, Robert Kiyosaki, was a very recent housing cheerleader might lead you to dismiss him as a hypocrite. That may be true and you may be right, but I think what he has to say now is relevant (if not too late).

I think a lot of people have been buying houses because they see their friends and neighbors making a lot of money (at least on paper) by buying and selling property or read volumes of articles about folks making money from property. People are not asking themselves "Gee, is this house really worth the price?" Instead, they are thinking to themselves "It doesn't matter what the price of this house is relative to its value; all that matters is if I can pay the monthly mortgage because the selling price is only going to go up and I can flip it in a week, month, year, whatever, for a small fortune". That is typical investor (not owner-to-live-in) psychology.

The sad thing is even if someone is only buying a house "just to live in" the chances are they are still speculating whether they know it or not. They are speculators because of the fact that they are willing to pay an exorbitant price for a house not because they think the price accurately reflects its value, but because they see other people making a lot of money when they sell and they have heard, with recent (and I'd wager temporary) confirmation from the market, that "housing only goes up." The fact that history says otherwise is irrelevant to them.

Now you say "Hey, Marinite, isn't this obvious? What rock have you been living under?" And I say, it is obvious and has been for some time but it is clearly not obvious to a lot of recent buyers. The typical house buyer probably does not think of himself as a housing speculator per se. But depending on what the thought process was that led to the decision to pay an inflated price for a house (as opposed to just renting an equivalent house), I argue that they probably are speculating. If so, that means the recent "official" estimate that roughly 40% of recent California house buyers are speculators probably greatly underestimates the true percentage.

It doesn't matter that current lending standard are so loose that even a [insert some low wage job here] can get a loan for a half a million dollars with a small monthly payment (at least for a while). The majority of people are still buying with the expectation of making a small fortune by selling sooner rather than later.

Housing prices are very likely to correct. Not all at once, not overnight. Rather, housing prices will likely erode over the course of quite a few years. There will be some minor up ticks in prices (i.e., "dead cat bounces") along the way down and some people will jump in at those points thinking the bottom has been reached just like they recently did as the NASDAQ crashed. But the true bottom won't be reached for quite some time I think. Some people are calling for the bottom in five years; others predict it will come in ten years or even more. I don't know when the bottom will be reached, but given that your typical house owner sells (for whatever reason) on average every five years or so, this means a lot of folks are going to be "under water" or else be trapped in their mortgage for like the next 25 years.

"But that's just the way markets are. Sometimes you win, sometimes you lose." I say "wrong". This is going to be a bigger problem than it would otherwise have been because of the generalized speculative environment that we find ourselves living in today. First it was the dot com bubble and on the heels of its spectacular decline came the housing mania. And is it a coincidence that casinos are on the comeback? What's next? What's the next speculative mania that we have to suffer?

Up to now we have had to endure a seemingly endless stream of articles and stories about the "shrewdness" of average people who reaped huge rewards due to their financial "acumen" for having bought a house and the resultant lavish vacations, plasma TVs, new SUVs, their vacation house in [name some glorious vacation locale], etc. If it were true, that's great. But these endless upbeat articles have helped to further the housing myth and the speculative thought process. Are we to soon have to suffer endless articles and stories about the sad tales of the financial misfortunes of these formally shrewd Americans as well as their resultant law suits?

One thing seems certain, if you buy a house now or do so in the immediate future you have to ask yourself "Can I stay in this house for the next 20 years or so or can I afford to take the capital loss?" People are going to be rudely reminded that the mortgage debt is real and the price is a matter of opinion; what matters most is the balance on the loan and not the monthly payment if for no other reason than the life of the loan is almost certainly longer than the life of a speculative frenzy.


Blogger sf jack said...

"what matters most is the balance on the loan and not the monthly payment if for no other reason than the life of the loan is almost certainly longer than the life of a speculative frenzy."



If I thought housing cycles were longer than mortgages (even 15 year mortgages), then perhaps I would have ignored the stage of our cycle and bought "whenever".

Of course, if I was one of those innumerable wealthy foreigners, or perhaps a trustafarian, or a mommy-daddy downpayment beneficiary or even someone who has to golf in Marin in January in my shorts and go skiing four hours away - perhaps I'd have acted differently.

Jan 24, 2006, 1:17:00 PM  
Anonymous Anonymous said...

Stocks and houses, apples and oranges.

Are you going for an "I told you so book deal"?

Jan 24, 2006, 3:53:00 PM  
Anonymous Anonymous said...

"apples and oranges"

Both go rotten in the end.

Jan 24, 2006, 5:12:00 PM  
Blogger sf jack said...

"Stocks and houses"

And only one beats inflation by a measurable margin over long periods of time.

As for the "book deal", if you were asking me - I haven't told anything that wasn't obvious.

Stock market out of favor, 9/11 nesting, the free-money policies of Easy Al = home prices going more or less "straight up" for the last half decade. Everywhere.

I have to ask anon 1 - did you think that was going to last forever?

Jan 24, 2006, 5:29:00 PM  
Blogger Out at the peak said...

People wanted to jump on the bandwagon because they saw people retire from their houses.

This mania induced people getting in at any cost because they believed the same would happen to them.

When I was selling my house (Oct 2005), my mailman was curious how much profit I made. The wheels just spun in his head thinking he too could make $60K-$70K appreciation per year if he buys in now. I warned him that the whole reason why I was selling was because the market was going to turn. He nodded that off and $$$ filled his head.

Jan 24, 2006, 6:00:00 PM  
Blogger sf jack said...

Ah... well done there out at the peak.


Jan 24, 2006, 6:16:00 PM  
Anonymous Anonymous said...


I am curious: are you renting now? Do you plan to rent indefinitely? With the selling costs, you have to assume the market will go down 6% in the near term and it is safe to say that both your property tax bill and mortgage payments will be higher in the future than they are today should you choose to get back in. Or is your plan to leave the area entirely?

If you had a lot of equity in your home and a manageable mortgage, you essentially hedged yourself against inflation -- at least in your housing costs. Given the inlationary pressures today, why did you do it? Did you need the money for something else?

I am just curious, because even the most bearish of my friends are just going to sit tight through this cycle.

Jan 24, 2006, 7:30:00 PM  
Anonymous Anonymous said...

And only one beats inflation by a measurable margin over long periods of time. -sfjack

Sure, but most real estate is leveraged, which greatly enhances the return (both up and down). Bay Area real estate has averaged a 9.5% CAGR over the past 30 years (www.ofheo.gov) which, assuming you are leveraged 2:1 50% equity, average paid off over 30 years), means you are really getting 19% over the long term. It would be tough to find any stock picker that has performed that well for 30 years.

Stocks are also considerably more volatile and you have to trust the CFO's are being truthful with the books. There are risks to both asset classes -- they are just different risks.

Jan 24, 2006, 7:36:00 PM  
Blogger Chuck Ponzi said...

Hi all,

What some have forgotten is that the guy writing this article is Robert Kiyosaki. He must be one of the most complicit in ramping up the real estate bubble with his book, rich dad, poor dad. He claims to have made substantial sums of money in real estate, but it all appears to be smoke and mirrors. Which, judging by his tax tactics, would all be funneled through illegal and evasionary tax deductions. This guy is probably more dangerous for people's money than Carlton Sheets. At least Carlton understood real estate.

No, he's a bandwagoner, and has jumped on the whole gold thing because it's a rising asset class. He claims he was buying it already back in '98. Do any of us believe that? I don't think you could trust this guy farther than you can throw him.

Jan 24, 2006, 9:53:00 PM  
Anonymous Anonymous said...

Kiyosaki and gold make sense since you don't have to pay cap gains taxes on those Kruggers that you bought at the height of the dot com and stashed in his backyard- unless you really want to. (his statement could also be true that he bought gold in 98 if he bought his wife a cheap pair of earrings).

A huckster with a smile. A real american. Kiyosaki

Jan 24, 2006, 10:56:00 PM  
Blogger hammertime said...

I read this Kiyosaki article the other day, before you posted it to MREB, and was thinking that exact same thing: "wasn't this guy just hyping real estate in this column two months ago?" I'm searching for the article that he wrote this fall, in which he stated that one MUST own a home, and that real estate never goes down. I will post it to the comments once I find it. At least he's realized the error of his ways, if nothing else...

Jan 25, 2006, 7:26:00 AM  
Blogger sf jack said...

junkie -

Of course Bay Area real estate has outperformed stocks recently, we've had an incredible run in RE around here - perhaps why the mania that out at the peak described exists.

People think they are going to retire on their homes, rather than through saving and investing.

Will that continue?

Jan 25, 2006, 10:55:00 AM  
Blogger fredtobik said...

I got to play Half Moon Bay Ocean Course the day, I shot a 84 with winter rules. Very soggy, but amazing views, thank god I didnt have to pay too 180$!~

Made it to Tahoe once so far, have two trips planned in the next two weeks...

Buffet also said, paraphrasing "The best to sell a good investments is never". Do you think Marin RE is a good investment?

Jan 25, 2006, 2:27:00 PM  
Anonymous Anonymous said...

Buffet also said that 'a good investment is one that is priced low relative to its intrinsic value'. Clearly that is not the case for Marin or many other bubble markets.

Jan 25, 2006, 3:26:00 PM  
Anonymous Anonymous said...

I meant to say

"Clearly that is not currently the case for Marin or many other bubble markets."

Jan 25, 2006, 3:28:00 PM  
Blogger sf jack said...

fred -

Good to see you're back in the saddle here. And, of course, out enjoying the out of doors and hitting the links. How was the snow? It was great in the South Lake backcountry last weekend and the weekend before that at Kirkwood. Knee deep most places - I haven't had to make a groomer run since MLK weekend.


One of the many anons said:

"Clearly that is not currently the case for Marin or many other bubble markets."


And in 1995, I'm sure ol' Warren would have been able to say that "Marin is priced low relative to its intrinsic value."

And the same may apply five years hence.

Jan 25, 2006, 4:37:00 PM  
Blogger sf jack said...

Correction on the conditions:

"since early in MLK weekend."

Jan 25, 2006, 4:41:00 PM  

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