Surreal Estate

A reader brought my attention to this article in the SF Chronicle. Here is an otherwise unremarkable person who has no job, no steady income, and yet who chose to go $2.3 million into mortgage debt, with an average negative cash flow of $10,000 per month. On paper she and her partner are very wealthy. In truth, they are dependent on debt extraction. This degree of leverage reminds me of the Long Term Capitol Management business model and we all know (or should know) how that ended (and those guys were all Ph.D.s for crying out loud!). But the thing is, this is not an isolated case; it is going on all around us. It is vigorously encouraged by the RE industry, lenders, the Fed (remember Greenspan touting the goodness of ARMs at one time?), "the Jones", and others. Here in Marin real estate investing is of epidemic proportions as it is something of a hobby and really has become our only industry.

So what happens when the RE cycle changes as it seems to be doing now and as it has always done in the past? Should lenders be allowed to lend to people in this position? If their house of cards blows away, who should be held accountable? The borrower? The lender? Someone else? For my part, I don't begrudge anyone financial success in the real estate market; but irresponsible lending (and that is what I think is at the heart of it) needs to be significantly reigned in. And the only way to effectively reign it in is to make the lenders personally liable for the consequences of poor lending decisions -- use people's self-interest for positive social change.

What can YOU do? Share your thoughts.

Some choice quotes:

"In the three years since Sacco and McCook put their faith in real estate, the couple have embarked on what might conservatively be called an E-ticket ride, pulling equity from appreciating properties to provide down payments for the next investment. They have bought eight vacation properties - four homes in Florida, three in California and 100 raw acres on top of a mountain in Lake County."

"They don't have jobs, but their lives appear to be a whirlwind of work. They don't have incomes either, though they maintain middle-class lifestyles."

"Sacco estimates that along with McCook's mother, who has been a silent partner, they've made $1.3 million since they began their buying spree, but all of this is still in equity on their properties. Their monthly reality is more sobering. They have $2.3 million in mortgage debt and negative cash flow that ranges from $5,000 to $15,000 monthly depending on the season."

"So how do they pay the bills?"

""We sort of count our equity loans as our income," she says, with the slightest wince. "If we had real jobs, we'd be fine, but we just need to get some money in. Some people call it a pyramid, but I don't like to think about it that way.""

"Surreal financing? Bubble economics? Perhaps. But it's also the way people are increasingly approaching real estate: as a bet..."

"Whether it's first-time buyers who take out interest-only loans or investors who extract equity from one property to fund the next, real estate is an industry that is being buoyed by a belief in continued appreciation."