NPR Weekend Edition Sunday Gen X Takes The Housing Hit; Boomers Only Grazed Another Misleading RealEstate Report?
I was listening to Weekend Edition Sunday and heard another of those reports that didn't seem to add up in my head. Later I ran the numbers based on their scenario. Still doesn't add up as reported.
This was the story, Gen X Takes The Housing Hit; Boomers Only Grazed
One of the points made was, “But still, even after adjusting for inflation, a person who sells a house purchased 10 years ago will make a profit today.” Another was, “the slump could permanently reduce the net wealth of an entire generation...”
People starting out who want to build wealth may be far better off not relying on the idea of their home building wealth for them. Especially with so many having a good college education, people today are very capable of learning how to invest in other assets – even real estate in the form of commercial and residential rental properties.
Why would we allow one segment, housing, to “permanently reduce the net wealth of an entire generation...”? When there are so many other ways to invest if you have the amount of money, income or cash flow that it takes to buy a home. We are being “mis-educated” by this kind of financial advice.
In reality, most Boomers did not make a profit on their homes. Or, they could have made much greater profit investing in other areas. Your story used a $100,000 purchase price for a home that was bought approximately 10 years ago and now being sold for $170,000. The idea behind these numbers did not seem very strong to me so I ran them out in two scenarios. Even in the 20% down scenario it can be strongly argued that the buyer (they are all buyers, not owners since the home was never paid for) could have increased their net wealth far more by renting and investing the difference in the monthly payments in other types of assets. Of course, we must also assume that these buyers did not Ever refinance. If we run the numbers I believe that we will find more people who are upside down because of multiple refinances than we have people who did not Ever refinance during the period that was discussed.
Where do the rich keep and create their wealth – in their homes as the rest are encouraged to do?
This animation is from the Guardian – the entire video is great but go two minutes in and watch for one minute: http://www.guardian.co.uk/news/datablog/video/2011/nov/16/99-v-1-occupy-data-animation
After the numbers below there are two links to articles about the cost of buying that show that these numbers are reasonable. In fact, some would argue that the amounts should be higher to reflect replacement of equipment such as A/C units, water heaters and things like carpet.
It is time that we stop staring at the evaporation of artificially pumped up home values that clearly had to correct (deflate) and educate our young people about the methods highly successful people use to build and maintain wealth. The housing boom was always a bubble and an illusion.
I am not arguing against owning a home if that is what you want to do. But lets go back to the basics that a home has value as a place to live and maintain a private lifestyle. A home is not an investment vehicle.
If we look at a home as an investment vehicle this is what we see using your example:
Assume:
$100,000 purchase amount
100% financing but no additional penalty for Private mortgage insurance
6% 30year fixed
If Never Refinanced
|
Mon/Year
|
Payment
|
Principal paid
|
Interest Paid
|
Total interest
|
Balance
|
|
Dec 1991
|
$665.30
|
$81.97
|
$583.33
|
$583.33
|
$99,918.03
|
|
Jan 2011
|
$665.30
|
$154.52
|
$510.78
|
$60,591.32
|
$87,408.05
|
|
|
|
|
|
|
|
$665.30 x 1.40% = 931.42 actual payment
Total payment for period shown above = 111,770.40
Allow 30% for tax breaks on interest = 18,177.40
total “cost” of payments over time period
117,770.40 – 18,177.40 = $99,593.00
The buyer has paid $99,593.00 for a $100,000 home and still has a balance of $87,408.05.
Now the buyer becomes a seller and sells this home for $170,000.00
There is a 6% Real Estate Broker fee = $10,200.00
Closing costs = 3,155.00
Total Costs to Sell = 13,355.00
Balance to Seller = 170,000 – 13,355 = 156,645
Payoff of mortgage = 87,408.05
Balance to Seller = 156,645 – 87,408.05 = 69,236.95
Cash paid out by this buyer $99,593.00 - $69,236.95 amount netted by sale after 10 years =
Net profit/loss = - $30,356.05 for 10 years
20% Down
Assume:
$100,000 purchase amount
80% financing but no additional penalty for Private mortgage insurance
6% 30year fixed
If Never Refinanced
|
Mon/Year
|
Payment
|
Principal paid
|
Interest Paid
|
Total interest
|
Balance
|
|
Dec 1991
|
$479.64
|
$79.65
|
$400.00
|
$400.00
|
$79,920.36
|
|
Jan 2011
|
$479.64
|
$137.85
|
$341.79
|
$41,460.73
|
$69,220.64
|
|
|
|
|
|
|
|
$479.64 x 1.40% = 671.50 actual payment
Total payment for period shown above = 80,579.52
Allow 30% for tax breaks on interest = 12,438.22
total “cost” of payments over time period
80,579.52 – 12,438.22 = $68,141.30
So the buyer has paid $68,141.30 + $20,000 (down) = 88,141.30 for a $100,000 home and still has a balance of $69,220.24.
Now the buyer becomes a seller and sells this home for $170,000.00
There is a 6% Real Estate Broker fee = $10,200.00
Closing costs = 3,155.00
Total Costs to Sell = 13,355.00
Balance to Seller = 170,000 – 13,355 = 156,645
Payoff of mortgage = 69,220.24
Balance to Seller = 156,645 – 69,220.24 = 87,434.76
Cash paid out by this buyer $ 88,141.30 - $87,434.76 amount netted by sale after 10 years =
Net profit/loss = $706.54 for 10 years
Renters:
Renting house next door to purchased house – stayed in home for same period as buyer.
Rent avg per month = $665 Cost to Rent = 79,800 for 10 years
Funds available for investment
(no down payment amount saved) save/invest 266.12 per month = 31,93.44 over 10 years
(starts with savings equivalent to 20% downpayment savings account) save/invest 266.12 per month = 31,934.40 + $20,000 (the savings equivalent to the down payment) = $51,934.40 over 10 years
What could that have made over the 10 year period?
In our neighborhood, renting in Los Angeles – gated condo community, mostly long time owners who occupy their homes sale prices went to $450,000 and are now back to around $225,000 - $250,000. Rent remains constant at less than $1,000.
Buying in this Condo Development instead of Renting During the peak assume:
20% down
$360,000 mortgage
5% 30 yr fixed
Payment $1,932.56 + .4 (taxes, insurance, maintenance) = $773.02
Total monthly expense = $1,932.56 + $773.02 = $2,7055.58
Of course, at the peak many of these deals were 0% down:
$450,000 Mortgage
5% 30 yr fixed
Payment $2,415.70 x .4 (taxes, insurance, maintenance) = $966.28
Total monthly expense = $ 2,415.70 + $966.28 = $3,3819.98
These figures, as we know are catastrophic since these homes are now appraised at half of what they were bought for. The buyer cannot win on this one no matter what she does.
The point is that making a home the major asset and wealth builder is and was a bad idea. People who invest in real estate as a business are not counting their personal residence as an investment. They buy rental properties, commercial and residential and do the numbers so the properties have positive cash flow and make money. The expenses associated with these properties are tax deductible because they are part of a business.
There are many variables in the scenarios that I presented. The NPR report was, in my view, predictable and standard advice but very misleading and defeatist in tone.
Boomers experience has proven that homes are poor wealth builders. Why would the upcoming generations want to follow the same path that has become even less rewarding in a way that is very visible to everyone?
Background Articles on cost of home buying:
http://biz.yahoo.com/pfg/e10buyrent/art011.html
http://www.myspendingplan.com/articles/viewarticle.aspx?id=10
