Saturday, April 18, 2009

Calm down bears

OK I see my last post caused some bear angst.

Yes, buying and renting are coming closer due to dropping prices and low interest rates.
However buy/rent comparisons are just one factor and even though logically it SHOULD be one of the main drivers of price, we do not live in a logical world and therefore it is not.

Let me explain

Generally speaking people prefer to own than rent. There are many reasons and I have listed some of them in my previous post. So buying should have a small premium over renting.

However as we all know this premium reached crazy levels over the last few years. Bears noticed this and it had been mentioned by me, VHB, Freako, Mohican and the many other housing bear bloggers.

Why buy something when you can rent it for almost half the price!

What we forgot is that most people are not logical or analytical. When they see something running up in price they jump on board, fundamentals be damned. That is exactly the same reason why a stock can sell for a price/earnings ratio of 10 one day and 15 the next month, even when fundamentals are unchanged.

Things have flipped the other way now. The asset is dropping in price, instability and job uncertainty reigns. The risk has moved from missing the RE band-wagon to falling off it and getting bones broken. So, as Jesse said in the comments section, buying should be at least balanced and probably cheaper than renting, since there is less risk in renting than buying right now.

Previously you could over-extend and buy, and then if you needed to repair the water heater or roof, you would get an appraisal which would show your property up X% and would get an home equity loan and off you go.

Now with prices dropping, you will have trouble getting that extra money and may have to sell. Throw in an illness, job loss, divorce or other life calamity and the house is in foreclosure.

So by buying you are taking on a lot more risk.

As I said In good times people prefer to buy. In bad times, they have to rent.

Also one more point, the buy/sell comparison only works, because you are paying down the debt and are 'forced to build equity'. However as bonuses, and then wages drop people will have trouble meeting their primary obligations never mind putting aside equity.

Also building equity in a dropping asset is a losing proposition.

It is exactly the same as cost-averaging into the stock market for the last 10 years. If you had put $10,000 of your savings on the first day of trading into the fasting growing US companies in the US - the Nasdaq- you would now be down nearly 40%. So much for building equity.

So am I buying now?- No. I am expecting the cost of owning to drop BELOW the cost of renting.

...and I am expecting rents to drop too, as jobs disappear. So both should come down. However there will blips up, on the way down.

However that is just my opinion, and like all bears I have been wrong for a long time, and have vindication is not as sweet when you have to wait half a decade to be proven right.

What happened earlier this year was the near complete collapse of the capitalist system. It took the irresponsible central bankers who did NOTHING while the bubble expanded -an enormous amount of money, zero interest rates (near enough) and huge bail-outs to prevent implosion.

However, in less than a year we have gone from full employment to rapidly increasing unemployment around the world. SO is this over? I don't think so. I think we have an interlude while folks enjoy and adjust to the new lower interest rates and then we realise that a bubble of this magnitude will take more than half a year and a quick, contained drop in RE to end it.

Feeling better bears? :)