Friday, January 18, 2008

Still the best investment

If more people thought of their home as a place to live, rather than a financial investment there would be a lot less turmoil in the real estate market. Despite what Wall Street wants you to believe, owning a home isn’t the same type of investment as owning stocks or bonds. A homes value can’t be totally calculated as a percentage point. Thinking of the family home as an investment opportunity is partly to blame for our current predicament. It’s confusing to view homeownership and high-risk investments as the same. Owning a home requires an investment of money but is more than a financial transaction. It’s a use asset. No other investment vehicle provides us as many tangible and inherent benefits.

We seem to be using the term “investment” more often and for more things that traditionally have been considered an expense. Purveyors of goods and services have discovered Americans prefer to use the term investing when parting with their hard earned dollars. It somehow justifies our purchase if we are investing rather than spending. So we no longer spend money on anything; we invest it. Today we invest in clothes, entertainment-technology, health care and beauty products. Is buying an expensive car really an investment or just an expense? What about my wine collection?

Owning a home is both an investment and an expense just as it is an asset and a liability. It’s a hybrid. Owning a home isn’t as risky as owning stock in a subprime mortgage company but having a mortgage is a greater responsibility than owning common stock. An investment in a home has more in common with an investment in a savings or retirement account than it does with day trading in stocks. It’s a long-term commitment. Tracking the monthly percentage increase or decrease of the national housing market and then relating it to an individual property is fruitless and frustrating. Every home is unique and a personalized use investment.

Some real estate purchases are indeed traditional financial investments. Buying vacant land, rental or commercial property for future resale value or income production should be strictly an objective financial decision. A true real estate investor will analyze income and expenses of a property to make a determination as to its value. Investors are objective when deciding where to invest their dollars while homebuyers make subjective decisions based on personal preferences.

My stock portfolio averaged a 6 percent return last year. I have had better years but worse also. My home value fell too but overall I think I did better in my home than in mutual funds, here’s why. I have never seen one of my stock certificates but I have seen some beautiful sunsets from our back deck. I have never visited the corporate offices of any of the companies where I own stock but I have walked peacefully through our pasture and oak woodlands. I don’t know any corporate executives of publicly held corporations but I know all my neighbors by their first name. I have never been to a shareholder’s meeting but I have never missed a neighborhood picnic. Experiencing life at home is worth more than a positive decimal point on a balance sheet. In addition to lifestyle, here are a few other differences to think about when comparing a traditional financial investment to owning a home.

Years ago I purchased a substantial number of shares in a high tech company that was on the verge of going public. Prior to their public offering and my “guaranteed earnings”, the CEO skipped the country with his self-proclaimed severance package and my money. The company declared bankruptcy, dropping my stock value to zero in an afternoon. Barring catastrophe, a homes value will never be as worthless as was my high-flying stock. Long-term value and the security of a real estate investment are well worth occasional fluctuations in home prices.

Controlling one’s investments is a comforting feeling. When buying stocks you put all your money into a company and have no influence or control of its direction. You’re paying some CEO 500 times the average worker’s salary for results that you would lose your job over. Homeowners have complete control of their investment making decisions. We determine when to buy, sell, improve and expand our home. The only board of directors we need to answer to is our family members.

Leverage is another investment advantage. With stocks, all of your investment ends up owning a small piece of the company. With real estate, a buyer is able to own 100 percent of the investment for often a small downpayment. There are still many loan programs available that offer 100 percent fixed rate loans. A few will even advance the closing costs.

Buying stocks provide no tax advantage, while buying a home has several. What other investment can you purchase by using none of your own funds, be provided a federally subsidized below market interest rate loan, reap all the appreciation, deduct all interest and taxes during ownership and when you sell, pay no capital gains. The federal government subsidizes homeownership and farmers. If you’re not one, you should be the other.

Chance of market declines

Mortgage Insurance Companies make money by providing mortgage insurance to borrowers who have less than 20 percent for a downpayment on a home. They pay money out to a lender when a borrower defaults on a loan for a percentage of the lender’s loss. One of the largest mortgage insurance companies is PMI. They produce a quarterly report with their best guesstimate as to the direction of the real estate market.

PMI's Winter 2008 U.S. Market Risk Index showed a greater than 50 percent chance of price declines in 13 of the nation's 50 largest housing markets, up from 10 in the previous quarter.
PMI said some of the increase in house-price risk was due to changes to its model, which now includes data on foreclosure rates provided by the Mortgage Bankers Association. But in many cases, higher risk scores reflected "a significant deterioration of the housing market in the third quarter."

There is a "high likelihood that home prices will be lower in many of these MSAs two years from now," the report said. Although the number of MSAs with relatively low home-price risk continues to outnumber those with relatively high risk, that could change if the economy and financial markets worsen further, PMI warned.

All but two of the 13 highest-risk markets were in California and Florida. In California, the report noted, markets in the Central Valley and Southern California are weaker than those in the Northern California MSAs, where employment continues to be strong.
The metropolitan statistical areas (MSAs) with the highest risk scores were Riverside, Calif., where PMI forecasts a 94 percent chance of a two-year price decline; Las Vegas (89 percent); and Phoenix (83 percent).

Markets that saw significant price increases from 2002 to 2005 are "at much higher risk of price declines" than those where prices appreciated more modestly, said David Berson, chief economist for PMI's parent company, The PMI Group Inc., in a statement.
Although housing affordability improved in 161 of 381 MSAs studied, it declined in the remaining 220 markets. Nationwide, the affordability index was 95.53, compared with 95.96 in the second quarter of 2007.

The number of MSAs experiencing year-over-year price declines during third quarter -- 89 -- was also up from 67 in the previous quarter, the report said, citing numbers from the Office of Federal Housing Enterprise Oversight (OFHEO).
Among the top 50 MSAs, the 13 judged by PMI to be facing a greater than 50 percent chance of price declines in the next two years were:

Riverside-San Bernardino-Ontario, Calif. (94 percent)
Las Vegas-Paradise, Nev. (83 percent)
Phoenix-Mesa-Scottsdale, Ariz. (83 percent)
Santa Ana-Anaheim-Irvine, Calif. (81 percent)
Los Angeles-Long Beach-Glendale, Calif. (79 percent)
Ft. Lauderdale-Pompano Beach-Deerfield Beach, Fla. (78 percent)
Orlando-Kissimmee, Fla. (74 percent)
Sacramento-Arden-Arcade-Roseville, Calif. (73 percent)
Tampa-St. Petersburg-Clearwater, Fla. (72 percent)
West Palm Beach-Boca Raton-Boynton Beach, Fla. (71 percent)
San Diego-Carlsbad-San Marcos, Calif. (69 percent)
Oakland-Fremont-Hayward, Calif. (65 percent)
Miami-Miami Beach-Kendall, Fla. (58 percent)

The markets identified by PMI as the least risky, with a less than 1 percent chance of price decline during the next two years, were Charlotte-Gastonia-Concord, N.C.-S.C.; Kansas City, Mo.-Kan.; Austin-Round Rock, Texas; Columbus, Ohio; Cincinnati-Middletown, Ohio, Ky., Ind.; Indianapolis-Carmel, Ind.; San Antonio, Texas; Houston-Sugar Land-Baytown, Texas; Pittsburgh, Pa.; Dallas-Plano-Irving, Texas; and Fort Worth-Arlington, Texas.

Economic considerations

The Commerce Department finally has those much-talked-about Christmas spending numbers. Consumers spend 0.4 percent less than a year ago, the worst consumer showing since June 2007, and that's accelerating fears of recession. We're not there yet, but many pundits believe we're about to be. Consumer spending accounts for approximately 71 percent of the gross national product. If the consumer doesn't spend, the country is headed for recession.

The question is: why are we surprised? Jobs are contracting; unemployment is up half a percent over a quarter ago. Housing is in a holding pattern with the first loss in home prices in decades, and gas prices at the pump have risen 10 cents a gallon in the last two weeks

Energy prices have finally impacted wholesale prices by a whopping 6.3 percent over 2007 -- the biggest gain in 26 years. And it's safe to say that consumers are already feeling it.
Tighter credit hasn't helped. Consumers are no longer able to turn their homes into ATMs unless they have lots of equity and good credit. What the impact will be for spring on the housing market is anyone's guess.

During the last mild recession following the technology stock meltdown and the horrors of 9/11, consumers surprised the economy by cocooning. They made buying a home a statement about needing to feel secure. If nothing else is secure, they want to be secure at home. Those homebuyers kicked off a six-year record-breaking run in housing.

However, unlike the previous recession, inflation is a greater threat this time. Mortgage interest rates aren't as likely to be as obliging as they were in 2002 when new record lows were reached. We're already close to those record lows now. Inflation risks are likely to cause the mortgage bond market to react, and mortgage interest rates will rise. Not by much, but they will rise.
That means homebuyers will need more convincing, particularly that they'll be financially safer in a different home. And that won't be easy to do in a rising interest rate environment. So, home sellers will have to step up to the plate with better prices, more improvements and other incentives. The other possibility is that people could stay put, afraid to make the wrong move. That also could impact housing negatively. Either way, housing is likely to be pivotal in determining whether the economy recedes or moves forward.

Monday, January 14, 2008

Rollercoaster Economy

Rollercoaster aficionados had a field day last week, for up-and-down volatility was the norm, not the exception. Countrywide Financial, the country's largest mortgage servicer, spent most of the week pressuring capital markets with rumors of bankruptcy, but then Bank of America rallied the markets by stepping forward and announcing it was purchasing the beleaguered mortgage giant in a $4 billion stock-exchange transaction.

Earlier in the week, the National Association of Realtors reported that pending home sales decreased 2.6% in November following a larger-than-expected 3.7% gain in October. But the grim outlook was tempered by Lawrence Yun, the NAR's chief economist, who said that “although there could be some minor slippage in the first quarter, existing home sales should hold in a narrow range before trending up.”

The disappointing pending-sales report was further mitigated by good news in the mortgage markets, where application volume – both refinance and purchase – surged 32.2% during the holiday shortened week ending Jan. 4, according to the Mortgage Bankers Association's weekly application survey.

What's more, application activity could surge again in coming weeks, thanks to plunging mortgage rates. By week's end, the prime 30-year fixed-rate mortgage averaged 5.87%, the 15-year fixed-rate mortgage averaged 5.43%, and the five-year Treasury-indexed hybrid adjustable-rate mortgage averaged 5.63%, according to Freddie Mac's weekly survey. Mortgage rates are now at levels unseen since Sept. 2005.

Bank of America's rescue of Countrywide was received positively last week, as it should have been; no one wants to see the country's largest mortgage servicer go under. But there was a disconcerting acknowledgment in the accompanying press release: “The combined company won't make subprime mortgages and will limit its purchases of large packages of loans from other lenders.”

That's too bad, because the current mortgage crisis has never been about subprime mortgages per say: It has been about the pricing of subprime mortgages, which didn't reflect the risks involved. Down payments, interest rates, and fees have to reflect borrower risk. This is the economic rationale for giving someone with an 800 FICO score a 6% loan with nothing down and giving someone with a 600 FICO score a 9% loan with 20% down. That paradigm broke down, and needs to be revisited. As homes become more affordable, the last thing we want is to exclude qualified people from the housing market, and that includes people who only qualify for subprime mortgages. The key to successful lending is to appropriately price the risk of lending. Hopefully more people will embrace that economic maxim once the credit crisis subsides.