Why buying at the peak was a brilliant move

If you bought a house in L.A. in the summer of 2007, paid peak prices and have watched your home's value drop by 33%, you have to admit: You made a really bad financial move, right?

Er, wrong, according to a contrarian opinion piece in today's L.A. Times that argues that buying L.A. real estate in 2007 -- even at peak prices -- was "a smart investment."

The author, and proud peak buyer, is Chris Ayres, who lives in L.A. and writes for the Times of London. He argues, "Those of us who purchased nonspeculative property from 2004 to 2007 for the gratuitously self-indulgent purposes of raising a family and investing in our neighborhoods will ultimately have the last laugh."  The words "cheeky Brit" do come to mind.

Ayres' logic: Peak buyers got easy financing on good terms. Interest rates were low. Inflation -- possibly a bigger factor in coming years than in the recent past -- means the value of of his home in dollars will someday rise, while his loan payments will become relatively cheaper.  Perhaps the biggest advantage, he argues, is "the glorious all-American instutition that is the home mortgage interest tax deduction." 

His back-of-the-envelope math on savings from the peak purchase of a $1.2 million home (not necessarily his home, just an example Ayres chose):
--$20,000 per year in income tax savings, for $200,000 over the next 10 years.
--Another $200,000 over 10 years by getting a lower interest rate on his bubble-era loan.
--Another $700,000 in savings and equity that 5% annual inflation will ultimately add to the value of his home and increasing affordability of his mortgage.

He concludes: "The penalty for having bought at the height of the worst real estate bubble in history adds up to a potential $1.1 million gain."

My two cents: He's trying to have it both ways on rising interest rates and future appreciation. If interest rates do settle two points higher than they were last summer, as Ayres argues, home prices will take an even bigger hit, and his home will not increase as much in value -- regardless of what inflation does.

Off topic but tangentially related: Ayres is a journalist, a trade with a glorious history and a questionable future income stream. Salaries for journalists are not likely to keep pace with inflation over the next 10 years. If you haven't noticed, free content is putting downward pressure on the cost of paid content. An era of 5% inflation will not be kind to journalists.

--Peter Viles
Your thoughts? Comments?
Photo Credit: Home of the Week from this week's L.A. Times, by Charmaine David.

Comments

[E]

Pretty much every one of his "reasons" has been debunked over and over.

Income tax savings. There is the AMT issue and also the "spend a dollar to save a dime" theory.

You can always refinance your house but you can't renegotiate your purchase price.

Inflation vs. Deflation....I guess we will have to "wait and see".

Have him try to run his argument for people who bought in the areas that have toppled so far. We'll see what happens with the Alt-A option arms that are lurking in the "better" areas over the next few years.

Then again...he's a journalist that is going to SPIN SPIN SPIN as the L.A. times NEEDS it's RE ad revenue.

BRING ON THOSE HIGH INTEREST RATES!

I'll pay cash for my house and love the higher interest on my CD's.

[mbob]

Pete, you are spot on about journo's future prospects.

Your paper's new boss was a satellite wonk from Hughes who decided their little beeping boxes were good for something other than bird dogging rebellious peasants for cluster bomb gifting. Like "I Love Lucy" reruns beamed down to insomniacs. AKA DirecTV after it got spun off from GM/Hughes.

Here's another Britishism -- "...jam yesterday, jam tomorrow, never jam today." Ayres' projections at least are consistent with UK tabloid trumpeting. Flashy.

[E]

P.S.

Nice to see that you're back in control of the Blog Pete.

If the L.A. times is hard up for revenue...perhaps they should just give all the other contributing bloggers their pink slips.

[Mike P.]

BWAHAHAHA! What an idiot! Getting 25 cents back for every dollar paid (in interest) is NOT a smart investment, especially when the price paid on the home is overinflated by 30 to 50%. Besides, a fixed-rate mortgage is always a 'better' deal in times of inflation. However, we are seeing deflation (credit is being destroyed) and spending contraction right now, not inflation. Mrs. Fields doesn't have to declare BK if wages are going up.

Rising mortgage interests rates will only force home prices lower - because the monthly mortgage payment of principle plus interest still has to be affordable. If the interest portion rises, then the principal portion falls.

[Truth2Pwr]

Did this guy take his math lessons from the guitarist in Spinal Tap who infamously claimed that his favorite amplifier was louder because "this one goes to 11"?

It sounds more like he's trying to make a general argument about the benefits of owning vs. renting in order to distract the reader (and primarily himself) from the hard cold fact that by the time the SoCal market bottoms he will be stuck paying roughly double the market value of his home, and will have to choose between living there for oh roughly...FOREVER, give or take a few years, or taking a Marsellus Wallace in Pulp Fiction-style S&M beatdown financially.

[150 multiple choice questions]

Damn it, why didn't I buy all the Bear Stearns stock at $70?

This kind of crap is embarrassing for the LA Times for many reasons. Most of all the desperation to create some kind, any kind of interest by writing things simply to inflame (but that at the same time try to post something advertisers (realtors) may enjoy).

I bet Ayres knows better than the drivel he's writing because I bet he has a 7th grade knowledge of math... but I could be wrong. Hmm, and I'm not sure he knows what inflation means or does so maybe...?

[Laker]

Peter, You made my Sunday!
What a Moron this Chris Ayres is...WOW. And i thought some Realtards are morons...This dude makes the others look like Einstein...
After 1st glance i assumed he took a fixed rate 30 year at 5%...so he would see his payment devalued...BUT, he took " an adjustable-rate mega-jumbo mortgage". Probably he has a 5, 7 or a 10 year ARM. Now he is arguing that the inflation today at official 5% and only will grow higher....So he completely fails to mention that when inflation will shoot that high and stay there, interest rate as in FEDs rate, LIBOR and others will go much higher to compensate high inflation...That will make his payment jump through the roof in 5, 7 or 10 year. He is banking on appreciation at the rate of 5%, but forgets that if interest rates will be 8%, or 10% it will reduce the purchasing power of his potential buyer, so that directly reduces the price of his house.
Another thing, he is arguing on the deduction of his property taxes... If he got a loan of million dollar and can comfortably pay it, it means he is making nice money which is fine. BUT therefore very likely that he is subject to AMT and thus can't deduct any cent from property taxes...
He is thrilled about the ability to deduct interest, and acting like the woman that goes to macys and screams that she just made $500...by buying a $1000 dress for $500...
In order to deduct you need to make the money. So spending $1 to get back $0.30 is stupid.

ON THE OTHER HAND, if you buy a comparable house like this in a year, you'll pay $600,000. So your interest rate will not be 5% but maybe 7-8%. But then you'll have more of interest to deduct...and your property taxes will be much lower...(HALF) and will start rising only from there by 2%...
This guy is so stupid, and if anyone falls for his argument is as dumb as he is and therefore deserve it. I'm not sure if LA Times has a comics section after all the cuts, but i would highly recommend that this article will be place there. I'm still wondering if it is more funny than dumb.

[JIM]

What a complete moron this guy is. He buys a house at the peak of the market and instead of admitting that he made a mistake he is proud of it? Imagine a neighbor who buys an identical home at 33% less than this guy. According to this guy, the neighbor who bought at 33% isn't doing better than he did at full 2007 Summer home prices?

LOL! This reminds me of the guy who buys Google stock at $700 or years ago when people bought Yahoo stock at $260 a share.

[sunsetbeachguy]

Question for the bloggers:

At what stage in the Kubler-Ross grieving model is Ayres?

I will register my vote.

He is oscillating between bargaining and depression.

Well at least we are beyond denial and anger.

Oops, I forgot about those swipes at Hong. Ayres is somwhere between anger and bargaining.

Depression is the next stop.

[Maggie Knowles]

I saw David Carr of NY Times on the Colbert Report last week:
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Colbert: You now write about new media for the New York Times. How long before new media destroys the New York Times?

Carr: I think new media has given us new audiences, it gives us access to young people in a way we've never had. We have a terrific audience. It's a way to leverage our assets... and reach so many more people around the world. The problem is there's not a great business model to go with it. When you're trading sort of, dollars for pennies, in the long run, it's not great. But we're working on those things. I do allot of video for the New York Times, I do allot of blogging for the New York Times, and we've have a ton of new audience, and it's a way for us to reach... And all we gotta do is figure out a way to pay the bills.
~~~~~~~~~~~~~~~~~~~~~~~~~~~
So Peter, what are you planning to do career wise? What's your process for figuring it out?

[blackbox]

wow, he's stupidity is breathtaking!!!

[Laura]

If the journalist that wrote this piece wrote another "sob story" or "how l lost money during the real estate bubble/boom" would he get published? Probably not. Would it be "controversial"? Probably not. Would any of us be discussing him? Nope.

This is probably how he was able to afford the $1.2m house. Sneaky fellow.

One has to wonder if he himself believes what he wrote. Regardless if he bought in the right area, right location the price will most likely stay the same, so in some sense he's correct, if he were to buy today or in a year the price may be the same but his interest rate will be a lot higher. As usual it comes down to location.

Of course these types of specific locations represent a small portion of our real estate market. I would have to know his address and comps. He would actually have to know his comps to be able to honestly write his article.
E.g. what if the house next door got short sold for $850K last week....his entire "theory" is awash.

[Uncle Billy Is Puzzled By Mt. Pelerin]

Oh, oh, I know. He's the advance team for Rupert Murdoch who will be buying this paper within 6 months? He's a troll. He has to be a troll. Or maybe trying to create enough conTROvery to stimulate some book sales.

The following, if it's true, sheds a little light:

http://tinyurl.com/685ec9

He might want to apologize to Peter Hong as well. Hong is a pro. This fella is not.

The most honest reason I've heard given for purchasing a home now, came from a prominent economist who actually just completed his purchase in l.a. The reason: "I won't have to deal with a landlord." This is guy who specializes in real estate, a guy who actually created some of the metrics by which we measure our misery (oops, too many m's). He knows the numbers don't make any sense, so he doesn't even bother to rationalize it that way. My only response to this is that there are plenty of decent landlords out there! And they will most likely try to be even more decent as the months wear on because their tenants have many more choices now.

[sfvrealestate]

But where are Laker's and Cal's comments on this? Are you guys just too apoplectic about the Ayers article to post? BTW, Peter, I'm surprised that you pro journalists are having even a single moment of worry about downward salary pressure from amateur producers of free content.

[Laker]

".....1. Timing interest rates is less important than timing prices. You can always re-finance to a lower interest rate later. You can't re-finance yourself out of overpaying by $400,000......"

That is what i thought too, until Dodd, Frank, and their fellas brought us the housing bailout bill....
It seems now possible to refinance yourself out of overpaying....If this plan works like they wanted, it will create a huge inflation as money that got "lost" is actually being reprinted again...to compensate.

[l weinman]

was this in the humor column ?

last reported year on year inflation was 5.6%

last reported price change in la RE was around 20%

so in one year socal RE UNDER performed inflation by 25%

say next year so cal real estate declines a (very optimistic) only 5% and inflation falls to 4%

that puts the 2 year UNDERperformance by socal compared to inflation of 34% (its actually more because there is compounding)

do a little math and figure out how much socal RE would have to outperform his 5% inflation assumption just to break even

and of course as others have pointed out interest rates go up with inflation

also at some point he will either sell the house to buy another residence and/or to fund his retirement. His retirement or new housing expenses would have gone up by the same inflation rate so he has gained nothing in purchasing power.

It s called money illusion. If you get no real (after inflation) return on your asset you are not making money

as a financial advisor I am well aware of the lack of financial literacy among otherwise well educated people at least it is a bit reassuring the problem is as bad in the UK....or maybe not ...we have mutually reinforcing real estate and banking crises, Now its easier to see why,

[Cal]

sfvrealestate:"But where are Laker's and Cal's comments on this? Are you guys just too apoplectic about the Ayers article to post? "

Boy, you sure got me, here I thought I was just having fun in Vegas and that was why I wasn't posting. But you have now showed me that it was out of fear. Thanks I really appreciate your once again analytical thought process.

For those that can actually DO math they can continue reading. The authors premise is as follows. $1.2 million purchase price with 200k down in 2005 that is worth 800k now but will be worth $1.3 million by 2015. If you just assume his optimistic appreciation assumptions are true his tests fail on many levels, leaves some data out, and clearly shows anyone who bothers to THINK about what he is saying that the "benefit" of owning is only a break even AT BEST if you make some more wildly optimistic assumptions (that he doesn't even address) .

Lets address the first major flaw. He ignores what equivalent rent is for what it would cost to rent the place that the owner overpaid for in 2005. My guess would be somewhere between $4,000 and $6000. Depending on where owner equivalent rent falls we get various savings for the renter that are ignored (we get it for higher rents as well but I think between 4-6k is reasonable). Without knowing or ballparking this you simply can't have an assumption of how much you "save" by overpaying for a house. Buying a house (especially in 2005) was paying a premium over renting, that premium is what renters save every month and isn't to be ignored.

Second major flaw, Opportunity cost. The return on invesement of the downpayment not spent by the renter and any savings they realize every month from not paying the more expensive housing payment. He assumes higher interest rates later which equates to a higher return for savers. He also conveniently allows tremendous appreciation (800k to 1.3 mil in 7 years) in the face of rising interest rates. He also talks about higher rates but then says anyone with an adjustable mortgage payment will go down.

Third major flaw. The writers knowledge of taxes is absolutely appalling, He literally must not do his own taxes and just signs a form that someone puts in front of him. If I am in the 33% tax bracket I don't pay 33% of my money in Federal taxes, I pay an incremental part at 10%, 15%, 25%, 28% and then finally some part at 33%. Depending on how much you make in the 33% bracket your blended rate would be somewhere between 22%-28% percent. These differences compound so they definitely shouldn't be taken lightly.

He talks about inflation, one of the most misunderstood issues in the world. But someone really has to explain to me how there is inflation in homes when they are dropping thousands of dollars a year in price. Once TOTAL monthly costs drop below equivalent rent, you can make an inflation argument because then fundamentals are aligned, until then you can't and you can really only assume appreciation at the lower house value amount at the rate of inflation. It will be a very slow adjustment process in that regard.

No accounting for transactional costs (selling and buying) when the seller gets the miracle $1.3 million sales in 10 years. I guess the realtors and everyone else will be working for free. And also ignored the costs of buying as well. Maintenance costs? His property is amazingly self repairing.

Author ignores liquidity issues, like if your job moves or you get divorced or need more room, and all the other various things that happen during life. If you are underwater you face some very hard choices. And economic issues, like let us just suppose that the country goes into a recession.... in his world things only ever go up.

The author made a 1.89 million (not 1.2...) bet on the housing market going up. He has to believe it too be true, he is too stuck if it doesn't. He can't think about all the money flushing away in realistic terms otherwise he will hate his home every single day. But the most realistic scenario is one of losing hundreds of thousands if not more than a million compared to renters. If his argument is that he will love his home and it isn't an investment and that the money doesn't matter then that is one thing. The money will have to not matter because I think the loss will be substantial. But from a purely financial justification that the author lays out it falls apart at almost every level and only historic upward growth in the economy over a very long period would turn things to a net positive in any reasonable time frame.

So SFVRE, maybe you can respond how exactly you missed all the many flaws in the story? How you provided no analysis and only took things at face value. Your real estate "expertise" certainly is taking a hit.

[Mark]

Ayres' ridiculous piece is an insult to the majority of us. He acts as if it's no big deal to buy a million-dollar home. Guess what, Chris - most of us couldn't have afforded a million-dollar home even with the most creative accounting scheme!

[J.W.]

I lived in SoCal for 30 years before leaving in the summer of 2005. I encountered many a "dope smoker" during those years........................but never one as addicted and deluded as Mr. Ayres. His fuzzy math is laughable (at best) and pathetic in his attempt to justify how smart he was to drink the housing bubble koolade and take such an enormous haircut. SoCal won't see 2007 prices again until 2020 at the earliest and possibly much, much later. Mr. Ayres should run for political office because he's as full of hot air as the overwhelming majority of politicians in the country.

[Brian]

Mr. Ayers is living proof of The Greater Fool Theory.

[Steve]

Mr. Ayers comes from a different perspective, where housing in UK is 3X compared to LA. He thinks he got a deal. if he buys and hold he will get a deal. This is one sure reality the Fed has scrwed this economy up so much there is only one way out and that is print money like never before, Inflation has and wll take off to rival the 70s, so 10 years from now this house will be a great investment.

[anonymous]

If he's happy, I'm happy.

I don't imagine his banker and accountant are similarly happy , but then again...

Who cares? As long as he can make his payments, everything is fine. It's the minute he can't make them the trouble starts.

[Doug in Toronto]

I see Ayres' point, and I can accept at least parts of it. We here in Canada do not have a tax deduction for mortgage interest, and while it may put a few extra dollars in homeowners' pockets, the money required to fund that that deduction could be better used. As for sandiegan's point about "geezers living in Santa Monica and paying $900 a year in property taxes", that's the real issue. While California struggles to come up with a budget that adequately funds the state's needs and keeps all the pet projects and deductions for the rich, I'd think it worthwhile to consider the removal of the tax deduction for mortgage interest; and yes, I know that's a federal issue but you have to start somewhere. Besides, if everyone in California is claiming a tax deduction for their mortgages, two questions come to mind: (1) why aren't they using this to pay down their mortgages? and (2) is this not encouraging people to overspend, as they know they'll get a nice fat cheque back from Washington?

[SoCalJim]

First, this is not London. Second, sounds like he should stick to what he knows - scribing stories likes the 100s or 1000s of others who scribe about the same thing, or hope he has funds for years of payments in reserve. Third, sounds like he should start looking for a new job since media and low level sales (cars, houses, etc.) do not have the value they once did. This blog is evidence of that - 90+% of content comes from someone else, and amounts to more entertainment rather than useful information. Otherwise, most of the media is generally garbage except for a few tid bits here and there.

[PNW Trojan]

You GOTTA LOVE the LA Times blog; a chance to spout some REALLY good stuff; Prop 13 etc etc. But look back...in 1990, property hit a GREAT new high - then when down the drain until '96. Only to be BEATEN by '97-2000...and capped by MORE in 2004-07! Where's it gonna end? We remember penny candy, 5 cent candy bar, 10 cent cokes and 5 cent pay phone calls...now, $2 for a pound of LAST year's apple crop - no, not the Macs!! Inflation at the PEOPLE level, VS that of the GOP and Dumb Dems, IS GONNA KILL US!!!