Podcast

Patrick Killelea: What Every Homebuyer (and Homeowner) Should Know Now

Beware today's investor-led 'recovery'
Friday, November 2, 2012, 10:14 PM

For many, the collapse of the housing bubble was the trigger that began the era of economic slowdown Americans find themselves mired in.

But recently there have been growing reports in the media of a housing "recovery." So we've invited Patrick Killelea, founder of the popular housing site Patrick.net and author of The Housing Trap: How Buyers Are Captured and Abused and How to Defend Yourself, to clarify the situation.

The short answer is this: While there are some markets where home prices are back in line with both fundamental and historic norms, buyers still need to exert caution when making a purchase.

First, to the reports of "recovery":

Prices at the low end are definitely rising. All measures are showing that. But I don’t like to use the word “recovery,” because it implies there’s something good about rising prices. Rising prices are a kind of inflation. I’d be delighted if reporters would use the correct term and say "housing inflation return." But back to the point, prices are rising at the low end. But it’s not really an organic growth.

What’s happening is that a lot of investors realize two important things. One is that the price of a house in the biggest bubble areas like Phoenix fell well below the price implied by the rental evaluation. So these guys want to make a profit and they realize, if we buy up these houses and rent them out, we’re going to get a better return on our money than we can get anywhere else, especially with interest rates being as low as they are. The return on a rental property, often referred to, as “capitalization rate” can easily be 10% in these areas. And that’s huge. So that drew the attention of not only little investors, but also actually even big hedge funds. Although recently a lot of those have announced that they’re getting out of the game. They seem to have picked over a lot of these places, and there aren’t the deals that there were even a year or two ago.

At the other end of the spectrum are really expensive places like New York City. The crash was very muted, and it was hardly a crash at all. It was a downward trend in pricing. But what that means is, it’s still difficult, or maybe even impossible, to buy property in New York City and rent it out for a profit. You can’t do it. You’ll lose money. So if you were buying there, you’d be betting truly on appreciation that’s not justified by the underlying fundamentals. 

I said that investors realized two things. The other thing investors realized is that they have cash. Ordinary buyers, families, don’t generally have enough cash to buy outright. So that gives the investors a huge advantage, especially since lending is still pretty tight. Even with the low interest rates, it’s still considerably harder to get a mortgage now than it was in the big bubble years, 2004 and 2005.

So I’d say it’s an investor-driven recovery. And that recovery is really only in the places where they had a huge bubble and a huge crash. I’d say that it’s safe to buy in those areas, especially in places where the house is lower than the rental equivalent cost.

Patrick goes on to share the key elements to keep in mind when buying a house, including price-to-rent ratios, leverage limits, construction quality, and diversity of the local economy.

Beyond that, he shares his concerns about how the playing field when buying a home is slanted against the buyer's interests. He warns of numerous tactics the industry employs, most notably information asymmetry, that consumers need to be aware of, including:

There are all kinds of tricks that agents play. I list a lot of them in my book, but it would probably take several more books to cover it all. There is a lot of psychological manipulation of buyers. Agents are used-house salesmen. That sounds harsh, but it’s true. They are kind of like used-car salesmen: they’re not there to provide value; they’re there to get a commission. That’s their goal. And if you don’t buy, they don’t get paid.

A typical trick of theirs would be first taking you around and showing you extremely ugly and overpriced houses. And then they show you the one that they think you’ll buy. Maybe it’s overpriced as well, but not as bad. So you’ve got an anchoring effect, and it makes you a little more susceptible.

There are all kinds of other and evil games that are played. And because the whole housing market is very non-transparent, it’s very hard to pin them down. You don’t have any way of knowing if there are any other offers at all, because you’re not allowed to look at the other offers. You don’t know that they exist. So agents can lie with impunity and say, oh, there are twenty offers, and people just believe it. They think why would the agent lie?

Clearly, they’re not thinking hard enough. The agent has a motive to lie. And if you can’t prove that they’re not lying, the agent has the means, motive, and the opportunity to deceive you for profit. That would be enough to convict them if they were in court. But it’s normal business practice in real estate, so nobody seems to think twice about it. 

And agents and house inspectors often have a cozy relationship. Maybe a little too cozy, where the agent recommends an inspector, and the inspector sort of passively agrees he’s not going to find anything. He gets business from the realtor, and the realtor gets the recommendation that you should buy it. You should really separate those things. Don’t take the realtor's recommendation for an inspector. Find your own inspector, preferably one who has nothing to do with that realtor. 

Patrick also shares insights from his analysis of years of national home purchases. These include: don't sell too often (the transaction costs will kill your returns), don't upgrade too frequently (it's more costly than you think), and it's worth it to transact without an agent if you're able to do so.

Click the play button below to listen to Chris' interview with Patrick Killelea (39m:55s):

Transcript: 

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, of course, Chris Martenson. And today I am happy to welcome Patrick Killelea as our guest. I have met Patrick, and he is the founder of the housing news and forum site www.Patrick.net, which was one of the most active websites warning about the collapse of the U.S. national housing bubble years before it inevitably popped in 2007. He is also the author of the newly published book, The Housing Trap: How Buyers Are Captured and Abused and How to Defend Yourself.

Now, I have invited Patrick on here to talk about housing, because for many, falling house prices were the canary in the coal mine that ushered in the era of economic melees we find ourselves mired in. But now we are hearing murmurs of a housing recovery. And a lot of people have a lot of questions about Is this the right time to buy a house? And if so, what should I look for? Are any of the old abuses still with us? These are all things I want to talk about today.

Welcome, Patrick. It’s great to finally land you as a guest here.

Patrick Killelea: Thanks, Chris. I’m happy to be here.

Chris Martenson: Great. So tell us about the current state of the housing market. Are we indeed looking at a recovery in home prices? Is it safe to get back in the water, like the Wall Street Journal and New York Times are trying to convince me of almost daily?

Patrick Killelea: Prices at the low end are definitely rising. All measures are showing that. But I don’t like to use the word “recovery,” because it implies there’s something good about rising prices. Rising prices are a kind of inflation. I’d be delighted if reporters would use the correct term and say, housing inflation returns. But back to the point, yeah, prices are rising at the low end. And I think it’s not really an organic growth.

What’s happening is that a lot of investors realize two important things. One is that the price of a house in the biggest bubble areas like Phoenix fell well below the price in private and rental evaluation. So these guys want to make a profit and they realize, if we buy up these houses and rent them out, we’re going to get a better return on our money than we can get anywhere else, especially with interest rates being as low as they are. The return on a rental property, often referred to, as “capitalization rate” can easily be 10% in these areas. And that’s huge. So that drew the attention of not only little investors, but also actually even big hedge funds. Although recently a lot of those have announced that they’re getting out of the game. They seem to have picked over a lot of these places, and there aren’t the deals that there were even a year or two ago.

At the other end of the spectrum are really expensive places like New York City. The crash was very muted, and it was hardly a crash at all. It was a downward trend in pricing. But what that means is, it’s still difficult, or maybe even impossible, to buy property in New York City and rent it out for a profit. You can’t do it. You’ll lose money. So if you were buying there, you’d be betting truly on appreciation that’s not justified by the underlying fundamentals. Even places like Zillow, which projected prices in various cities in the coming year of 2013, they project Phoenix will continue to rise. But they project New York City will continue to fall.

I said that investors realized two things. The first is that prices had fallen below the point where it makes sense to buy. So it does make sense to buy in those places. But the other thing investors realized is that they have cash. Ordinary buyers, families, don’t generally have enough cash to buy outright. So that gives the investors a huge advantage, especially since lending is still pretty tight. Even with the low interest rates, it’s still considerably harder to get a mortgage now than it was in the big bubble years, 2004 and 2005. So I’d say it’s an investor-driven recovery. And that recovery is really only in the places where they had a huge bubble and a huge crash. I’d say that it’s safe to buy in those areas, especially in places where the house is lower than the rental equivalent cost.

Chris Martenson: Supply and demand is always a part of this story, and you said there’s been demand on the low end coming from investors. These are people looking to do this purely for economic reasons, less so maybe than organic, I need a place to live. I’m going to buy this house. As one example, we know that Phoenix did undergo a pretty tremendous amount of overbuilding at one point. They had a nice bubble. You couldn’t build them fast enough, and people were speculating. Then they had a lot of supply. So let’s start on the supply side. I read a lot about shadow inventory for years, and it’s kind of gone on the back burner. I’m wondering if you have any insights as to how much the supply side of this story has been constrained by the fact that banks may be keeping properties on their books?

Patrick Killelea: That’s very hard to tell, because there really aren’t any good statistics on shadow inventory. By definition it’s in the shadows. So there are and have been for a long time rumors that the banks are holding vast amounts of property off the market. Or not even on their books. What they’re doing is refusing to foreclose on some properties so that they don’t have to take the ownership, and they don’t get the hit to their books. So maybe the mortgage is not being paid, but the money is still technically owed. I think there are certainly a large number of houses in this sort of limbo situation, but it’s really hard to tell exactly how many. Or at least I haven’t been able to figure it out.

Chris Martenson: I haven’t either. I was hoping you’d have better insights, because I keep hearing what is little more than slightly rumorish. There are rumors and there are hints that these things might be happening. For instance, when you look at mortgage default rates and you compare the overall staggering number of those against the actual number of houses that have gone up for short sales, or other sort of distress sales, there still seems to be a fairly sizeable gap there, which has to be shadow inventory, I guess.

Patrick Killelea: Exactly. You would think in theory it’s at least possible to pin it down, because a mortgage default does get recorded at the county offices as a Notice of Default. And even if the bank doesn’t take possession and sell it, you could compare the total number of defaults to the total bank sales to get some idea. But I haven’t seen anyone do that, at least not publicly.

Chris Martenson: Right. I only squint at it and make my best guess. It leads me to suspect there is more supply out there, but it only makes sense if I’m a bank. I would do this, too, if I had supply, if I had to recognize the loss right away, or maybe sit on it in the hopes that I could turn this whole thing around and maybe get out without a loss later on. Obviously, it makes sense to wait and see what’s going to happen. And of course waiting has helped, because here we are four years into this crisis. We have the lowest mortgage rates ever.

The demand side of this equation, which we’ve got to get to now, is going to stabilize and pick up at some point. The population continues to expand as long as the job situation is stabilized. Of course, local mileage varies in the story here. Are we talking about Spokane, or are we talking about St. Petersburg? It really depends on that side of things. So on the demand side, we’ve seen – obviously people have started to step in on the low end of the housing spectrum first. That’s where some of the best bargains were. The speculators were there; back again in some cases. That’s where people who couldn’t afford these new more stringent standards had to start. And as well, we had investors. So we’ve cataloged some of the demand that existed there on the low end of the housing stock. What about on the high end?

Patrick Killelea: On the high end, I don’t think demand has changed much at all. Prices don’t seem to be plummeting at the high end, but they’re not skyrocketing either. It just seems stable.

Chris Martenson: Stable. And this is national statistics, I assume?

Patrick Killelea: Right, just what I can get from, say, Zillow, or maybe the Case-Shiller, to the degree that they break it down.

Chris Martenson: Right. And if some day interest rates begin to rise, how do you think this is going to impact everything?

Patrick Killelea: Well it obviously should have a negative effect. It’s just like a bond – when rates go up, the value of assets that depend on debt go down. But historically, rising rates haven’t always forced down the price of housing. Sometimes the rates rise because there’s inflation. So I think maybe in the 1970s you had rising interest rates and rising inflation. House prices did not go down because salaries were increasing enough to keep up with the higher interest payments.

Chris Martenson: Interesting. So you mentioned before the most important part of this for me, which was that we should call it “house price inflation.” I guess once upon a time, we all thought that houses were real assets, like owning a company, but they’re not. It’s a depreciating asset. Getting house price rises is a part of that story, and it’s a good one if your house is rising in price.

But let’s talk about arguably one of the larger sources potentially of why things might increase in price through an inflationary dynamic, and that’s money printing. In your views, QE1, QE2, QE Eternity, all of this money printing that’s going on, what sort of an impact will that have on the housing market?

Patrick Killelea: You would think that it would cause general inflation, and therefore housing inflation. But it has to get into people’s hands. That means there has to be a salary increase first. The people have to get wages with which to buy houses, and that just isn’t happening. I think there’s very little wage inflation. In fact, wages declined for a few years there. All this money printing, I think, is really going to bail out banks. The Fed prints, which creates money, and gives it to banks in exchange for paying mortgage-backed bonds. So it doesn’t really affect the common man, the guy on the street. It doesn’t really change much for him. I don’t see it as affecting house prices directly, what it does maybe prevent the banks from having to take big losses on their mortgage-backed bonds.

Chris Martenson: Well, it does that. I think there is one other mechanism, which is that if a bank at 0% money from the Fed turns around and loans it to a private equity firm at 5%. They can go and scoop up thousands of properties in Phoenix at a 10% cap rate; you could find yourself as a common person looking for an affordable house in competition with that free money. At least through that dynamic to the extent that’s part of the market.

Patrick Killelea: Yeah, that’s true. That could happen. But I get the impression a lot of these big hedge funds do not actually need to borrow this money. They’ve got too much money as it is.

Chris Martenson: Yeah, all that cash came from somewhere. I look at that money printing as a leaky sieve. The Fed releases that money into the wild and it goes somewhere. Sometimes it ends up a hedge funds by who-knows-how. Okay, that’s a possibility.

Let’s imagine I’m a private individual. What factors should I most be concerned with today if I was looking at whether or not to buy a particular property?

Patrick Killelea: I’d say the price. It sounds silly, but so many people don’t look at the price. They look at maybe how much a month they’re paying, and can they at the moment afford that. I don’t think that’s a good way to make a decision to buy. I think what people should really do is to think of themselves as a landlord and buy only when a landlord would buy. And even if they’re going to live in it themselves, in a sense they’re renting it to themselves. So if you pay more than a landlord would pay, that might suit your personal lifestyle or desire to impress friends and family, but it’s not a good financial decision.

The goal is really to keep yourself free of debt. Debt is a trap, which limits your options. You can’t move to take a better job, and you’re forced to keep working. I’d say the real goal for everyone should be to keep yourself as free as possible and away from at least unreasonable debt. Some debt is reasonable if it means that you end up paying less for the house overall than you would pay in the equivalent rent if you were renting the same thing. So if you can use debt to lower your total expenses, that’s a good thing. If you’re just getting into debt because you just want to buy this thing, that’s not a good financial decision.

But maybe you’re asking about more specific house advice. Some things that come up on my forum are look for good construction, because the foreclosed houses and the ones that get into trouble tend to be of bad construction. They cost their owners a lot more money in unexpected ways. To know if you’re getting good construction, you can try to go by the reputation of the builder. But it’s always best to hire a good inspector on your own. Do not get a recommendation from a realtor, because realtors are trying to draw you in and sign a contract with them. So they’re going to try to maximize your debt and minimize your freedom, which is the opposite of what you really want.

In general, you want neighborhoods where employment is stable or likely to increase rather than decrease, because employment is what drives salaries, and salaries drive rent. It gives people the ability to borrow. So ultimately, salaries are what drive the underlying value of the house. Places with stable employment, especially a wide variety of employment, and not dependent on a single industry. One reason Detroit was a real disaster for people who bought houses was because the whole region was dependent on one industry, the auto industry. There weren’t really alternatives.

Look at Chicago, which isn’t very far away. It has the same weather, people, and history. But Chicago has a widely diversified industrial base. No one of them can bring down the whole city. Chicago was safer, and it proved in the long run that people who bought there didn’t lose nearly what people in Detroit did. They still had their own bubble, but it wasn’t very extreme.

Chris Martenson: No, perhaps not. I know people who try and live in the Washington, D.C. area. They say it’s still a very tight housing market there. Of course that’s the center of the empire. So there seems to be endless government demand for housing there, and that drives a lot, as well, I guess, out towards your neck of the woods. In Silicon Valley, I’ve heard a lot of stories that they’re still in extraordinary demand there. I’m wondering if you want to opine on one of these really hot markets. Let’s take northern California, the Bay Area. My sister happens to be there right now, so it’s a matter of personal interest. She’s been out there about six months renting. She’s kind of one of those people who I think wants to buy, and maybe for some of the reasons you’ve mentioned, she’s encountering what she considers to be a basic home for her and her family would be about a million bucks. That’s a starting point.

Patrick Killelea: Exactly, and that’s absurd.

Chris Martenson: So square that up. A lot of people look at that and go, it’s been this way for a long time. It’s that way in Vancouver. There are still hot spots around that we can point to and say, it’s still like that. Talk to us about the relationship that has to, should, or in your mind does want to exist, between median income and median house prices.

Patrick Killelea: People tend to overestimate how long the situation has been like that. There’s a great book called Sell Now! by John Talbott. He documents how the price-to-rent ratio in the San Francisco area was actually normal. It was like the rest of the country, until the dot-com bubble in the year 2000. Prices and rents were always high here. What happened is that prices pulled away and rents remained high. But prices went crazy. And I think we still clearly have a bubble in the Bay Area. I think it’s not uncommon for houses to be rented out at two to three percent of what the price would be for that house. That just doesn’t cut it, because once you take maintenance and property taxes, it’s down to zero. No landlord would do that.

And in fact, that’s one reason that there aren’t a lot of rentals houses around here. Landlords can’t make a profit with them. There are a lot of rental apartments, and that’s typically what people end up doing when they run into this for the first time. You do the math and you try to figure out, why is it exactly that I should pay that much? There is no rational justification for it. And it’s not a very long-term thing. It started at the dot-com bubble, and I think it’s going to go back one way or another. I suppose it’s possible that the already-high rents could rise further. But it doesn’t seem likely, because rents are very tightly controlled by salary.

You can see just by a little experiment, “Let’s go into a bank and borrow money to pay rent.” You walk in and say, Can I get a loan to pay my rent? The answer is going to be “no” 100% of the time. Nobody’s going to give you money to pay rent. Rents are really controlled directly by salaries. Whereas housing prices are actually often largely determined by lending. In the bubble, they’re determined almost completely by lending. Then if it got into a runaway feedback loop where banks would loan, people would use that money and buy, even though they couldn’t really afford it based on their salary. The prices would go up. The banks would count the increased prices as additional equity, and then loan more on the basis of the increased prices that they just caused. So that whole situation unwound here in low-end neighborhoods.

There are places in the Bay Area where it makes sense to buy, but they’re not good prices. They’re generally in poor neighborhoods. That’s where the loan-to-income ratio was really far out of whack. They’re in the Far East Bay and in parts of Oakland. Those people really couldn’t pay those mortgages, and didn’t. When lending stopped, those prices plummeted. And in fact, investors are buying up places. There are places like in South San Jose, and even people on my forum, people who have told me personally that they’ve gone down there found condos and bought them. They’re renting them out and making their ten percent, and they’re delighted. There are a lot of rich neighborhoods where there’s no way to buy and rent out at a profit. Those prices have come down slightly, but they’re still completely unreasonable. So I expect them to come down more, and in the same way Zillow is projecting a decline in the New York City market maybe by two or three percent. I think the Bay Area is still likely to fall further to get back to the normal ratio it had before.

Chris Martenson: And your prime measure of that is the ratio between rental rates and the purchase price calculated out on a percentage basis. So you’re seeing that you can still, in some cases, rent houses at two to three percent of the cost to own. That’s just one sign of the bubble. Do you ever look at median incomes to median house price, or is that not just helpful?

Patrick Killelea: I try, but the Bay Area is also a little weird in that when the dot-com bubble started happening, a lot of equity slowed from the rest of the country to here. A lot of people owned stock in tech companies, and their stock went way up in the bubble. Enough of them cashed out that there’s some unknown amount; it’s hard to tell what are the assets of everyone in this area. But I suspect that some of this is still driven by a residual effect of the dot-com bubble, where there was this huge amount of money sloshing in here. The rest of the country invested in www.pets.com, and the people who worked at www.pets.com out here cashed out. Some of that money is still here. It’s hard to tell exactly how much, because the IRS doesn’t report asset statistics as far as I know. I have lots of good income statistics for the area, but not asset statistics.

Chris Martenson: Well, that’s a great metaphor. It reminds me of Spain in the 1500s. They went out and started conquistadoring the world and brought all this New World gold back and they thought they were rich. All they did was ignite an amazing round of inflation. What happened was they brought new capital back into the system. Spain has this extraordinary bout of inflation. It turned out they weren’t any wealthier; they just had to pay more for everything, which is the essence of it. So I hadn’t thought of that. It’s kind of like a modern sort of gold accumulation. Once that equity lands in a region, it works its way through its region. Maybe one of the impacts of that are the house prices you still see out there.

Patrick Killelea: Exactly, the housing inflation. There was huge housing inflation here, and it was really a disaster for a lot of people. If you owned and you wanted to sell, then you win if you wanted to sell and downsize and move somewhere else. But if you own and you don’t want to sell, you don’t really win because you’re in the same house as before. In theory it’s worth more, but you haven’t sold. People who wanted tomoved here lost, because the prices are still unreasonably high for normal working people. So it really wasn’t a good thing overall in my opinion.

Chris Martenson: Right, and there’s that other pernicious effect, which is that because of the property tax laws out there, you could be living in the exact same house as your neighbor, but they’ve owned theirs for thirty years and you just bought yours. Your property taxes are going to be many, many multiples of theirs. It creates a little sense of injustice like, hold on. Not everybody is contributing the same.

Patrick Killelea: It is very unjust. Prop 13 is what you’re talking about.

Chris Martenson: Yeah.

Patrick Killelea: It was proposed as a way to protect poor old people from being forced out when their property taxes went up when house values went up. But what wasn’t really mentioned at the time – and I’m pretty sure was the real goal – was to protect businesses and wealthy people from paying property tax. There was no means test. There are a lot of extremely rich people. My boss’s boss at Charles Schwab owns a house in Palo Alto that’s worth $3 million. He lives in San Francisco and he leaves it empty. He’s a rich guy. I said one day, How can you just do that? Don’t you worry about the property taxes? He laughed and said, No. You pay my property taxes for me. And I thought that just encapsulates it perfectly. That’s what Prop 13 is about. Why should businesses, which never die, be exempt from property tax increases? If the general economy and land values are rising, their taxes should also rise.

But these things were sort of hidden in the back of Prop 13. It was sold very successfully as a way to protect these poor old people. But there was no means test and it also applies to businesses. And now it got even worse recently. They’ve altered it so that old people can pass on their low property tax rate to their descendents. So it’s creating a hereditary aristocracy. There’ll be a few families that own the land forever, and you just won’t be able to buy it.

Chris Martenson: Right, because somebody’s got to pay all of those tasty pensions and public works, and all the other things that do need funding. What an interesting thing. It’s created certainly some very odd incentives. If you can hereditarily pass it, that will maybe ripple a little deeper.

Okay. So let’s imagine that I’m out there, for purely economic reasons should I rent right now or buy? Is there a methodology that you use? How would I solve that for myself?

Patrick Killelea: Ignore the overall market. Just look at one house, and do the rent-versus-buy thing. If you don’t overpay, meaning you don’t pay more than a landlord would, then you’re pretty safe. The idea here is to stay safe and not to trap yourself in debt. So the main methodology is I would say, would you be able to rent it out and cover all the costs? Another way you can look at it is, let’s say you get fired and you can’t pay the mortgage any more. Now what? Well, if you’ve got a house where you could rent it out and cover all the costs, you have no real risk there. Maybe you’ll have to move and rent it out, but you’re not going to lose the equity and the work you’ve put into it. You don’t have to sell, because the rent can cover the mortgage, property tax, and the maintenance.

I would also say as a part of methodology that you do not rely on agents. If you think about buyers’ agents for a minute, they claim to be free. But the idea that you can get good advice for free, I don’t think that has a lot of credibility. Commission-based agents don’t get paid unless you buy. And even worse than that, they get paid more if you overpay. They may not care about the extra that they get paid more if you overpay, but they care a lot about getting paid at all. So their financial motive is to tell you to overbid by as much as possible. They push these emotional buttons. They’re really experts at it with status and family and home. Their goal is to get their commission as quickly as possible. And to do that, they want you to overbid by as much as possible. They want you to get deeply into debt so they can get that commission and get out of there. So I’d also say to avoid agents, especially avoid buyers’ agents. You can hire an agent by the hour, and then they don’t have that conflict of interest. Or, you can hire a real estate lawyer by the hour to look over the paperwork. You can fill out the papers yourself to make an offer. If you’re worried, an hour of a lawyer’s time isn’t that much. There are actually these books by Nolo Press; I don’t know if you know them?

Chris Martenson: No.

Patrick Killelea: They’re very good. They tell you how to do things a lawyer would do, and how to do it yourself. They often have all of the forms in the book.

Chris Martenson: What are they called again?

Patrick Killelea: Nolo, N – o – l – o. They have a whole series of books that basically tell you what to do yourself what lawyers do in simple cases.

Chris Martenson: Okay. So let’s imagine I’m looking at a house for purely economic purposes here. The costs of ownership are principal, interest, taxes, insurance, and some maintenance. So you’re saying that as long as the rent is basically covering that, you feel that’s relatively safe at this point in time?

Patrick Killelea: Yeah, I do. I don’t worry too much, like I said, about the overall market. It’s really hard to predict macroeconomics. At least I don’t feel confident that I can do it. But you can look at one house and say, clearly the rent here will cover the interest on this price and these other expenses. You can do that. I can do that. And I think that most people can.

Chris Martenson: So let’s imagine I’m on the opposite side of that equation. I’m in a house that I own outright or still have a mortgage on it. But for whatever reason, I own a house, and I’m positive that I can’t rent it out for what the monthly costs would be, even if I own it outright. I have very low expenses on this, but I’m looking at it and I’m going, this feels overpriced, in essence, at this point. What would your advice be to that person on purely economic terms?

Patrick Killelea: You mean they’re thinking of buying it?

Chris Martenson: No, they own it.

Patrick Killelea: Oh, they already own it.

Chris Martenson: You own a house where you’re positive you can’t rent it for what it would cost to buy.

Patrick Killelea: If you don’t have to sell, then you don’t have to do anything.

Chris Martenson: Right.

Patrick Killelea: It really depends on how much equity they have in it. If they are underwater, if they can’t sell it and get back enough to pay the debt that they have, in some states you can walk away and the bank can do nothing but take the house. That’s called a Non-Recourse Mortgage. There are non-recourse states. California is one of them, where the bank can’t come after your personal assets because the mortgage agreement said we are loaning money for this house and this house alone.

There are a lot of tricks in that. For example, in California if you refinance, quite often in the small print it says, “And by the way, now you’re guaranteeing this mortgage with all of your personal assets.” Then you have a real problem. Now you’re underwater and you can’t walk away, and they can come after your assets and completely bankrupt you. It’s not just the house any more. That’s the kind of thing where you need a lawyer to tell you exactly how much you’re on the hook for.

But if you don’t have to sell in that situation, then don’t. Why should you? Just because you’re under water, that doesn’t actually change anything, as long as you keep making those payments. Although I have to say there’s a common trick being played in California in housing divisions when the bubble started crashing where some people who were underwater and noticed that the house across the street was a house with an identical floor plan, and I could buy it for half as much as my current debt. So they would go out and they would buy this second house and then default on the first one. They would greatly reduce their debt that way. So that was one way that people underwater could lower their debt. Maybe it’s not ethical, but they were doing it.

Chris Martenson: That sounds like business to me.

Patrick Killelea: Yeah, just business. Mortgages are just business. The banks aren’t human. They don’t have feelings. They don’t care about you, and I’m not sure that you should care about them.

Chris Martenson: All right. Well, your recent book is titled The Housing Trap, implying there’s some risks and pitfalls in there that homebuyers and maybe sellers need to be aware of. You mentioned conflicts of interest that might exist within the profession. You’ve noted already that we want to make sure that we’re not overpaying for a house relative to what it could be rented for. What else isn’t in there that homebuyers should be aware of in this day and age? And if there’s anything there, how do they avoid them?

Patrick Killelea: There are all kinds of tricks that agents play. I list a lot of them in my book. It would probably take several more books to cover it all. There is a lot of psychological manipulation of buyers. Agents are used-house salesmen. That sounds harsh, but it’s true. They are kind of like used-car salesmen. They’re not there to provide value. They’re there to get a commission. That’s their goal. And if you don’t buy, they don’t get paid.

A typical trick of theirs would be first taking you around and showing you extremely ugly and overpriced houses. And then they show you the one that they think you’ll buy. Maybe it’s overpriced as well, but not as bad. So you’ve got an anchoring effect, and it makes you a little more susceptible. There are all kinds of other and evil games that are played. And because the whole housing market is very non-transparent, it’s very hard to pin them down. You don’t have any way of knowing if there are any other offers at all, because you’re not allowed to look at the other offers. You don’t know that they exist. So agents can lie with impunity and say, oh, there are twenty offers, and people just believe it. They think why would the agent lie?

Clearly, they’re not thinking hard enough. The agent has a motive to lie. And if you can’t prove that they’re not lying, the agent has the means, motive, and the opportunity to deceive you for profit. That would be enough to convict them if they were in court. But it’s normal business practice in real estate, so nobody seems to think twice about it. So those are some of the things that I go over in my book.

Chris Martenson: So caveat emptor. I read recently, maybe this was an extreme case, but there was some poor young family that found themselves getting sick in their home. And with a little bit of an investigation, they discovered it used to be a meth lab. It’s so saturated with chemicals that they literally were going to have to tear out everything that was porous, which is all the sheet rock and carpeting, and redo it. They just couldn’t swing that. In the process of discovery they said, this seems like a material disclosure. Who knew about this? It turned out that the realtor knew about it, but they didn’t ask. That was the defense, “You never asked.” You would think that material disclosures like that is a part of it, but it turns out to this young family’s dismay that it wasn’t a part of it. In fact, it was caveat emptor.

Patrick Killelea: Yes. And agents and house inspectors often have a cozy relationship. Maybe a little too cozy, where the agent recommends an inspector, and the inspector sort of passively agrees he’s not going to find anything. He gets business from the realtor, and the realtor gets the recommendation that you should buy it. You should really separate those things; I mention that in my book. Don’t take the realtors recommendation for an inspector. Find your own inspector, preferably one who has nothing to do with that realtor.

Chris Martenson: Right. Okay. Well, let’s imagine real quick that we’re on the other side of this. I’m a seller. What advice do you have for me?

Patrick Killelea: I think the main thing is, don’t sell too often, because it really is very expensive. Even though I think you don’t need a realtor to sell, in fact you’ll come out ahead if you don’t have one, most people still do use them. But that means that you’re paying probably six, seven, or maybe eight percent to sell a house. If you do that every six years or so, you’re losing quite a lot of money. It’s like 1% per year, which is a lot. Most people think that when they buy a house they’re going to stay there twenty or thirty years. But the reality is the median length of ownership in America is only six years. So don’t count on staying somewhere too long when you buy.

And also, when you own, don’t upgrade too frequently. It’s more expensive than you think it is. I guess my other advice is you can probably make more money and get a better deal on your own than with an agent. There are a lot of “For Sale by Owner” sites now. You can even just pay to get listed in the MLS and avoid the agents. Or maybe you need to hire an agent by the hour and then the agent will list your house. But with the Internet now, it’s pretty easy for buyers to find all those other houses. And they do.

Chris Martenson: It’s interesting that in this county it’s so embedded that of course you have to have a real estate agent involved. In the UK, I discovered, it’s vastly different. First of all, the commission is 1%. And second of all, often what the realtor is doing is just making the initial introduction. Then almost all of the negotiation happens face-to-face, buyer to seller. It’s just a whole different model.

Patrick Killelea: Right.

Chris Martenson: As soon as I saw it I was like, of course you can do it that way, too. It would be like you buying a car from me. There would be some sort of an arrangement that we would go through.

Patrick Killelea: Yeah, that sounds like a much better model. And I’ve heard that’s true in other European countries, too. People don’t expect to use a realtor, and they certainly think it’s strange that anyone would expect to get free good advice. You can get good advice or you can get free advice, but it’s probably not going to be good and free.

Chris Martenson: Pick one.

Well, we’ve been talking with Patrick Killelea, spelled K – i – l – l – e – l – e – a. You can find his book, The Housing Trap, on Amazon. I found it on Amazon right away when I looked. If you’re thinking of buying or selling [a house], or maybe just know somebody who is or is interested in this, you really ought to get a copy, because you’ll have to pay for this advice, but it’s not a lot. It’s good advice, and I advise you to take a peek at that book if you’re interested.

So, Patrick, thank you so much for your time today. Do you have any final words for us here on where the housing market is going?

Patrick Killelea: It’s daily excitement. I have a forum at my website www.patrick.net. People can follow it there. There’s lots of activity.

Chris Martenson: Lots of people talking about and discussing where the markets are.

Patrick Killelea: Right.

Chris Martenson: Excellent. It’s a great site. I learned a lot from it over time. So thank you for all of your work you’ve done there, and I wish you all the best.

Patrick Killelea: Okay. Thanks, Chris.

Related content

5 Comments

Nate's picture
Nate
Status: Gold Member (Offline)
Joined: May 6 2009
Posts: 459
Prop 13

A rural view of Prop 13.

Prior to Prop 13, farmers in California were being squeezed by high property taxes.  In our area (1.5 hours west of Bay Area), the income a farm generated wasn't enough to cover property taxes.  Without prop 13, many farms would have simply gone out of business. 

The 40 acres west of us have been in 1 family for 3 generation.  The 20 acres south and 20 acres east of us have both been in 1 family for 2 generations.  My wife and I (and our neighbors to the north) both moved in in 1987.  By locking in low property taxes for generations, you reduce turnover and generate community.  Real community.

And the elderly?  They would have been forced to sell their home and move to another state if Prop 13 wasn't enacted.

The Bay Area is very wealthy by rural California standards.  If Prop 13 bothers anyone in this state, you have the option to pay additional property taxes if you choose.

Nate

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 2069
The Hook.

Real Estate = Royal Estate.

You never own it. You rent it from the State. Too much counter-party risk for me. Keep your options open. 

I've got to get back to work on my boat.

RJE's picture
RJE
Status: Diamond Member (Offline)
Joined: Aug 31 2008
Posts: 1369
CM said: "sounds like

CM said: "sounds like business to me", and this is so true.

My opinion: It is preferable to rent than buy in this economy because of the freedom to move at any time. This is a huge chain attached to your life, especially if the economy goes wacko again. I would still wait until the dust really settles. The only asset with regards to a mortgage for me is one where a good piece of land is attached so that you may plant/produce a cash crop to feed yourself. Now is as good a time as any especially if you see yourself living there a long time.

You must not be emotional, do the math, and take advantage of the laws, the system, to benefit you.

There is NO moral hazard to your thinking at all are my thoughts. Remember, you owned a home pre-2008 that is now worth 30 to 40% less and your interest rates are probably in the 5 to 6% range or higher on your original mortgage. That is an injustice that must be dealt with so however you deal with this is a personal matter. Besides, we get back into Recession and property will really find its bottom but will stay there a lot longer than most Folks think because if the trend is part time workers then what bank is going to lend you any cash?

Additionally, I am convinced that there are so many homes held off the market because banks are trying to prop up the prices, and there are so many Folks who will still bankrupt their debt.That this beast has a ways to go before prices truly clear. No question in my mind about this. I believe and can find where I read that 1.2 Trillion dollars have been removed from the liability side of the homeowners budget doing just this. I say, GOOD FOR THEM. That makes me believe that this is just the first wave of this story.

I personally know many GOOD FOLKS who have one member of the family making a very sound wage but one who has lost his/her job or is now hired back part time so that Business can take advantage of controlling its Business costs. They also got slammed by the economy and carry substantial credit card debt that's interest payments have risen very substantially to 12. 14 and even 20% ( or more) because the credit card companies are allowed to charge these rates. These are the same cards that these Good Folks have faithfully paid on time for many years at 3, 4 or 5% interest. Banks or anyone charging these new, higher rates was loan sharking back in the day and people went to jail for this. Not anymore. If you are a bank and have given Good People a credit card then laws don't apply to you.

Even though you still have one stable wage earner in your household if the math says you can bankrupt, you can bankrupt. Lastly, many Folks are paying their debt by cashing in their retirement funds, and they are not aware that bankruptcy protects all retirement accounts and NO ONE can go after your retirement monies so why would anyone do this? Just BUSINESS!

Think of this legal option as transitory. 

Anyways, many of these Folks that I know here in Michigan have bankrupted, eliminating all credit card debt and all the loan shark interest rates. They have bankrupted their property but still live in the home, can live in the home FOREVER if they choose but have gone back to their mortgage company and have negotiated a new interest rate of 3%, have taken a 12 to 15 month rent free savings as they await mitigation with the banks, and have negotiated longer terms which only reduce the costs to their mortgage payments.

Additionally, they have just stopped paying their second mortgage (usually a lien to the 1st mortgage) which then gets charged off so that eliminates their second mortgage costs.

Bottom line, what does this save?

Well, take $25 thousand bucks for credit cards (and most Folks will max the cards out because they are bankrupting) @ 10% interest (average now) and do the math. Then take an average $50 thousand buck second mortgage that is usually higher interests than the 1st mortgage so 7%, and a reduced savings from a 6% interest barring account on a 1st mortgage and reduce that to 3% plus add 10 years to the mortgage because after all you are a renter now. This is like $25,000 a year for the rest of your life! You are debt free Folks and it's just business, and legal. 

You will NEVER get back what you initially signed up for when you mistakenly thought your home was an investment when in fact it is just debt, a money pit.

The next generation of home buyers will make less wage, be part time workers, will have tremendous student loan debt, and will NOT be as secure with their jobs going forward. This beast hasn't found its bottom at all are my thoughts. If anything the risks to banks is greater. The banks only need to park their funds at the Fed earning a gauranteed spread, and the system is now set in quick sand not bedrock.

Folks, you are talking about a serious supplemental wage savings here, and a couple thousand a month that you can walk away from at anytime in the future that will still be protected by bankruptcy court.

The negative is you will probably not be able to buy a home in the next 5 years (so what), you would have eliminated all debt (good deal) and live within your means now (great idea), and you become good consumers again because you have a few extra bucks in your pocket (Fed will love that) and all stress have been removed. PLUS, the system favored you this time, you played the game and legally righted your families ship (Yippee). Everyone is happy. Good deal are my thoughts.

Just one hang up: Recourse-Non-recourse States. Yikes!

Read this and notice who the new hires are and why.

http://www.zerohedge.com/

Then read this and understand just what is going on in the Bankruptcy and Mortgage end.

http://theautomaticearth.com/Finance/us-hyperinflation-is-a-myth.html

I know for a FACT this is happening and a brief excerpt from the article.

"This couldn't be further from the truth, and to put baseless rumors of this nature to rest once and for all, below we have compiled a simple chart using the NY Fed's own data, showing the total change in mortgage debt, and what portion of it is due to discharges (aka defaults) of 1st and 2nd lien debt. In a nutshell: based on NYFed calculations, there has been $800 billion in mortgage debt deleveraging since the end of 2007. This has been due to $1.2 trillion in discharges (the amount is greater than the total first lien mortgages, due to the increasing use of HELOCs and 2nd lien mortgages before the housing bubble popped)."

...and for balance, and please note how many times the word MIGHT was used:

http://www.nytimes.com/2012/10/27/business/rise-in-household-debt-might-be-sign-of-a-strengthening-recovery.html?_r=0

Respectfully Given

BOB

RJE's picture
RJE
Status: Diamond Member (Offline)
Joined: Aug 31 2008
Posts: 1369
This is a good topic Chris and I can't let it go...

No Sir, now is not a good time to buy are still my thoughts.

We now have the world entering in a contraction, a Recession and probably a pretty serious one. Europe is a mess, China, Japan, Australia, Canada, etc...This will come home to roost on our shores. That in mind, then a pretty severe down turn seems inevitable as everyone begins to seriously protect their own turf.

Recession-Depression, still feel the same. We have had no real economy now since the Fed started pumping and propping, and until we do then a set back is inevitable are my thoughts.

Part time workers in place of full time workers is a situation where it isn't hard to imagine people just getting by. Like sharing a full peanut butter and jelly sandwich among four people. They all live but no one is really full.  Play this out in the real economy and I only imagine a zombie like existence. Better for sure than having half the people starve, and half just a little better feed.

Business must get and stay lean. So if the economy turns then business do not want to lose their best people but still need to trim some muscle now. So they technically will remove hours, and explain to the workers that "I love you Brothers, and we all have to sacrifice here a bit to keep everyone together". That means Business can still get accomplished what they need too but their expenses drop with relations to benefits, unemployment insurance and a whole host of persistent costs that they no longer are required to pay. Wherever business can save a buck they will, and labor is the most expensive costs usually.

Walmart is a great precursor to what labor can expect to face if things get worse.

I just don't see where this will benefit the worker, the consumer. I can see how this would benefit business as more people will still be able to afford the very basics and nothing more. So big ticket items just don't seem to be a long range priority. Most Folks will  just want to make sure they get at least a corner of their sandwich.

Hell, we could get so many people off the government rolls and too work doing jobs that pay the same as food stamps and associated unemployment costs to our government. As I think of this that sounds like a great idea and we should do this. However, what are the unintended consequences of this? That will be another thoughtful muse for later. Socialism?! YUK!

The problem then becomes stagnant to falling wages as hiring and firing is made easier for business so the sheeple plays by the rules.

The problem going to a bank for a mortgage, new car, big ticket item as a part time worker is negative right from the get. Credit will just die on the vine. We are a debt based consumer driven economy, right?

For so many Folks discretionary funds will just not be spent if discretionary funds will even be there for these people. In the Great Depression and the after effects, the consumer was forever changed, and this Great Recession may just have the same effect.

I understand I have really simplified this but I just don't think that the consumer will be all that anxious to spend if given ANOTHER Recession, I just don't. This beast crashed in 2007 and really crashed in 2008. That's 4 years with a possible Recession up next that involves the whole world and we just might end up with a lost generation of consumers. Plus we have a cheap energy problem. The problem, it ain't cheap. 

Good Grief are my conclusions today. I say today because Lord knows Good Grief can really be Holly Cow tomorrow or Whoaaaa Nelly the next day, and at the end of the week, Kaboom!!!

Preparations and resiliency really is a good idea, and should always be our focus and get our undivided attention, EVERY DAY! Like a bonsai tree, a snip here, there...

http://topics.nytimes.com/top/reference/timestopics/subjects/g/great_depression_1930s/index.html?inline=nyt-classifier

BOB

Wendy S. Delmater's picture
Wendy S. Delmater
Status: Diamond Member (Offline)
Joined: Dec 13 2009
Posts: 1396
Spot-on, RJE

Bob, you are so correct when you say,

It is preferable to rent than buy in this economy because of the freedom to move at any time. This is a huge chain attached to your life, especially if the economy goes wacko again. I would still wait until the dust really settles. The only asset with regards to a mortgage for me is one where a good piece of land is attached so that you may plant/produce a cash crop to feed yourself. Now is as good a time as any especially if you see yourself living there a long time.

I agree that the deleveraging has a long way to go. And house or apartment is a just place to live. The people, not whether it's rented or bought,  make it a "home."  Budgeting for shelter requires a cool, detached look. Renting makes sense if you want to have flexibility. The only reason I am no longer renting is that I married a man who has a paid-off house (with enough of a yard for a nice kitchen garden.) Oh, and by the way, we are both debt free. My friend Erin (regional manager for our small, community bank) tells me that those in debt are hurting badly while those who have no debt are doing well.

One thing I told Erin was that some banks are donating empty, foreclosed home to the communitiesfor a tax write-off equal to what the mortgage/original value was. Then the community fixes it up and sells it for what it is now worth. Everybody wins.

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