Wikinvest Wire

Money Magazine on "Cashing Out"

Tuesday, July 26, 2005

We once again turn a curious eye over to the real estate section of the CNN/Money website, where we find this article which asks the question, "Should you cash out of the real estate market?" Not surprisingly, you pretty much know everything that Money Magazine wants you to know on the subject by reading the title and subtitle:

    Homes: Cashing out might freeze you out
    Is it ever a good idea to try to time the real estate market?
While there is some worthwhile information and some good advice in this article, the headline writers at CNN/Money never cease to amaze. In the title, they colorfully answer a very specific question about cashing out real estate gains (i.e., selling, then renting with the intent to buy again in the same area after prices fall), but then they ask a much more general question on the same subject in the subtitle.

So, what might seem like an obvious question and answer pair really isn't. They get around to answering the general question hundreds of words later, in the last section, while most of the article focuses on the headline answer.

To the unwary Money Magazine reader, the message is clear - DON"T CASH OUT!

[We are spending way too much time commenting on CNN/Money stories, as is clear by looking here, here, here, and here ... no, maybe that is the right amount of time.]

Good Advice

The good advice contained here is pretty simple - if you gamble, be prepared to lose:
The biggest gamblers are even attempting an extremely tricky maneuver, according to Christian Coleman, district director for Zip Realty, a publicly traded real estate broker with offices in 10 states.

They're selling their houses with the intention of buying back into the market at a lower price in a couple of years or so -- after the bubble bursts, they believe.

The advice from the real estate industry pros is: Resist this temptation. It's almost impossible to time this market.
Now, investing in condos in the summer of 2005, with expectations of quick and plentiful capital gains would seem to be a much trickier maneuver than selling your primary residence at a time that appears to be, more and more, the peak of a bubble. But, that's not really relevant here.

The cash out maneuver described above is tricky indeed.

It is similar in some ways to selling a stock, and then shorting it - the short sale part of the transaction being the intention to buy back into the market, sometime in the future, at what is hopefully a lower price. Of course, when you do this with stocks you must cover the short position. For housing, you have the option of moving to a lower cost state.

So, if a seller is planning to live in an area for the rest of his life, then, yes, this is very risky. Anyone who has unsuccessfully shorted equities knows the old adage, "the market can remain irrational, longer than you can remain solvent", and it is indeed possible that housing prices will just flatten out or rise moderately while rents and incomes catch up.

The couple from San Diego who sold two years ago at $850,000 and now look at that same home with a price tag of $1.2M, must be painfully aware of this by now. Let's hope they invested some of their home sale profits in oil and oil stocks two years ago.

Wait Just a Second!

Before we continue, can we just pause and think about how bizarre this whole situation is?

A major personal finance magazine has actually published an article asking if it is wise to cash out real estate gains on your primary residence and rent a home while waiting for a real estate bubble to burst. This question is being directed at millions and millions of homeowners in the bubble areas of this country, many of whom are now obsessed with their home equity - either trying to figure out how to spend it, how to invest it, or how to preserve it.

Can you imagine your parents or grandparents faced with questions like these when they were young adults?

Other than the 1925 Florida real estate market, can you think of any other time in history when questions like these were asked?

Imagine if you could pocket a cool half million today, then everything falls apart next year, and then after another three or four years, you use that half million to buy back in. You end up with the big house on the hill that you longingly looked at back in 1997 and thought, "there's no way I'll ever be able to afford a house like that".

In 2009, you are pretty much the same person you were in 1997, a steady job, some moderate salary increases over the years, but now you're living in that big house on the hill.

Calling this one correctly could set you up for life! Is this a great country or what?

Nothing Bad Will Ever Happen

While Money Magazine does offer good advise from time to time, they also know that part of their job is to help prevent confidence from faltering:
Anyone even considering it should take heed that many experts predict that the strength of the housing market will continue for the near term.

The latest forecast from chief economist Doug Duncan of the Mortgage Bankers Association, for example, is that the price of a median house will rise a total of 6.8 percent in 2005 and between 4 and 5 percent in each of the two following years.
Many people have made many forecasts in this world, and with the exception of predicting quarterly financial results, pessimistic forecasts are few and far between. What's the point? No one goes back to check on your forecast unless you issue stock - in that case it matters.

What harm does it do for any economist to predict blue skies and clear sailing? What fun is there in being a wet blanket?

And, finally to the "elephant in the living room" as some call it - the argument that real estate will not falter because the underlying economy is strong:
Drops of more than 20 percent in local real estate prices have never been common and the worst falloffs are almost always related to reversals in the economic fortunes of an area.
Conveniently omitted from this shot of confidence is the horrifying reality that our economy is, as never before, dependent upon a booming real estate market to not only provide jobs (construction, home improvement, and finance), but also to enable increased consumer spending via home equity withdrawal. This phenomena, for the county of San Diego, has been previously discussed here and here.

To use this argument is to completely ignore the role that real estate has played in today's Frankensteinian economy.

At some point in time, we will all look back and wonder what we were thinking. How could so many people in such high places have thought that it was OK for real estate values to play such a large role in economic growth?

But, for now, we just watch and wait.


Anonymous said...

Your summary leaves out the article's admittedly superficial discussion of taxes and commissions:

"Unlike stocks, which are cheap to trade, there are high costs involved with buying and selling houses. You have to deduct real estate commissions, attorney's fees, moving expenses, rent, closing fees, and other expenses before you can even start to make money.

"The market would have to drop a good 10 percent for you just to break even.

"That's not even taking into consideration the tax implications. As housing prices have soared to seven figures and more in many housing markets, it has pushed more homeowners up into the price levels where they would have to pay capital gains taxes when they sell.

"The first $500,000 of profits ($250,000 for a single person) are exempt from this tax if they've lived in the house for at least two out of the last five years. Most others will pay 15 percent on any profits above that."

Tim said...

There is another article here where specific details for one "cash out" example are provided (including taxes). Not surprisingly, certain assumptions were made to make the selling expenses come out very high - whoever's paying 6% for Realtor's commission is a fool, and in most cases there will be no capital gains taxes.

I was thinking of doing another version of this table using more realistic assumptions to see what a more realistic break even number would be.

Anonymous said...

>>I was thinking of doing another version of this table using more realistic assumptions to see what a more realistic break even number would be.

I'd be curious to see what your idea of "realistic" is. Since I haven't bought or sold in years, I have no idea what realtors' normal commissions are any more, but 6% used to be the standard, going rate, and your claim that, in "most" (50% + 1?) cases, people will not pay capital gains taxes suggests you are not thinking of California. In addition, please be sure to factor in the cost of renting a replacement (which varies from market to market) and the opportunity cost of home ownership (something which *no one* talks about much, especially the RE bulls).

My personal view is in line with the Money article: Even though cashing out sounds superficially appealing, by the time you add up all the costs and assess what the market has to do in order for you to come out ahead, it's not worth it.

I realize that means I stand to lose a lot of money, but, hey, what can I say? Asset prices go up, and asset prices go down, as anyone who bought Yahoo in the '90's can attest. Being a "housing millionaire" was fun while it lasted.

As an aside, there is a very interesting article in today's WSJ regarding the continuing relaxation of mortgage and HELOC lending standards by banks.

Tim said...

My understanding is that the going rate is 5%, but all you have to do is threaten to use a discount broker and you can get 4%. If you use a discount broker it's a flat fee ($4000?) for the seller's agent, then your choice about what to pay the buyer's agent (2.5% typical?). Add it up and it can be much less than 6%.

Taxes are the bigger issue - a married couple can take $500K tax free. The case they cited was for a single guy with a gain of $675K. Even in California, I'd bet that married couples with gains of less than $500K are much more the norm than singles with gains as large as the one used in the example.

What's ironic is that the example uses a time period of 15 years, which puts the purchase back in 1990 - the peak of the last real estate boom in many parts of the country. Also, a purchase price of $125K and a sale price of $800K is well beyond even the California craziness, which I think generally has prices about tripling since 1995. You'd have to go back 20 years or more to find something that then sold for $125K, but which today sells for $800K.

Anonymous said...

>>What's ironic is that the example uses a time period of 15 years, which puts the purchase back in 1990 - the peak of the last real estate boom in many parts of the country. Also, a purchase price of $125K and a sale price of $800K is well beyond even the California craziness, which I think generally has prices about tripling since 1995. You'd have to go back 20 years or more to find something that then sold for $125K, but which today sells for $800K.

I think the example is realistic, albeit not "typical" (whatever that means).

We bought our house in So Cal in June of 1989 for 242 and spent about 350 to rebuild it into something habitable. It is now worth somewhere north of 1.4, at least if you believe the LA Times.

You can do the math.

Tim said...

I didn't know this table existed, but I think it clarifies this discussion. While there are certainly exceptions to the rule, it is fair to say that Southern California home prices have about tripled since 1995, and from 1990 (the previous peak) to 1995 there was a noticeable decline.


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