As seen MSN.com today, Newsweek: “Dream House or Nightmare? by Daniel McGinn, one family’s lamentations on the depreciation of their custom built $750,000 home in which they have lived but for one year. In a nutshell, the owners invested inheritance funds, time, design efforts, money and general contracting oversight into the construction of a 3500 square foot, four bedroom, three bathroom home nestled on 2.3 acres in its very own Palm City, FL gated equestrian community. Compelled by a hot market, they made certain the house enjoys all the bells and whistles. Though they are liquid, well equipped to meet their mortgage obligations and very happy about where they live, their concerns revolve around their ability to maintain equity in the property. Furthermore, they now realize how much of that square footage they don’t use.
Theirs’ is a fair concern to be sure; shared by millions of home owners around the country. This particular family made their investment with the hope, nay expectation they would continue to enjoy aggressive annual appreciation, likely double digits, for the foreseeable future. This raises for me one fundamental concern about not only one family’s entitlement mentality but that of homeowners across the nation. Where is it written that houses should be appreciating at a double digit rate in perpetuity? Until recent years, a typical Seattle home’s value increased 3.8% per annum (an increase tracked over thirty years prior to this real estate boom). Traditionally, it has been a buyer’s ability to make a significant down payment when purchasing, thus establishing instant equity, that has protected the investment. Not today with zero down loans or, worse yet, loans at above appraised value. What we are witnessing and experiencing simply is history repeating itself. Whether the New Technology bust of the early nineties, dot.com bubble burst of 2000 or this year’s real estate woes, it’s familiar territory. News gets out that money’s to be made, consumers, investors and funders scramble to leverage the opportunity, markets become over-confident and boom, a massive correction occurs.
Years ago, I worked as a producer for a small interactive media company in Canada. We produced entertainment and educational CD-ROMS for children and young adults alike. One of the titles for which I was responsible was the very first product launching on a brand new console device, the precursor to the X-boxes and PlayStations of today. The market considered us a sure bet. Not unlike the heady days of Web 1.0, we rode a fabulous wave of success translating literally to an overnight market capitalization from CDN$500,000 to $100,000,000. We hired a young, photogenic Silicon Valley executive to head up the company. His first move – relocating business operations to the Bay Area while converting ours to a production studio. Investors from across the nation, one of which was the state funded pension fund from a major mid-west state, threw their money at us. We entered into co-production agreements with several Hollywood studios to convert their animated and live-action kid’s movies to CD-ROM games and interactive adventures. The company’s owners, their twenty one year old son and his best friend were instant multi-millionaires. All that success and within eighteen months, the company was on the brink of liquidation, the founders ousted, the two young men more or less broke. Long story short, assets were sold off, the state pension fund left licking its wounds, and the studio (the only substantive entity within the organization) was sold to one of those “Hollywood” entities.
Much as with that era or the Internet boom, people made out like bandits. But many more didn’t. Today’s sub-prime lending and real estate crisis is really no different. It is the product of lenders backing bad paper, consumers with little or no credit securing ridiculously risky loans, first time home buyers ability to enter the market being outpaced by sky-rocketing market values. The math is simple and remains based on supply and demand.
I have never counseled a client to do anything other than consider the long term picture and plan accordingly. I’ve unerringly advocated for the long term investment with the exception of those clients who are knowledgeable contractors and developers, keenly aware of the risks inherent in their businesses. The natural, sometimes severe fluctuation of the real estate market is the product of our market economy. Despite all the new reality programming promoting the lottery-like gains of house flipping, the old rules still apply. Stay in your home for a period of years and the odds are you will realize a gain.
Do I think people should not be investing to flip? No, not at all! Just don’t be surprised when the market doesn’t flip with you, and accept the risks. If you’re getting bad advice from real estate professionals, then shame on them for failing in their duties. If you’re not heeding good advice, then you are accountable to only yourself.