Broadly speaking: you are not "investing" in any market if you only own the amount you intend to use or consume for yourself. You are only "investing" if you own (or have contracts on) more than you intend to consume.
For example, having a few bananas in your fruit bowl does not give you a position in the banana market. Owning thousands of bananas you intend to resell, or shorting a banana company, gives you a position in that market.
Likewise with housing. Owning enough housing to live in (at whatever standard of living you intend) is a market-neutral position, so you should not be particularly excited by price changes in the market. If you own too little housing, you're "short" and price raises are a negative, and if you own excess housing (extra properties, or a larger-than-desired property) you're "long" and price raises are a positive.
This is an excellent point which deflates most of this article's premise. The "shelter short" you hold by being a living breathing person is really just what can be considered livable shelter. For most people, I'd imagine they live in houses that are well beyond what they could reasonably survive in, so that portion of the equity position of the house they live in is strictly "long".
This probably is better served by an example. Lets say you buy a $2m home as a single person. And lets also say you could just as comfortably live in a $250k home. If house prices go up and your $2m home suddenly becomes a $2.25m home, you can sell it and get a "free" livable home with the 250k profit. (Technically that house would be selling for 277k at that point so you get to buy a "livable home" for $27k, but that's besides the point.) You basically are now market neutral, whereas before you were long. You will have a livable home for the rest of your life, as long as your requirements of what is considered livable do not change.
Where does the "free livable home" come from? $1.75M of your original home was "long houses". Or, another way to look at it is you were leveraging beyond your $250k "survivalship position" in housing by 8x, and then scaled back the leverage to 1x when you bought your second home. This $1.75M was speculation (or investment, depending on how you look at it :)) in the housing market. The additional speculative risk you took via the leverage resulted in the market rewarding you with a place to live.
There are 2 ways we can see your example. Living in 400sq m house when you only need 40sq m could be:
1) equivalent to living in a 40sq m apartment and owning a separate ~300 sq m house elsewhere but not renting it. Well, of course in this case you're losing money as long as you don't rent it. Even if the real estate prices go up and you finally sell the house years later, you need also to subtract the money you threw away by not renting it, or say, compare to the situation you didn't buy the extra house and instead invested the money on Treasuries.
2) Going back to one 400sq m house. Now of course one could claim one's using and enjoying the extra-space beyond the 40sq m. Later, after the housing price goes up, you sell it and buy a 40sq m apartment; but this means you're cutting down on your monthly consumption of housing. So this doesn't deflate the article's premise either.
Not necessarily. In fact, I went to high school in NYC and I distinctly remember my 10th grade History teacher reminding us repeatedly "New York city is nothing like the rest of America!"
I think one takeaway from the article is that people misunderstand what market movements are good for them when they own a home exactly because they see it as a long investment, while they are actually often still short some proportion of their dream home...
If you want to one day trade down, like in your example, then increasing prices is good.
If you want, instead, to maximize the size of the the house you live in, within a similarly prized area, you should instead hope for a steadily deflating house market - the faster the better, down to a level where you have only just enough equity left to put down a deposit on a larger house.
People often see their house as an investment that will give them a lot of money, while forgetting that they likely dream of trading up, and forgetting that if their house appreciates, the price gap from their house to the their dream house is increasing too.
For most people other than the old, we tend to be perpetually in the situation where we would like to trade up. And so we should cheer on price drops, to a certain extent, rather than cheer on rises in equity.
But in practice people buy houses with heavy leverage (often only 20% down), meaning that price appreciations have the potential to multiply their capital and more than make up for the price gap widening.
I made the same argument lower in the thread but with omission of an instant price bump the instant you get the home or buying purely with cash, the idea of getting a very expensive home with the strategy of banking the difference in appreciation is typically a very bad idea. Banks will love to tell you its a great idea and that is because a million dollar loan held for 5 years at 5% interest will cost you 250k in interest to hold the asset effectively wiping out the 250k profit if that happens.
The only true reward is going to the bankers for taking the risk of loaning a million bucks.
It probably wasn't clear but I thought it went without saying that the example I gave is a horrible idea in practice. As soon as you see the word "leverage" you should start getting scared.
When I hear the word "mortgage" I hear "leverage" whereas most people hear "monthly payments where I own the house instead of renting it." It's bad news.
Leverage is the only way to larger returns. This is true whether you go from a 1 person company to a 2 person company, whether you borrow or take equity to expand a company, or whether you borrow to fund a house.
Without leverage, you're getting nowhere. Employing a person is using leverage - you're betting that the employee will generate more revenue than they cost to keep.
Buying a house with leverage is neither dumb nor smart. It is a strategy. Strategies only become successful or failure after the events unfold.
In the case of houses, you only lose if the resale value of the property falls below the outstanding amount of the loan, presuming interest + taxes + maintenance do not exceed the equivalent amount of rent. Because loans are fixed at a currency amount on the date of funding, a property that keeps pace with inflation wins.
There are also intangible aspects to ownership, including security of tenure and ability to modify the dwelling as needs arise. It's impossible to put a price on this, but you could imagine one by asking a tenant how much insurance would they pay per year to prevent being evicted.
The key to property in general is the land underneath the property. A dwelling is itself a depreciating asset, which wears out, becomes unfashionable and falls in value. The land underneath the dwelling is the bit that increases in value, or at the very least maintains it's value compared to a currency being systematically inflated by a central bank.
For many people, a modest mortgage and their own property is a sensible investment, provided that they do not trade houses excessively, dip into the equity or destroy the value of their house.
So, again, leverage is a strategy used everwhere with many things. Excessive leverage is high risk, but sensible, well managed leverage is the key to success in life.
Much of your comment is valid but this paragraph is just so wrong I needed to pull you up on it.
> In the case of houses, you only lose if the resale value of the property falls below the outstanding amount of the loan, presuming interest + taxes + maintenance do not exceed the equivalent amount of rent.
While absolute dollar loses may not be bigger if you are leveraged than buying the same house outright the buying power is and the absolute loss is greater than it would be if you bought something that you could buy outright.
Example 1: If you have 100K and buy an apartment for 100k then the market drops 10% you have 90K in equity and could still buy a similar apartment (and trading up is actually cheaper than before).
Example 2: You have 100K and borrow 400K to buy a 500K house. The market falls 10% and you have a 450K house with a 400K mortgage and only 50K equity and you are unlikely to be able to get a similar property. You may need to trade down substantially and you can't even buy a 90K apartment without a mortgage.
The final sentence is true but makes it sound like there is a high confidence of keeping up with inflation (doubtful in my view given the current levels of private debt.
> Because loans are fixed at a currency amount on the date of funding, a property that keeps pace with inflation wins.
Given the fact that you are losing value on savings due to the central bank increasing the supply of money, you also have to take into the account the amount of time it took you to save up the 100K.
You may very well actually saved 100K to buy the apartment, but the real value of that 100K may have already decreased by 10K.
The question is whether the rate of value loss by currency inflation is outpaced by the interest you'd pay on a mortgage.
In both my examples 100K was saved at the beginning so I'm not sure that is relevant.
Currency inflation is a positive factor for you if you have a large mortgage. Deflation while obviously historically less frequent but not unknown (US 1930s, Japan 1990-current) is a negative risk if you have debt, and one that you don't have if you haven't got debt.
> "Given the fact that you are losing value on savings due to the central bank increasing the supply of money, you also have to take into the account the amount of time it took you to save up the 100K."
Presumably the hypothetical subject isn't saving money by stuffing it in a mattress. In which case the interest rate on their savings should have been at least able to track inflation.
Right now in the US, interest rates on savings isn't keeping up with inflation. Not sure what macro-econ says about the sustainability of such a situation, but current fed policy is definitely penalizing savers in the short term.
And the current economic situation is an aberrant special case; it isn't implicit or ever-present.
And, even still: I think anyone whose annualized rate of return on savings -- over the last, say, ten years -- has fallen below the rate of inflation, can be safely said to have invested in a manner tantamount to stuffing it in a mattress.
You're right, it was poorly worded and has an obvious error. It should have said that you only lose if the price falls below the original purchase price. Of course any decrease in capital in absolute terms is a loss.
A house financed with a mortgage (which is what he said, imo) can be an investment. A mortgage by itself is not an investment, it's what you use the mortgage for that makes the mortgage part of the investment strategy.
Really, all the 'mortgage = bad!' speak in this thread is depressing. How do you people ever think of making real money? Leverage is a wealth multiplier. Of course it comes with risk, but so does crossing the street - you need to manage it well (looking left and right before crossing, and checking the economic fundamentals of your leveraged investments).
Leverage is a _return_ multiplier, including a _negative return_ multiplier. Another way of putting it is that leverage is a risk multipler.
As an investment single family homes are not particularly attractive, a mortgage may or may not make sense depending on the terms, risk tolerance, and the expected market behavior... but it's really only the inherent shelter-short you suffer that makes a mortgage interesting in most cases. (Because that short is what makes not owning a home also risky)
Most people should not be thinking of making "real money" when they purchase a home, they should be thinking of having a place to live. It takes a certain degree of financial security to start thinking about using leverage to multiply wealth, which many people buying mortgages don't have. Tying the risk of a leveraged investment to something as important as the place you live is dangerous for the large portion of the population that is not particularly financially savvy.
Could you recommend any resources for educating yourself on how to '[look] left and right before crossing, and checking the economic fundamentals of your leveraged investments'? I'm not a home owner, but eventually I may be, and this topic sounds fascinating to me.
Returns only increase if there is positive drift to the underlying asset walk. In other words, this only makes sense if prices are OK. If prices are fundamentally "off" (ie, housing bubble, stock market bubble), your going have your "correction" magnified.
You shouldn't have a change in liability after taking out a mortgage, unless you refinance to release equity, which is a whole other discussion.
The missing point in many peoples analysis is that inflation is constantly eroding buying power and savings, and that property with a large land component (house > apartments) is a good hedge against inflation, due to naturally restricted supply. Of course, governments these days tend to magnify the supply restriction by refusing to approve new land developments in many areas.
Even if you buy at the top of a bubble, if you hang on, you're still likely to come out ahead over a 10-20 timeframe, as inflation takes care of your overpriced purchase.
Of course all property is local, and it's very easy to permanently lose a lot of money by purcashing the wrong property for the wrong price.
Leverage however increases the variance of the random walk of prices. You hope/pray the RW has a + drift that exceeds your cost of debt (ie, value grows X% > Y% on your pmt). If you are forced to sell (say, divorce or to relocate) you are going to bear more of the brunt of interim Vol. Over the long run (if you run out 30 years) your just facing the pricing/cost of capital issue.
TLDR Mortages are from a time long gone, where people lived in houses their whole working lives, from 22-52, with the same job, a wife and kids, etc. Then it made much more sense then today, when you need 1-200k to down-pay a 1-2m house (age 32 to 62?) and move/change jobs every X years, divorce is 50% liklihood, etc.
>You shouldn't have a change in liability after taking out a mortgage
By this I meant the mortgage level should not increase.
>Mortages are from a time long gone, where people lived in houses their whole working lives, from 22-52, with the same job, a wife and kids, etc.
I disagree that the idea of a family residence is from a time long gone. Nearly all my friends fall into this category.
I agree that having to move frequently means you should not purchase. But if you reverse that and decide to not move frequently, it changes the aspect a lot.
I disagree that the idea of a family residence is from a time long gone
Agree, but Nobody is arguing/describing this. My point was if you are overconsuming (buying too much house), you are delaying ownership and extending payment, such that you never really get clear of the debt. A 30 year mortgage taken on at 35 needs you working at the same job until 65. But careers are no longer so stable, in this regards at all, or so it seems lookinga around the West. It also leaves precious minimum left to pay for college. In the example of 22-52, you had 13 years free to pay/save/recover from your housing expenditure to pay for schooling of your kids. This would require taking out a 15 year mortgage at 35, and that would be smarter. But many people could not then afford the payments....
This is part of the reason people have overbid for housing. The other reasons are social/signalling, etc. But that is as old as forever...think of all the nobles in europe living with massive debts, etc...
>As soon as you see the word "leverage" you should start getting scared.
Meh, that's mostly how I've played it so far, and I've done... poorly compared to the people I know who have leveraged. Especially in the housing market.
Especially in housing, I mean, as long as you don't have other assets, and the potential upside is large enough to make up for 7 years of poor credit, if some damnfool bank is willing to lend you a bunch of money to buy a house in a volatile market, why not leverage? If housing prices go up and you sell out before the fall, the potential for profit is huge. If prices fall, at least in California, my understanding is that most home loans are 'no recourse' - meaning that you can give the keys back to the bank and they can't come after you for the balance. Worst case, bankruptcy.
So yeah, uh, I can see how people that use leverage generally do better than I do.
What is really sad and irritating about my position is that yeah, I'm profitable, I own my servers free and clear, I have no outstanding debt, etc, etc, but I still have leases. And leases? as far as I can tell, are treated /exactly like/ debit if you want out early. Before the year is out, I'll likely be signing a five year datacenter contract worth as much as a nice silicon valley condo, and at the end of those five years, I'll own nothing. (and that one lease will save me rather a lot of money over the two smaller leases I currently have.) That's a lot of money. It's very rare that the value of my servers is higher than the remainder of the lease. (well, the amount I could actually get for the servers. the 'replacement value' is considerable. Retail is hard work.)
I mean, I own my servers, but after five years, the thing is worth a tad more than it's value in steel (yeah, there's gold in them circuit boards, but not a whole heck of a lot of it.)
For me? that's what changed my view of the rent vs. buy question. Leases, especially commercial leases are usually less flexible than buying. And every time they renew? if the landlord thinks it's hard for you to move, prices go up. It's terrible. I'd much rather have a payment I can count on for the next 15 years, and then know I'll own the place after that (modulo property taxes)
Here in Australia I'm quite bullish about commercial property. The residential market is garbage because people buy emotionally, and the market is therefore full of irrational actors. But the commercial market is boring and therefore full of investors who logically value any potential assets and don't pay too much for them (meaning you can still find decent returns).
Being a commercial land owner is great, as you've found yourself on the receiving end of.
And by the same token, your business customers no doubt pay you for a service and at the end of each month have nothing tangible to keep, which is kind of the same deal.
But I'll keep renting my residential house, let the owner subsidise my rent by taking a loss (negative gearing), and put my savings into commercial property where I receive enough to cover the interest on the loan and then some.
>Here in Australia I'm quite bullish about commercial property. The residential market is garbage because people buy emotionally, and the market is therefore full of irrational actors. But the commercial market is boring and therefore full of investors who logically value any potential assets and don't pay too much for them (meaning you can still find decent returns).
I think there are irrational folks in both camps; Here in silicon valley, in 2007? clearly residential housing was overpriced. I really haven't been paying attention to the commercial market until quite recently, but I do know that recently, residential rents have been going up pretty dramatically, and sale prices of houses have been falling dramatically; There was a point a few years back where buying was a ridiculously better deal than renting (prices are coming back up, especially towards mountain view.) But yeah; as they say, real-estate is intensely local.
I mean, I wasn't paying attention to commercial real-estate at the time, but certainly businesspeople can be irrational too. I kind of get the feeling that most people here were still in school or something during the first dot-com, but I remember it well.
Really, I think it has to do with the ratio of rent to purchase price (and the cost of capital)
>And by the same token, your business customers no doubt pay you for a service and at the end of each month have nothing tangible to keep, which is kind of the same deal.
Yeah. And that's the thing to think about. I mean, a whole lot of what I'm selling is that I sell you servers in smaller chunks, and nobody has yet figured out a reasonable 'server condo' business model, (I've thought a lot about this, and I think it's mostly because the condo model doesn't cope well with rapid depreciation, and nothing depreciates like servers.)
But the other thing customers are paying for is me maintaining the equipment, which is significant. I mean, don't get me wrong, if the customer was using a whole server to themselves (I mean, a real whole server, you know, 128G ram on up) it'd probably be cheaper in the long term for them to own even if they have to buy hardware help at $100/hr (you can usually get hardware help for rather less) But, that requires, you know, knowing someone who is good, and evaluating people outside of your skillset is difficult.
Those same problems also apply to real-estate (well, except the condo model seems to be workable in real-estate. Not perfect, but it seems to work.) If I owned the building, especially if I owned the datacenter, I'd have to learn a whole lot (which I'm cool with; considering that I pour more money into this that I pay myself, it's worth the effort... but there will be a significant cost, measured in years.)
Of course, with plain old warehouse space, the landlord seems to do almost no work at all, so next time one of the industrial condos down the road goes up for sale, I'm probably gonna go for it.
Volatility, when it comes to large numbers with dollar signs next to them, is scary.
Startup culture is not leverage in the sense I am using here. Startup founders are generally leveraged on the upside but not on the down. They own calls.
If you don't believe me consider that sometimes the powerball jackpot every few years has a positive expected return. Unless you are going to live forever, you need to be mindful of volatility.
>Startup founders are generally leveraged on the upside but not on the down.
I don't agree with this at all. This assumes zero costs on the part of the founder when it comes to a startup. There are significant costs, including extra work, low or no salary, and opportunity costs.
I agree that the potential upside is much more like a call than a long position, but all calls have a premium cost, and have a much higher risk of being out the premium cost with no reward.
Agree - I wanted to point out the problem with the seemingly rosy situation of using leverage to "get ahead." There are many people that think they are being financially smart by buying as much a house as the bank will give them with the assumption they will bank the difference while seemingly never paying attention to where their paycheck is evaporating each month.
The market does not "reward" you for taking "risk" in that sense. You got lucky. Portfolio theory does suggest some risk premium on undiversifiable assets but not that.
One does not invest in markets. One invests in assets, preferably productive assets.
If I drink milk, I can either continue to buy it at the store, or buy a cow. By investing in a milk-producing asset, I've made myself market neutral to milk prices. I'm pretty sure that a single cow would actually be more milk than I would consume, so I run into the inconvenience of the asset not trading in odd lots.
Housing has the nice feature that it can be conveniently bought and sold in units that match my consumption (unlike half-cows). I think the analogy of being short housing is apt as well, because housing is something I am pretty much certain to consume.
The more interesting game is the one in which the housing market is not assumed to be homogenous. If you can somehow anticipate a positive change in a local housing area, buy a house there and then sell it after the change occurs, moving to a cheaper, less desirable house, you can indeed make a profit. However, this requires two things: a) that you correctly anticipate the change and b) that you don't want the change for yourself. The nice thing about this play is that even if the change never occurs you still have a house. (There are many examples of positive change - e.g. the new railroad going through Rock Ridge in Blazing Saddles.)
You can do this. This may seem idiotically simple, but you can easily see how very possible this is. Track the market you are interested in purchasing a home. Watch the number of homes sold vs the number of homes coming up for sale. (simple supply and demand) If you see more homes coming on than being sold you are going into a buyer's market (price dropping) If the opposite, then seller's market (price goes up). By doing this, you can stay ahead of the market. Note: you must seasonally adjust, which is very easy to by getting a history of the market you are tracking.
Proof:
Look up historical solds vs "on the market." (ask a realtor for this info, keep calling you will eventually find one who will give it to you) Then look at zillow or any other site that tracks historical home prices. You will see the supply leads price, usually by months/years not days or weeks.
How can this the be possible?
1. Realtors, on average, are wildly misinformed and much more interested in making a sale than doing market research.
2. It does not pay for large investors to buy individual properties so you do not have savvy investors correcting market errors. (this does not apply to commercial property)
A couple issues with this though. Realtor commissions (possible to avoid if you have enough knowledge), and/or loan fees, closing costs, title insurance, etc. Also in the US, capital gains taxes if you don't live in it for at least 2 years. So the appreciation or difference in price would have to be significantly large.
The housing market does not have the same liquidity that other markets have and this creates opportunities where a spread exists between actual and perceived value. There is always someone who needs to sell now and always someone who is willing to wait as long as it takes to get a specific price.
Also keep in mind that on the "housing ladder" it's always easier for someone with a big property to down size than it is for someone to move up. Mid to low end housing will have a completely different market dynamic than 2 million dollar estates.
you don't have to be "investing" in an asset to have exposure to that asset.
you have short exposure to an asset iff: asset value up => your utility down. the opposite is true of long exposure.
by owning and using a car, you have a short exposure on gasoline. gasoline prices up => you are worse off. you're not "investing" in gasoline, but you still have an exposure.
you have a "natural" short exposure to housing because if you do not buy a house and housing prices increase, you will be worse off. if you rent, housing price increases will drive rents up, and if you are going to buy a house, the amount you have to pay for your house will increase.
by buying a house, you become housing price neutral. if you already have a house, then an increase in housing prices doesn't make you any better off - even though your house is worth more, so are other houses.
I generally agree with your point that you are not investing if you are not taking a long position in an asset above its needed weight.
When the typical person buys a home they do so with a lot of leverage. 20% down gives you 80% debt which is now 4x leverage.
The way I see it, you have two potential choices when you are considering an home purchase with debt like a normal American.
1) Go short 100% the value of a house.
2) Go long 5x 100% the value of the house.
I am glad a few people get this. High housing prices are an unmitigated disaster. They are sometimes a symptom of something good (a robust job market) but often not even that.
For that, high housing prices have more to do with supply disruptions and destruction than with demand, because housing prices are extremely inelastic. A 1% drop in supply can push rents or prices up by 20% or more. (Ask New York.) Mouth-breathing bourgeois fuckheads clap their fat hands together when prices rise and say, "People really want to live here!" No, fuckface. What actually happened is that all those stupid NIMBY regulations made it impossible for anyone to fucking build, and so there's a supply crunch, making prices and rents three times as high as they should be.
This also explains why New York real estate prices went up after 9/11 (except for Lower Manhattan, which dipped for a few months and then went up) and will probably do so after Sandy. It was speculation driven by the possibility of future supply destruction, which would be bad for the few thousand people affected but increase overall price levels.
I agree. Nimbys and current owners prevent the building of higher density and modern housing. You would hope that the Federal government would step in because new construction would create jobs. Also in the Bay area, you could add lots of higher density housing near the Caltrain and gain that way.
My city's aging infrastructure is having trouble withstanding the population boom that's come with recent high density building. Sewers, traffic, and public transit are all suffering from unchecked construction. Sometimes NIMBYs have good reasons to fight development.
Agree. Especially in the south bay/peninsula, you have all the millionaire NIMBYs preventing the area from becoming a new dense metropolis. It doesn't seem possible for cities like SF and Manhattan to be built today.
Rising housing prices for owner occupiers are popular politically. Or at least, they were until the bubble popped and people started noticing that real household incomes had never risen to match the housing prices.
The alignment of class interests has changed on this issue. Renters and net debtors are now the majority, rather than the bubble temporarily making every other owner-occupier into a net profiteer.
For example, having a few bananas in your fruit bowl does not give you a position in the banana market. Owning thousands of bananas you intend to resell, or shorting a banana company, gives you a position in that market.
Likewise with housing. Owning enough housing to live in (at whatever standard of living you intend) is a market-neutral position, so you should not be particularly excited by price changes in the market. If you own too little housing, you're "short" and price raises are a negative, and if you own excess housing (extra properties, or a larger-than-desired property) you're "long" and price raises are a positive.