Investment Comparison: How Does Real Estate Stack Up?

There’s no question that we are in funny economic times.  The stability of the housing market is potentially uncertain.  With the downgrade, the stock market is extremely volatile.  Even “safe” investments (like commodities and bonds) bring their own risks.  Here’s why to invest in real estate versus other places:

  1. Leveraging: the idea of leveraging is very important within real estate.  Let’s say you’ve got $100,000 to invest.  You can take that money into the stock market and invest in companies.  Today, the United Parcel Service (UPS) is trading at $66.26 per share.  You can take your $100,000 and buy about 1,500 share of UPS stock.  If UPS increases by 10% in one year you’ve made yourself $10,000.  Congratulations.  Within real estate, however, you can leverage that same money and increase your return on investment.  With a mortgage, $100,000 can be a 20% down payment on a $500,000 house.  If one year later the real estate market appreciates by 10% your $500,000 is now worth $550,000.  Same time period.  Same percentage increase.  Different result: congratulations times 5.
  2. Tangibility: similar case as the one above, only flipped.  Instead of a 10% increase, both the stock market and real estate markets take a hit of 50%.  Everything is worth half of yesterday.  Your $100,000 investment in UPS is worth $50,000 (on paper) and your $500,000 house is worth $250,000 (on paper).  The difference is that your house is something tangible you use everyday.  If UPS goes out of business and their stock goes to $0.00 you just had a really bad day and nothing to show for it.  If your house became “worthless” in the same time period, you would still be living there, still raising your family there, still able to rent it out or run a business out of it.  Neither is a great day and paying a mortgage on a house less than is owed is a crappy place to be, but nevertheless you’ve got a roof over your head and something physical to hold on to.
  3. Tax Shelter: I’ve talked about it much within many other blogs.  In the stock market (like other places) you can write off your loss.  Only in real estate is there the potential for tax write-offs when the property is going up in value. Property taxes and interest are just two of many places to save money within your taxes by owning.  Consult your CPA for additional information.

Record Low Interest Rates Yet Data Shows Lack of Activity. Why?

I recently read an article written by Time Magazine’s Alison Rogers discussing the recent trends within the national real estate market.  Her argument is that data has shown that while interest rates are at an all-time low (since Freddie Mac began keeping track of them in 1971) buyers still haven’t jumped in.  Her short article cites the restrictions of lenders as the main cause (albeit, not the only one).

Lending has definitely become more restrictive.  Gone are the days of people making $10/hour qualifying for $500,000 houses on “stated” income (you tell the lender how much you make, rather than any kind of documentation required).  I will also agree that the pendulum has swung to the uber-conservative where people with good income, good credit, and little debt still find getting a loan exhausting.  (Tangent story: recently had a client buy a house for his son and, as a lesson of responsibility for his son, got a loan and put his son on the title.  The father could’ve bought the house cash and nearly did when the lending got so tedious and involved.)  However, I cite many other reasons for the lack of activity in the market.  I see them as follows:

  1. Uncertainty in Where the  Market is Going:  yes, if you are a first time home buyer the tax advantages of buying a house far outweigh waiting out the market, even if it declines (see one of the Blog’s from last week: “Renting vs. Buying: The Whole Story”).  Still, it’s very hard to buy something today when it may decline in 6 months.  Psychologically, everyone wants to buy in an appreciating market where you can know for sure that the value is going up.  Those who are affected most by a declining market are investors.  Flipping a house has become very difficult unless you’ve got a lot of cash on hand and the ability to renovate at cost.  Even then, you gamble a little in a relatively shaky market.
  2. Uncertainty in the Job Market: in August of 2011 the unemployment rate was at 9.1% nationally.  Remember, that’s 9.1% of the total labor force that is unemployed but actively seeking employment and willing to work.  What that number doesn’t take into account are people who have jobs but see the guy in the next cubicle get canned.  Leah has a great job but sees Joe in the next office get laid off.  I can assure you the last thing crossing Leah’s mind is running out and buying a house.  People need jobs to buy houses and get loans and without the peace of mind of a stable job we aren’t going to see an increase in activity.
  3. Better ROI Elsewhere: return on investment (ROI) is the name of the game these days.  Got cash and need somewhere to put it?  Before the downgrade, the stock market might have been a better, albeit riskier, decision than the real estate market.  Take an above average example, Apple Inc.  At the beginning of 2009 it was selling for around $100 per share.  As of today (October 6, 2011) Apple Inc closed at $369.80 per.  Quadruple your investment since 2009?  Probably wouldn’t have happened in real estate unless you had cash.  The difference is that real estate has been a safer, longer term investment.  People that own houses and already have the tax shelter find that for bigger ROI the stock market is the way to go.

Overall, real estate is always a good investment if you’re in it for the long haul.  If you want to buy something and flip it in the next 6 months, I’d say you better have experience doing it and trust that you can get something well below market.  Buying today and holding for 5 years or more?  I can honestly say that within that time frame the market will be in a better place.  If you have questions or are interested in discusses the market, please always feel free to call or email me.

Are There Any Penalties for Backing Out of Escrow As a Buyer?

I was asked this today by a first time buyer and thought it would be a good question to blog about.  In California real estate, the buyer is protected by the contract.  First off, with most transactions the buyer will write what’s called an Earnest Money Deposit (also called an Initial Deposit or EMD).  This is generally 1-3% of the sales price and is put into escrow.  The money is taken out of the account and held.  Think of it like a security deposit when you rent a place.  The buyer puts some skin in the game and then has the option of getting it back.  How you ask?  Everything is negotiable but in a standard contract the buyer has 17 days after acceptance to get all inspections done, review disclosures from the seller, get the loan in order, and order and approval an appraisal.

Side notes (it’s easy to go off on many tangents but I will try and keep it simple):

1.   Notice that I say “the buyer has 17 days after acceptance…”.  Let’s say the buyer writes an offer on Monday and the seller counters the offer (Counter Offer #1) on Tuesday.  Then, after thinking about it for a day the buyer accepts the sellers Counter Offer #1 on Thursday.  All the time periods for the transaction will be based off the buyer’s acceptance date of Counter Offer #1 (Thursday).

2.  The seller can never cancel the deal… unless the buyer says they’re going to do something and then doesn’t do it.  For example, a standard contract says that the buyer has 17 days after acceptance to remove contingencies (meaning, the buyer has done all inspections, read all the disclosures from the seller, had the property appraised by the lender, etc and is willing to move forward and make their Earnest Money Deposit non-refundable).  If day 18 after acceptance comes around and the buyer hasn’t removed contingencies (as they said that they would do in the original contract), then the seller has the opportunity to take action.  The seller can give the buyer a “Notice to Perform” which gives the buyer 48-72 hours (depending on the contract and what’s been agreed to) to “perform” (in this case, remove contingencies).  If the buyer doesn’t perform in the time specified by the seller, then the seller has the ability to cancel the agreement.  Under section 14C of the Residential Purchase Agreement discussing the Seller’s Right to Cancel it states:

“If, within the time specified in this Agreement, Buyer does not, in writing, deliver to Seller a removal applicable contingency or cancellation of this agreement (in other words, if after the 17 day period or whatever was agreed upon in the original contract, the buyer hasn’t given the seller a removal of contingencies or a cancellation) then Seller, after first delivering to Buyer a Notice to Perform, may cancel this agreement.  In such an event, Seller shall authorize the return of Buyer’s deposit.”

3.  Long story, short: if the buyer backs out of the transaction within 17 days (or whatever is agreed upon) and never removes contingencies, in writing, then the contract says that the buyer is entitled to their full deposit.  In California you don’t a reason to back out of a transaction as a buyer.  Cold feet, changed your mind, spite, etc.  These are all acceptable answers.  (Not so in the famous Seinfeld episode of the “spite” coat.  Take a study break and watch the 1 minute video by clicking the link below)

\”You Said Spite\”

As is traditional with my blog posts, I’m getting long-winded.  The answer to the question, “Are there any penalties for backing out escrow as a buyer?” is that it depends on when you back out.  The only money you don’t get back is the money you pay for the physical inspection (since it’s a third party company coming to do it) and the appraisal.  Both are about $400-$500 each.  If you back out within the contingency time period (usually 17 days, as discussed) then you are entitled to your full EMD back.  If you remove contingencies in writing, you are making that money non-refundable and it goes to the seller for costs they’ve already incurred (moving vans, repairs, etc) as well as their time off the market.