Investing Advice Please

[brunt]

Or the prices will stay the same for a very long time. In my area, prices never go down. They just stay at the same level until the economy can support rising prices.

To be (once again) nit picky, there is a world of difference between "have not gone down in recent memory" and "will not go down".

Pretty well anyone under the age of 40 has never really seen a real estate downturn. There are a huge number of reasons for this, but first and foremost is the fact that interest rates have fallen pretty well continuously for the last 30 years. This makes the value of a fixed income stream increase, which pretty well translates directly to house prices increasing.

If interest rates were to increase to a more normal 7% or so, I guarantee that house prices will fall - even in those areas where they "never fall". Not saying that rates are to increase in the near future, but "never" is an awfully long time.

Furthermore, demographic trends have been in place since about 1946 that set up much of the current economic state of the country. These trends will be changing - as the boomers age, their spending will go from large houses to travel, medical care, and to smaller housing, and even managed care.

I stand by my previous claim - if the average family cannot afford the average house, then prices will fall over the medium to longer term.

[blueeyetea]

If interest rates were to increase to a more normal 7% or so, I guarantee that house prices will fall - even in those areas where they "never fall". Not saying that rates are to increase in the near future, but "never" is an awfully long time.

Furthermore, demographic trends have been in place since about 1946 that set up much of the current economic state of the country. These trends will be changing - as the boomers age, their spending will go from large houses to travel, medical care, and to smaller housing, and even managed care.

Well, since you are being nit picky, you can't guarantee anything, because all you're doing is making a calculated guess that might, or might not come true. It's one of the jokes of the financial industry that the experts are never able to predict when a crash will happen, but the minute there is, they're all adamant they could see it coming. Of course, many factors would influence price decreases, but not necessarily a hike in interest rates alone.

As for the predictions of the boomers, that's another prediction that may or may not pan out. Right now, the predicted trend that boomers would be downsizing as they retire hasn't happened. The forecasters hadn't figured into their predictions that boomers would be reluctant to pay more for a smaller house then what they originally paid for the one they currently owned. I wouldn't bet on a prices coming down due to a glut in the market caused by boomers offloading their houses. On the contrary, as adult kids are moving back home, it's just as likely that they'll leave the house to their kids.

[Carlotta]

MortgageQueen, I just had to respond to this post.

Please don't take this as a personal attack - my nickpicky side is from an academic background where any idea is continually in "open season" for others to pick at in order to get to the bottom of the truth.

Bottom line - in today's rate environment, there is no way that you can guarantee a rate of 12%. It simply cannot be done. It is possible (but difficult) to get it, but quite another matter altogether to guarantee it.

This is not to say that the people with this company have any ill intent. In fact, as the failure of Long Term Capital Management has shown, even winners of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (I simply detest when the media call it the "Nobel Prize in Economics" - it isn't) cannot reliably return rates of return far in excess of the market without running the very real risk of blowing up spectacularly.

There are only three ways to get these kinds of returns: 1) big time luck, 2) high risk investments, or 3) margin. All three of these ways are pretty well statistically impossible to maintain over the long term.

If the big economic egg heads cannot see all of the risks they are taking on, I certainly would not trust some other company to be able to beat the odds. The market is indeed a harsh mistress.

Just my thoughts.

Your thoughts are correct Brunt, and I couldn't agree more!

If it sounds too good to be true..... RUN! Anyone who GUARANTEES that you can make 12% growth on any investment in this economic environment is pretty suspect to me. If the big banks and credit unions can only guarantee 2% on your GIC, what do you think your chances are of actually getting your 12%.... Or more importantly even your original capital back? They are not investing in regular mortgages... They are investing in high risk mortgages.... Ones the banks would not touch. They charge that much interest to desperate people who can't get funding elsewhere.... Maybe that should be the first clue that maybe this is not a safe place to put your life savings. If you are into high risk, speculative investments, go for it. But don't dare put in more than you can afford to lose.

[brunt]

Well, since you are being nit picky, you can't guarantee anything, because all you're doing is making a calculated guess that might, or might not come true. It's one of the jokes of the financial industry that the experts are never able to predict when a crash will happen, but the minute there is, they're all adamant they could see it coming. Of course, many factors would influence price decreases, but not necessarily a hike in interest rates alone.

Actually, I am very careful in what I write.

I hedged my guarantee with the premise that interest rates rise. This is not a calculated guess. If interest rates rise, monthly mortgage payments for a fixed debt increases. Thus families with fixed incomes who are able to afford a fixed-size mortgage payment will be able to afford smaller mortgages. Thus, offer prices in general for house sales will fall as banks give families smaller mortgages. Thus, the selling prices of houses will fall. There is no guessing involved here, this is a direct result from a given event - in absence of increases in income higher than the mortgage interest rates, increased interest rates will necessarily result in lower selling prices for houses.

As far as the probability of interest rates falling, have a look at the following graph that I posted elsewhere on this board:


Source: http://www.alitisinvestmentcounsel.com/why-alitis

There's a pretty clear trend there, and the rates cannot and will not go below zero - it is a practical impossibility. Banks will not loan you $100,000 and take $90,000 back after five years of loan (which is what a negative 2% rate would be). They now, and always will require more money back than you borrowed.

And yes, house prices are affected by more than interest rates. But interest rates coupled with the loosened loan standards of banks are both at extreme historical points. People never used to be able to borrow 95-100% of the value of a home (nor should they). When I built my first home, my "good rate" was 12.625%. The probability, over the longer term, of interest rates remaining at today's low rates is minuscule, albeit admittedly non-zero.

When examining the various measures of house affordability in Canada, all but one measure indicates that houses are waaaaaay overpriced. The one outstanding measure is monthly affordability - the average mortgage payment required for the average house. But this one measure is "affordable" only in that interest rates are at levels that have literally never been seen before. Price to rent and price to income both point to an extremely overpriced market.

I am not an alarmist - I don't believe that house values are going to "crash" dramatically, other than some areas that have been more insane than others (think Vancouver here). But I think that a 25% fall in prices is conceivable. As a mathematician and engineer, my position is not to freak out at such a possibility, but to ensure that in case of such of an eventuality, our financial position will not be unduly negatively affected.

The single factor that would most contribute to finding oneself in a bad position is the amount of mortgage taken on to buy the house. And the one factor that most affects this is a possible increase in interest rates. This is not alarm, this is good planning. I don't buy life insurance because I am afraid of dying but rather in case I die.

Similarly, I have carefully examined house affordability, and the two areas of greatest concern to me are highly related: the mortgage interest rate, and the percentage of the house that is mortgaged. Despite the fact that these two factors greatly affect affordability have current values that are way out of historical norms concerns me greatly.

An example here. The house in which I was born was built in 1960. My father, a high school drop out with a semi-skilled job was able to purchase this house with 2 1/2 times his annual salary. This very same house can now be bought for five times the salary of a senior engineer with 8 years of university. And what gets me the most is that it is a 50+ year old house. There are far fewer jobs in the town than when Mom and Dad bought the house, shopping is still a 20 minute drive away. For any other asset, its value would have fallen - houses, like every other asset decay over time, and their value should depreciate to reflect this. Oddly, various factors have combined to result in the opposite of common sense.

As for the predictions of the boomers, that's another prediction that may or may not pan out. Right now, the predicted trend that boomers would be downsizing as they retire hasn't happened. The forecasters hadn't figured into their predictions that boomers would be reluctant to pay more for a smaller house then what they originally paid for the one they currently owned. I wouldn't bet on a prices coming down due to a glut in the market caused by boomers offloading their houses. On the contrary, as adult kids are moving back home, it's just as likely that they'll leave the house to their kids.

You highlight an interesting demographic trend that I would like to examine. Yes, kids are returning back home. But what is the effect of this on the real estate marker? Previously, these kids would have bought houses, but are now not. This results in a net reduction in housing demand. This would exhibit a downward pressure on prices, not upward.

And assuming that boomers can stay in their houses until they die (government-provided long-term care requires payment if you have assets like a house), and assuming that the house does not need to be sold for end of life medical expenses (not everything is covered there either), then it is possible that houses may be bequeathed to a child.

But even there, if there is more than one child, it is not possible to easily divide a house, and few siblings would voluntarily live together in a jointly-owned house. The only solution would be to sell it to free up the money tied up in the house. Additionally, the house can only pass free and clear to the children if the parents have a positive net value outside of the house. Seniors today comprise the sector of the population whose debts are increasing faster than any other age group (link: http://www.cbc.ca/news/business/cons...iors-1.1346089). In order to fulfil the will, debts must be paid first, and the net value of the estate (minus expenses) will then be distributed. This may result in the forced sale of the house if all of the parents' net value was in the house unless the child can pony up the difference.

Now, I am not rubbing my hands together in glee praying for a housing crash. I own a house myself, and will be adversely affected as well. I am, however, greatly concerned by the state of the real estate market, and the dangerous positions into which many people have put themselves by paying too much for their current house (either buying a house that is better than they should be able to afford, or just plain overpaying for a given house).

I am not guaranteeing that house prices are going to fall, either. It is just that the numbers point overwhelmingly in that direction. And it will not be a good position for most people.