Tuesday, December 11, 2007

Can't Stop the Bleeding

I have noticed an up tick in rental offerings around here. Seems folks know that the market is slow in winter so they are trying to rent instead.

I call this the bleed slowly strategy. Many owners would much rather bleed $500 a month below carrying costs, than sell for $10,000-$100,000 less than it would have fetched in 2005.

Now if I had paid more attention in finance class, I would have been able to present a nice options model to value these two choices over time with market condition assumptions. Instead I have just prepared some simple numbers to show how costly the bleed slowly strategy is in a down market.

If someone rents out their home for a $500 monthly loss, that's $6,000 a year they are in the hole. However, if you add onto that, the longer they wait to sell, the more their home will have depreciated from its peak value....its a double whammy.

If they decide to "wait till the market comes back," then they have tied up their cash for 10 plus years. Thus they still have the opportunity cost of the cash (foregone investment returns elsewhere) they put into the deal, as well as the loss they have taken on the rent.


10 comments:

G Spot1 said...

Renting only makes sense if you really think the market will come back soon. But the fact that sellers have to cut their price SEVERELY in order to sell should be a good indication to them that the market ain't coming back soon. If a house drops 50%, it needs a 100% gain from the bottom in order for you to break even...

Jacob said...

If they decide to "wait till the market comes back," then they have tied up their cash for 10 plus years.

Naw, the market will have a soft landing next year, then in 09 we will be back to double digit appreciations. Just ask any realtor for confirmation...

sacramentia said...

BT - good points - I think your 10yr number is fair for a peak to peak decline, but if you've already lost the first ~25% and are sitting on the house today. What you have lost is lost. And the break-even point looks like less than 10yrs now.

The slow bleed works better for tax purposes than a one time capital loss without a gain to offset it.

A 500 loss becomes 300 per month. On a 400k home, the sales fees alone are equal to many years of carrying cost. I wouldn't carry a negative - but you could argue the other point.

And the slow bleed is a transfer of wealth that helps the afford-ability of the area, so it is not all bad.

Paul said...

Average Buyer-

Almost all of the REO purchases in my area were bought by investors who are seeking to rent, thus increasing the rental supply. I think this makes sense because each homeowner removed from the market by an REO, lacks the credit to buy, so we don't really have any new homeowner buyers (who intend to occupy).

The "slow bleed" is one of only a few options available to most folks. The first is foreclosure. Second is the almost-impossible short sale. Third is the slow bleed, because by definition, most of these folks don't have the +$50k to pay into escrow to close a sale. I think some of them simply hold out hope for a quick turnaround to bail them out. If the turnaround doesn't happen, eventually they will just stop making those neg payments. (Of course, this doesn't include the segment who are just pocketing the rents and not paying the bank anything.)

Jacob-Assuming you are being facetious, what a hoot and amen! The questions I have are, "Are Realtors embarrassed by the NAR? Does the NAR's total lack of credibility reflect negatively upon its members?" (I know many Realtors are honest, but the NAR's outrageous hyperbole could cause some folks to think that all Realtors engage in such non-stop, hyperbole.)

mr big said...

I am renting a 1 br in roseville for 1k / month at the moment.I rented my house in arizona so I could come back and make some money.I am losing money / month but depreciation and tax loss will help me a little.I paid 209k for the house that once sold for over 300k when the people were camping out at the open.I plan to buy another property there in march.I figure I will dollar cost average into the weakness as I will never pick a bottom.

smf said...

If they decide to "wait till the market comes back," then they have tied up their cash for 10 plus years

Time Value of Money says that if the prices return to the same level 10 years from now, it is still a loss.

This bubble was so high, that I doubt we will ever see houses at 10X income levels again.

As to purchasing for rental purposes, that is still a crapshoot, even if the numbers work.

Why?

There is as much of a glut in rentals as there is in for sale homes.

Patient Renter said...

The chart looks good to me. One thing to note is that someone who is "waiting it out" most likely thinks this thing will be back to "normal" (20% YOY gains) in no time. They don't believe the 10 year thing.

I agree with the 10 year estimate though.

Patient Renter said...

Mr Big said:

"I figure I will dollar cost average into the weakness as I will never pick a bottom."

Picking a bottom in RE is not as hard as the RE industry would have you think it is. Bottoms usually are flat for a few years (check out the Shiller graphs). When things stay flat for 6 months or a year, you're close enough to the bottom.

Gwynster said...

I noticed a jump in MFRs coming onto the market in downtown/midtown. These were supposed to be bomb-proof investments but as the crime rate ticks up, listings in this area will accelerate.

Also, for giggles, look up rentals in CL for $3000 and above. Talk about some slow bleeding... wow.
The 2br 1801 L ad was pretty funny.

HOUSE2008 said...

Wow, all good points. So much to think about when negotiating. This is better than any schooling that fer shure. Real world examples beat class anyday. Not knocking class mind you...