Archive for July 18th, 2005

The NY Times ran a Sunday front page sob story on how the real estate market in Denver is showing signs of slowing down. I love the anecdotal examples they use.

Tom Woods, a 37-year-old defense industry consultant, wanted to build a nest egg for one of his young son’s college tuition. Inspired by rising prices for homes in this Denver suburb, three years ago he invested in a new three-bedroom townhouse for $155,000. His hopes were that renters would cover most of his mortgage and that the property’s value would appreciate by at least $10,000 a year.

But last October, when Mr. Woods put the townhouse up for sale to help pay some unforeseen medical bills, there was more pain than gain: the house sat on the market for eight months. He finally found a buyer in June, but to seal the deal he had to make big concessions, including paying the buyer’s closing costs. After handing over the keys on Friday, he ended up with a profit of just $10,000 for his three-year investment.

Am I supposed to feel sorry for this guy? A few observations:

  • "Just" a $10,000.00 profit after three years on a property initially valued at 155,000 is not the tragedy the piece seems to suggest. Taking into account his closing costs, real estate commissions, and the closing costs he paid for the buyer, if he realized a 10,000 profit the sales price must have been $180,000-$185,000. That is $27,000 in appreciation, or $9,000 for each year he owned it. That is  6% appreciation annually, which is better than traditional appreciation. 
  • Three years is not enough time to outrun closing costs and commissions that all investors (and speculators) must deal with. The guy paid retail for the property because he was interested in a long term retirement/college equity vehicle. Can’t fault him there. But if he was in a distress situation, such as unforeseen medical bills, the market does not owe him a break. If his house rotted on the market for 8 months, it was overpriced. That falls on his shoulders. Had the initial price been better he could have had a better chance for a better price.
  • A better option would have been to refinance the property to cash out and save the asset. All he’d need to do to get that $10,000 would be to raise his mortgage payment $60.00-$80.00 per month. He would still be able to amortize the loan via the rent and only be 2 years behind his original schedule. If his young son is 5, that is 12 years to retire the loan and at 5% appreciation, he’d be sitting on a property worth $278,000 and his mortgage balance would be somewhere in the neighborhood of $110,000. $168,000 in equity beats a pointed stick in the eye.
  • Another scenario is that Mr. Woods needed more than the 10,000 profit. He might have needed to cash out some equity. Let’s assume Woods bought the place for 20% down and therefore had $30,000 in equity. That would net him $40,000.00 in proceeds net at closing for his medical bill. If he sold the place at distress for 180-185k, it is likely he could have gotten it to appraise for $195,000.00. He could have easily refinanced it for  $165,000, which would have given him proceeds of $41,000 for his needs. It would be tax free, because you don’t pay income tax on borrowed funds. His mortgage payment would be $200 higher in this case, but the rent would catch up if he had any kind of margin to begin with.
  • If he had the kind of money to buy the property he should have gotten health insurance first.

There were other examples of prices having to be lowered. For example, a builder had McMansions in the $500,000 area which were marked down $40,000. The key point here, though, is that asking prices are nebulous things. The real key is what the buying public will pay, and I will bet my hat, rear end and coat that the builder will make a margin. He just won’t have one as big as he wants.

Local analysts say it was inevitable that surging prices would not last. "Now we’re back to what I would portray as a normal market," said Mr. Bauer, the real estate consultant. "Historically we had 5 percent appreciation, and now we have 5 percent appreciation."

While many homeowners have adjusted to the new reality, others pine for the good times that still exist in other markets.

I’m not disputing that the market may be cooling off. This cannot go on forever. But make no mistake. This is not blood in the streets, and many of the sob stories, especially the one about Mr. Wood, could have been remedied with some better judgement.


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