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davelj
Participantoops… I’ll get back to this…
ParticipantI think that’s “Privatize profit, socialize risk,” but I know what you mean. Yup, that’s the M.O. of the government.
ParticipantI think that’s “Privatize profit, socialize risk,” but I know what you mean. Yup, that’s the M.O. of the government.
ParticipantAnother thing (I think) this auction shows is something I’ve discussed in the past. Despite the fact that these properties are overvalued and should get huge haircuts, there is a HUGE amount of money on the sidelines this time around. This wasn’t the case during the early-90s meltdown. I know a lot of wealthy, liquid folks who are not overextended and are waiting for property values to drop. While I think there’s a lot of downside left, when people start talking about 40%-50% drops from peak to trough I keep thinking, “Ain’t likely to happen – there’s just so much real dough out there waiting for the sh*t to hit the fan.” Just something to think about.
Participant“A B C. A A, B Be, C Closing. Always Be Closing. Always Be Closing!… Gentlemen, get them to sign on the line which is dotted.”
ParticipantFSD and JG,
Yeah, I was talking about nominal rents, which are very sticky on the way down (or not down, as the case may be). If inflation is 3% and your rent stays the same, do you feel any richer? I wouldn’t. But that’s just me.
ParticipantI doubt rents will fall. If they do it probably won’t be by much. I believe I remember looking at what happened to rents in San Diego during the 90s downturn and found that they stagnated or were slightly down – like maybe less than 2% – for a couple of years and that was it. Anyone else ever see that data series?
ParticipantCONCHO said, “No one here (to my knowledge) is saying that you should never buy homes or invest in real estate.”
Actually, that’s practically what the author (Jack) is saying in this article. Re-read the article if you doubt me. No, he doesn’t use the word “never,” but he clearly suggests that his preference would be never to purchase a home, but rather to perpetually rent and earn his “7% on shares.” Read the last paragraph of the article again.
One thing where Jack gets completely confused is when he states: “If you have $300,000 and a choice between spending it on a house or shares, you’ll pay $6,000 a year in incidentals if you buy the house or about $15,000 a year ($1,250 a month) in rent if you buy the shares. But the shares will return $21,000 a year after inflation while the house will return zero. (My numbers work out even better than these. I pay a smidgen less than $1,250 a month for rent, while house prices in my neighborhood are far higher than $300,000.)”
Jack is completely wrong here because he ignores the impact of leverage (as I noted before). Assuming a 20% down payment, a mortgage at 6.5% interest, a return on stocks of 8%, inflation/home price/rental increases of 3%/year, and IMPORTANTLY assuming that rent and the costs of owning the home are approximately equivalent (not realistic right now here in SD, but realistic for many people much of the time in much of the country), you’ll come out WAY ahead buying the home. Work through the math as this guy did not (properly).
Now, is buying a home a good idea right now in SD, LA, SF, Phoenix and other bubble markets? Probably not. BUT THAT’S NOT JACK’S POINT. He’s making a blanket statement about buying versus renting as a long-term financial decision – regardless of price – and it’s based on faulty math and reasoning. End of story. Again, go back and re-read the story.
ParticipantTheChaz,
Yes, you can margin securities, but only 2-1, unlike real estate which can be levered 10-1 (or more, with 0% down). Also, mortgage rates for a “standard” loan (i.e., not subprime or funky) will almost always be at least 200 bps below broker’s call rate which is what you’ll have to pay to use margin.
CONCHO,
Remember, I said “fairly valued” real estate, not freakishly overpriced as we see today. I’ll give you an example. I bought a condo in Carlsbad back in 1999 that I lived in, but for argument’s sake, let’s say I was going to rent it out forever. When I bought it, it would have been slightly cashflow positive from a rental standpoint, after a 20% down payment and including HOA, taxes, etc. Now, prices happened to skyrocket and I sold a few years later, but lets assume I hadn’t sold. 3% annual appreciation in the home would have led to AT LEAST a 15% annualized return before considering rental increases. There’s no magic – it’s just math. The trick is that you can’t buy when prices are through the roof as they are right now. But, make no mistake, there are LOTS of wealthy folk who have used this approach and logic for years. The author of the article is NOT a clown because he can’t earn 15% per year on his investments; he is a clown because he didn’t take into account one of the single most important considerations where real estate returns are concerned: leverage.
“Sounds like you’ve invented the financial perpetual motion machine. Why are you wasting your time posting here on Piggington when you should be frolicking in the Mediterranean on your 100ft yacht?” – CONCHO
I’m not into sailing. But, otherwise, I do often ask myself similar questions. My answer: I’m just trying to help out; deep down I’m a philanthropist.
ParticipantI’m forced to second that nomination.
ParticipantThe author is a clown. He completely omits the positive impact of leverage over long periods of time. For example, if I purchase a property that is “fairly valued,” with a 20% down payment and it increases at 3%/year (that is, zero real return after 3% inflation), my nominal return is 15%/year on my invested capital (and 12%/year after inflation) assuming I relever the property every few years to maintain 20% equity.
Omitting the impact of leverage when looking at buying a house or evaluating a real estate investment is like omitting the impact of earnings when valuing a company. It completely discredits the author.
Furthermore, his 7% real return assumption from owning businesses is largely dependent on his starting points for calculating such returns (when valuations were relatively low). There have been plenty of one- to two-decade periods for which the return from owning businesses was in the low single digits. It’s probably best to assume a “real return” of about 4% over the long term. That’s 2% productivity growth plus 2% growth in the population – and I’m being VERY generous.
It’s hard to believe that articles this fallacious actually get published. Who edits this stuff?
ParticipantFSD,
Yes, despite all (the negative stuff) I’ve posted, IF earnings hang in there over the next few years (that is, they don’t decline materially) AND rates don’t materially increase, then the S&P is arguably roughly at fair value, give or take 10%. The Nasdaq, however, still could get a shellacking because it’s valuation is considerably greater (mid-30x EPS) with no commensurate earnings growth advantage (anymore). The key will be earnings, in my opinion. I don’t expect long rates to increase materially for the foreseeable future. But I think earnings are going to take a pretty big hit, as they did in 2000/2001… I’m guessing in 2008/2009. But, in any case, we’ll see. For the record, I have no direct exposure to the S&P or Nasdaq, or publicly-traded stocks in general, but they do convey a lot of information about where market/economic psychology is at a given point in time.
ParticipantDear Diary,
Why don’t people take me more seriously? I mean, I’ve been totally right about everything that I’ve ever posted on the internet except for all those times when I’ve been completely wrong and it’s been pointed out to me in the most unceremonious fashion by those evil Piggingtonians. Anyhow, back to the drawing board. Note to self: Remember to order the steel bars for the windows and the new security system. I fear for my safety, Diary. Really, I do. Especially from sdrealtor and Rich. If I die under strange circumstances, Diary, please point the police in the direction of the aforementioned. I’m sure they will be found culpable.
Yours always,
PowaysellerParticipant“Now, about that risk premium. How does your current assessment of a risk premium of 1.5% compare to history?”
– FSDThis is a good question, FSD, and gets to the heart of the matter. Long story short, since 1926, the 3-month treasury bill has averaged around 3%, the 10-year treasury around 6%, and stocks have returned around 11%.
So, historically – “historically” being the operative word – the risk premium for stocks over short-term treasuries has been around 8%/year and over long-term treasuries about 5% per year.
The question is what SHOULD the risk premium be. After all, at 1926, the typical starting point for a lot of the long-term studies, stocks were “cheap” by today’s standards. Consequently, the long-term historical returns are skewed by this fact (although this skewness declines each year). Pick a different starting point – say 1968 – and you’ll get a much smaller risk premium because stocks were more expensive. Many researchers have suggested that the long-term risk premium realized by stock investors was too high with hindsight and suggest that the “real” risk premium over the 10-year treasury “should” be around 3.0%-3.5% based on relative risk and volatility under a “rational expectations” framework. I agree with this approach.
So, here’s my opinion. 30-day treasuries should yield about the rate of inflation over the long term (you shouldn’t get much a premium over inflation for taking no risk); let’s use 3% inflation just for argument’s sake. The 10-year treasury should yield some premium over short-term treasuries due to duration risk. In my view, this number should also be around 3% – that’s what it has been historically. In other words, historically investors have said, “If I’m going to invest for 10 years I want a 3%/year return premium for doing so because I don’t know what’s going to happen in the interim.” I think that’s a rational expectation.
Likewise, I think it’s rational to expect to earn another 3% per year over the 10-year treasury for taking on stock market risk. Again, these numbers aren’t exact (obviously), but they’re good ballpark numbers in my view based on what I think a reasonable person should expect given the relative risks involved.
Clearly the risk premium shrinks and expands over time based on participants’ appetite for risk and judgements about the future. But I think the 3%/6%/9% (approximate) framework is what we’ll see over the very long term as a mean-reverting series. Why? Because in the absence of some other, more logical view, it just makes sense.
So, the problem right now is that I think the current high margins will mean revert over the next couple of years AND the risk premium will expand to 3% (or so). The combination of these things means stocks are likely headed down. Whether that’s 20% or 40% I don’t know. But it’s going to be a surprise to most folks and it’s going to hurt. That’s how markets work.
[One other thing: the chart you posted is essentially the so-called “Fed Model,” which has been thoroughly discredited as a tool for equity valuation from both theoretical and empirical standpoints. Google “problems with fed model” and you can read about the model’s shortcomings, which are many and varied.)
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