Real Estate Update - Part 1

Introduction and Fundamentals

It seems like it is time I updated, or is that, restated, my views on the real estate market, how it works, and what to do and what not to do, and where we are headed now.

We need to do what no other real estate so-called expert does, and we need to do that first. We need to define a few terms so we understand the different nuances and therefore the differing consequences of any actions we might take, and be quite clear what we are trying to achieve in the first place.

It’s probably fifty years since Bob Beckman produced his book on the real estate markets with the buzz-phrase “your home is your nest, not your nest egg”.

For most people that is presumably true, but it is certainly not the whole truth, but it is as good a place as any to start this investigation.

Most people reading this, or watching the presentation will simply be average individual buyers who are looking to own their own nest. Many other people will be coming to this with all sorts of pre-conceived nonsense which is largely irrelevant and needs to be jettisoned.

First, for those of you who dont know who I am, a brief introduction. After all, why listen to me? What do I know that you maybe dont?

I have been involved in real estate markets since the age of twelve. I am now supposedly retired, except, like most successful people, I prefer to go on being successful. That’s what I do. It works, so why stop?

At the age of twelve I tried to help my mother buy a place called Brickendonbury. It was for sale for the then huge sum of £15,000. We didn’t have that kind of money, but I was quite good with algebra, and I worked out a way we could buy it, and get the parts we wanted, sell the rest, and pay off any mortgage.

As I say in my main book on real estate, the bank manager couldn’t handle being told how a financial transaction could work by a twelve year old kid, so we didn’t buy the place. Shame. Here’s a picture of the main house.

The next transaction my mother did worked out rather differently. I was older, but the bank manager still wouldn’t lend to me, but he did lend to my mother based on my figures.

Let’s move perspective.

I decided that as I had no money I would build a house myself. We bought a ruin in deepest Somerset, or rather my mother did. I studied how to draw proper plans for the building inspector. I learned how to mix cement, and bought a shovel, a spirit level, and a few other tools. In short, I drew the plans, dug the footings, built the walls, put in the floors, the roof, fitted the plumbing and the electric circuits, and ended up replacing the chimney pot. I then went out and did it again in the village of Hermitage, just north of Newbury.

I then did it again, and again.

The point I am trying to make is that I know everything there is to know about houses; how they are built, what they cost, what is the government’s involvement, how the money side of things works, and how to make it all come out in terms of success. And I have been involved in building and developing real estate in nine countries on three continents.

On top of the above, it was me who invented buy-to-let in 1991, when I moved into the depressed property market down in Hastings, and wrote the book on how to use buy-to-let to set up your pension. I tried to get the book published in 1993 in the face of wholesale opposition. Basically, the publishing world said I was an idiot.

I therefore published the book myself, showing how it was done, and it is now in its third edition.

One more thing.

I decided to go online back in 1992 with an online real estate market program. I had been online for over a decade using bulletin boards, and when the public data network morphed into the world wide web in 1991 I set up my stall on The Well in San Francisco, moving my operation to the UK the following year when the UK went www as well. A year after that I went public with the web’s first real estate site, called The Unique Property site, which I still run.

OK, with that out of the way, now you know a little about me, let’s get down to business.

So the first question we have to answer is: why are you buying a house? You could be looking to simply move house, or you could be seeking to get a foot on the housing ladder, or you may be wanting to start a rental business. Each answer would lead to a different set of requirements.

Let’s start with the first answer.

If you are simply looking to move, there are really only two matters to consider. Are you going to do a straight financial swap, moving your mortgage from one property to another? Or are you going to sell because property prices are high and you think they are likely to fall so it may be a better bet to sell now, then rent while prices fall so you can buy back in at the bottom.

If the former, then it doesn’t really matter what you do because you are effectively swapping one set of circumstances for a similar set. If the latter, then you have your work cut out, because you have to understand the possible dynamics, which takes us neatly into some basic metrics which you need to understand and be able to recognise. Understanding them should be reasonably simple, recognising them is not so easy.

This is where we have to introduce several basic parameters which you need to understand.

First, you need to understand that real estate markets do not always go up. That is a fallacy. I once did some extensive testing on this matter. The longest peak to trough I found was between 1760 and 1945. In terms of relative buying power house prices were the same on those two dates. House prices do not always go up.

There are two things which affect house prices. People give all sorts of absurd reasons for the way house prices move. There are think-tanks with clever people who check out the various metrics they devise to get the ultimate best analysis. Every year since I have been measuring their results (fifty years) they have been wrong in their pronouncements, while I have been right.

The number of people wanting to buy a house is a meaningless number. How many people want to buy a fancy car? A meaningless question. You only buy a fancy car if you have the money to do so. What you want is not a meaningful factor. So throw that one out.

How many people are there in relation to the number of houses available?

Another meaningless number. Kids who have no money stay at home with their parents. People who have no money or no job wont be eligible for a mortgage, so you can take them out of the equation. And so on, and so on.

The only meaningful factor in terms of house prices is the number of people who are both able and willing to pay the prices asked. Everything else is irrelevant.

You can get quite sophisticated in these terms, but a simple metric gets you a good enough handle on where house prices are going at any time. If the economy is going well, wages are going up relative to prices, and potential buyers have the disposable income, then house prices are likely to rise.

There is, however, one metric which does tend to interfere with this simplistic approach, and that is interest rates.

Let me go back a bit.

In 1760 the only way you could buy a house was if you had the money to do so. Things started to change quite considerably when it became possible to borrow money. The purchasing metric changed. The money you had in the bank retained a certain importance, but an extra element was added in the purchaser’s favour. What was the buyer’s income which could be set against a mortgage?

This metric itself also changed over the course of the last century. Initially you could only borrow a small percentage of the price of a house. That percentage went up and up as the century moved on. It even became the norm for a short while for banks to offer 110% mortgages. Under such circumstances the number of people who could buy a house went from a very small number to almost everyone who had a reasonable income.

What this means is that henceforth one of the most important metrics to consider when buying a house is the state of the economy, plus knowing where interest rates are historically speaking.

This has led me to state what is one of the most important rules when considering buying a house, and hardly anybody pays any attention to this fundamental rule.

Ideally you buy a house when interest rates are high but falling, not when they are low and can only rise.

Putting this another way, you should enter into a long term financial arrangement when the cost of that arrangement is likely to fall rather than when it can only rise sometime in the future. And of course you dont know the future, so what are you doing taking on the biggest financial decision of your life probably when the continuance of the deal is based on guesswork, or luck.

An ideal test would be to look at a chart of long term interest rates. A modern chart would show a long term decline down to what were effectively negative interest rates, when set against inflation. The joke is that although they are rapidly rising at the present time, they are still lower than inflation. But the important issue is, how do those rates affect someone’s ability to pay?

Let me assume someone has a £200,000 mortgage bought when interest rates were 2.5%. That would mean that the notional annual interest would be £5,000 a year, or £100 a week on top of your monthly repayment sum.

Such a mortgage would now be subject to 6% interest. That works out at £12,000 a year, or approximately £250 a week. The cost of your mortgage has more than doubled.

In 1760 what mattered was the relative cost of the house. What matters today is the relative cost of the mortgage.

In 1760 the important financial question was: could you pay the money on the day you bought?

What matters today is: are you likely to be able to pay the monthly interest plus the monthly repayment if interest rates rise?

I’ll unpick this, and it’s consequences next week.