Standing Up for Peak Buyers

Posted by Dave Fratello on Monday, August 18th, 2008 at 6:14am.

Rising to the defense of recent L.A. home buyers is recent L.A. home buyer – and writer – Chris Ayres (that's not his photo to the right).

In Sunday's LA Times, Ayres says that his only regret in buying a home in Hollywood last year is "wishing I'd borrowed more money and bought a bigger house." (See "Loving Your House Again" from the Sunday LAT.)

No hand-wringing over buying at the peak. No worries about future sale prices. Ayres is thinking he got a great mortgage before the credit meltdown, and he figures that, over time, he and other peak buyers will be fine:
Those of us who purchased nonspeculative property from 2004 to 2007 for the gratuitously self-indulgent purposes of raising a family and investing in our neighborhoods will ultimately have the last laugh.
Much of Ayres' argument falls into the "buy and hold long-term" category. Broadly speaking, over time, your value goes up. Meantime, you can deduct mortgage interest from your taxable income and deduct property taxes. Better to own and get those write-offs than not, he's saying.

Ayres also advances some arguments regarding the "real" value of money as price inflation takes hold. The real-dollar value of a current million-dollar mortgage will be only $600k in 10 years, he says. So it will appear to be relatively less of a burden then. (Ayres assumes 5% inflation for the next decade, which is very high by historical standards.)

But Ayres goes off the rails in trying to support a notion that today's peak buyer is better off – by big bucks – after 10 years. After running his numbers, Ayres says:
Net result? The penalty for having bought at the height of the worst real estate bubble in history adds up to a potential $1.1 million gain.
So where's the $1.1m? Can you tap it, spend it? Sad to say, Ayres is a journalist, but that $1.1m is fiction.

The first $400k is from writeoffs. We could quibble with those cocktail-napkin figures, but we won't. It's the last $700k that's a problem.

In Ayres' example, a home was purchased for $1.2m in a recent peak year and is now worth $800k (an extra-large chop of 33%). Over the next decade, its value returns to $1.3m. However, the loan is "worth" only $600k in real dollars. The gap? $700k in hypothetical equity!

If you're following at home, we hope you noted the bait-and-switch. The actual loan balance in 2018 is probably still close to $1m – but Ayres is asking you to think of it as just $600k. The problem is revealed if the hypothetical owner successfully sells at $1.3m. The gain is $100k (minus costs of sale) and the seller gets his $200k down payment back, plus any principal paid. Sorry, the snake oil doesn't work – there's no $700k bonus.

The fact is, if prices dip sharply and return to peak over the course of a decade (as they did, roughly, in MB in the mid-1990s), no one gets a big payday out of it. Tax writeoffs? Great. Being king/queen of your castle? Very valuable. Big equity gains? Nope.

For the "last laugh," Ayres will need to think a little more long-term.
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