Are You Smarter Than A Real Estate Agent?

Rule 10b-5 of the Federal Securities Act of 1934 Employment of Manipulative and Deceptive Devices states:

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

For an overview by Professor Marilyn Cane see http://nsulaw.nova.edu/faculty/syllabi/Rule10b-5%20(2008).ppt

There are currently numerous examples in Detroit and Cleveland, and an assortment of others in places like Indianapolis. When prices drop below several thousand dollars, the current owner is very likely paying out more than the purchase price for a real estate commission, title search and title insurance, and documents fees.

This most commonly happens to smaller homes in poor repair, and in areas where the population is dropping. http://news.google.com/news/url?sa=t&ct=us/0-0&fp=49671eb0070dbe74&ei=K3FnSZnEKoKQNe2KwOkE&url=http%3A//money.cnn.com/2009/01/08/real_estate/thousand_dollar_homes/%3Fpostversion%3D2009010812&cid=1291117800&usg=AFQjCNHqWeJv4ixHrneUNW4mMuh0APfrLw

Of course not, they all attend the same public schools. Parents don’t need to buy in a good school district in order to have their children attend school there. Thus, a good school district does not provide any particular incentive to buy rather than rent.

A. Real estate is not a security. If recent experience is any guide, they would be ignored or mocked, but would not encounter any sanctions. Real estate itself is not classified as a security, and the Federal government does not regulate misrepresentation regarding investment returns on real estate.

An extremely public example of a questionable or misleading claim is a National Association of Realtors ad which first aired in 2008. It claims “On average, the value of a home nearly doubles every 10 years”, http://www.youtube.com/watch?v=AyZpNIyVKQk .
The Wall Street Journal skewered this claim, and another investment return calculation from the National Assoc of Realtors at http://blogs.wsj.com/developments/2008/01/29/nar-campaign-touts-real-estate-as-a-great-investment/ . Here is an excerpt:

"Is it just us, or does the National Association of Realtors’ new public awareness campaign –- launched earlier this month – seem just a tad out of whack?

As home prices slide and some debt-straddled homeowners lose their homes to foreclosure, the trade group is pushing the concept that buying a house is nothing but a sure-fire, winning investment.

In a NAR television ad that is now running, the trade group maintains: “A home isn’t just a great place to raise a family, it’s also the key to building long-term wealth. On average, the value of a home nearly doubles every 10 years,” the ad says.

On NAR’s web site, the trade group compares placing a down payment on a home to investing in the stock market — and rates buying a house as the better investment:

“Over the past 30 years, the median price of existing homes has increased an average of more than 6 percent every year, and home values nearly double every 10 years, according to historical data from NAR’s existing home-sales series. Thanks to the power of leverage, a homeowner’s return on investment is even more impressive over time.

For example, over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5 percent would return nearly five times the stock market return, at $110,300.”

“Five times the stock market return?” We know that the trade group’s purpose is to boost home sales, but is this statement pushing things too far?

“It’s a “very misleading statement,” said James R. Webb, director of the Center for Real Estate Brokerage and Markets at Cleveland State University and a professor of finance. Mr. Webb noted that housing-price appreciation rates vary across the U.S. and that “the rates for appreciation that we saw in the past few years were artificial due to the fact that we gave a zillion people mortgages who shouldn’t have gotten them. If we hadn’t given those people the mortgages, those rates of appreciation wouldn’t have happened.”
It’s best to view a house as a home – not as an investment he stressed, adding, “You shouldn’t buy a house if you don’t need a house. You should buy a house because you want to live in it, not because it’s a good investment. People have become seduced by the idea that a house is a good investment.”
We also phoned Chris Mayer, the director of the Milstein Center for Real Estate at Columbia Business School. About NAR’s down payment/stock market comparison, Mr. Mayer said, “That’s insane. If one of my students made that calculation, I would fail them.”
NAR’s calculation leaves out several important variables, such as closing costs, how much money goes into maintaining a property, brokers’ fees, property taxes and “the risk of using 95% leverage – in the example NAR puts forth, the buyer only puts down 5% of the home’s cost and borrows the rest, he explained.”

Couples with children are the most likely to file bankruptcy, and the most likely to be foreclosed on. “The families in the worst financial trouble are not the usual suspects. They are not the very young, tempted by the freedom of their first credit cards. They are not the elderly trapped by failing bodies and declining savings accounts. And they are not a random assortment of Americans who lack the self-control to keep their spending in check. Rather, the people who consistently rank the in the worst financial trouble are united by one surprising characteristic. They are parents with children at home.” The Growing Threat to Middle Class Families, Elizabeth Warren, Harvard Law School, http://www.nacba.org/files/new_in_debate/GrowingThreatMiddleClassFamilies.pdf .

Prices drop about as often as they rise. When adjusted for inflation, home prices have dropped slightly more often than they have risen. This is true from 1890 to 2008 (52% of the years prices dropped after adjusting for inflation), from the end of WWII to 2008 (51% of the years prices dropped), from 1980 to 2008 (48% of the years prices dropped). The chart below shows inflation-adjusted single family home prices in the US (From Robert Shiller http://www.econ.yale.edu/~shiller/data/Fig2-1.xls ).

Stocks 6.7%, Bonds 2.6%, Single family homes 0.7%. Those are real numbers adjusted for inflation, assuming no leverage, and that investments were bought and held long term. Since they are all measured over the same time periods, without adjusting for inflation, stocks would still have outperformed bonds, and both would have outperformed houses. Sources: Real rates of returns for stocks and bonds Prof Jeremy Siegel, Wharton School, http://archives2.sifma.org/boca2005/pdf/JeremySiegel.pdf . Real returns on homes prices, from Robert Shiller, Yale University, http://www.econ.yale.edu/~shiller/data/Fig2-1.xls .

Rise by 1-3% per year. Because the costs of maintenance, insurance, and property taxes all rise over time, having a fixed rate loan is only a partial hedge against inflation. The portion of the mortgage payment which is interest drops each year, and the standard deduction rises. For people who take the mortgage interest deduction, the aftertax mortgage payment rises slowly over time, even with a fixed rate mortgage.

25-35%. At the end of 25 years, at 6% you would have paid off 29.4% of principal. At 5% interest, you would have paid off 32.5%. At 7% interest you would have paid off 26.6%.

51-80 years. From 1890 to 2000 this had never occurred, even if you purchased at the bottom and sold at the top. In 2001 home prices adjusted for inflation were twice as high as 1921, the first time a doubling had occurred. The shortest period of time for prices to double was from 1949 to 2006, 57 years.

Approximately 43% of homeowners take the mortgage interest deduction.

In 2007 there were 75.6 million owner occupied homes. Owner occupied homes were 68% of all households. Only 29% of tax filers itemized and took the mortgage
interest deduction. 26.7 million (35%) of homeowners have no mortgage. 48.9 million (65% of homeowners) have mortgages. 42% of homeowners have mortages and take the mortgage interest deduction. Sources: Number of owner-occupied homes, 2007 American Housing Survey Table 1A. Number of owner-occupied homes with and without mortgages, 2007 American Housing Survey Table 2-19. Portion of tax returns with mortgage interest deduction from IRS Publication 1304 (2006), tables 1.1 and 2.1.

Note that many people who take the mortgage interest deduction don’t get to deduct the full interest cost. If you have no other deductions, the first $11,400 of mortgage interest doesn’t exceed the standard deduction.

500,000-600,000 http://www.ocregister.com/money/estate-real-number-1970845-people-last. As of Dec 07 there were 548,959 people with CA real estate licenses. One for every 24.2 housing units. The number of housing units (including 8% vacant) is from http://factfinder.census.gov/servlet/NPTable?_bm=y&-geo_id=04000US06&-qr_name=ACS_2007_3YR_G00_NP01&-ds_name=&-redoLog=false. 60.2% were owner occupied as of 2006, *http://www.census.gov/hhes/www/housing/hvs/annual06/ann06t13.html . That means one real estate agent for every 14.6 households. Of course, not all real estate agents do residential sales. Some do commercial, some do leasing, and some have licenses for other purposes.