Surveys are a funny thing. They are often cited (especially on news networks like CNN, who think that the release of a new poll is, for some unknown reason, newsworthy). The scientific flaws that confront polls are daunting. For one thing, polls cannot tell you what a person thinks, only what he's willing to admit out loud. Secondly, the phrasing used in a poll can alter the results in drastic ways.
Think back to the 2004 presidential election when Bush won in a close election. The major story for the following months was "moral values" and how that issue won the election for Bush. The power of this "moral values" voter bloc was indicative of a major swing in American society, and a result of the growing divide between the "Red" states and the "Blue" states.
There was just one small problem... This "moral values" demographic was simply a creation of the pollsters. Were moral values an equally powerful voting motive in 2000? Or 1996? We'll never know, because no one ever asked those voters if "moral values" were a major instrument in deciding their vote. This exceptional article illustrates far better than I the myth of the "moral values" voter.
So if you took a survey of real estate investors and asked them why they do what they do, I'm certainly you'd have a group of outliers who claimed to invest for "societal benefit" or "future management experience" or other nonsense. But the vast majority of real estate investor would probably honestly answer your question and tell you that they do it for financial gain.
That's the dream isn't it? The beach side mansion, the personal jet, the lavish trips to Europe, the beautiful cloths and huge parties. We may not expect all of these things, but they are certainly part of the dream that drives us. We are investing in real estate to get rich, or as close to rich as we possibly can.
The rich in America can be divided into two groups, the patient rich and the lucky rich. I'm sure that there is going to be a lot of scoffing at my division, much less the names I've assigned the two groups, but be patient and bear with me as I explain.
By now books like The Millionaire Next Door have publicized the idea of the patient rich to the point where I don't feel the need to over explain the concept. These are the people who save patiently their entire lives. They live below their means, save everything that they can, and invest their saving for the long-term. Getting rich in this way is not difficult (anyone with an income can do it with enough discipline), but it takes a frustrating amount of time to achieve, and after living such a disciplined lifestyle for so long, it's unlikely that when you break the 7 or 8 digit barrier you are going to run out and drink $500 champagne every night.
So it's the lucky rich that I want to talk about. This group involves a diverse groups of people ranging from Tom Cruise to Donald Trump to Kobe Bryant to Bill Gates. Already I hear the protests, "but [insert rich person's name here] works hard for his/her money. He/she earns every penny paid to him/her". That's almost certainly true. I've never met a wealthy man who didn't work extremely hard for his money. But I've also met many not-wealthy people who work equally hard for their money. What's the difference?
Let's look at Tom Cruise for a minute. Though acting sounds very glamorous, I've heard stories about the grueling lifestyles that many successful actors face. They work 18 hour days, often have to gain or lose large amounts of weight in short periods of time, and can spend months living in trailers away from home. The most successful actors are often perfectionists to the point of obsession. It's easy to see why they earn millions of dollars a film instead of the high school dropout who is waiting tables in L.A. But there are many very hard working aspiring actors in L.A. as well who are still earning almost nothing. Why is Tom Cruise a millionaire and they are earning below average salaries?
Bill Gates created a software company that has made him the wealthiest man in the world. I've known and read about dozens of people who also created software companies. Some of them are multi-millionaires now, some are broke, and some are still working hard every day for a relatively average salary. Obviously some of the broke entrepreneurs were fools and looking for a short cut to wealth, but many of them were every bit as hard working as the success stories. What's the difference between them?
The difference is luck. If you are a fan of any sport you can probably identify with this ages old adage for the NFL, "it takes skill to get to the playoffs, but luck to win a Superbowl." The idea behind that saying is that a good coach and a good general manager can put together a team which is generally successful and will win a majority of its games. That means that the team will typically be successful during the regular season (when success is measured by the results of 16 independant games), when they can have some bad luck, lose a game early, and still do very well. However, once you get into the playoffs, one small mistake can cost you the game and end your run. At this point luck plays such a powerful role that one bad officiating call (which wouldn't even be your fault) could undo all of your work.
The quintessential example of this would be the Indianapolis Colts. For the last 4-5 years they been one of the absolute best teams in football. Their success in the regular season shows what a great job their office has done is assembling a tremendous team, arguably one of the best ever in the NFL. But they have yet to even go to a Superbowl.
On the other hand we have the New England Patriots, also an example of how a good manager can assemble an excellent team, although their regular season records haven't been as good as the Colts. But with a remarkable string of good luck (including the now-infamous "tuck rule") they've won the championship three times in the last 5 years.
So obviously I'm just saying that it all comes down to luck, right? So why bother even trying? Not so fast my friend! The difference between the Colts and the Patriots may just be luck, but the difference between the Arizona Cardinals and the Patriots is much more. (If you are tiring of the football analogy, bear with me, this is the last one. I promise!) While the Patriots have won three Superbowls, Arizona, like the Colts, has won zero. But unlike the Colts they've never even had a chance. Arizona, plagued with poor management, hasn't even made it to the playoffs. The difference between the Colts and the Cardinals is that every December (when luck kicks in) the Colts have a shot to go home with the title. The Cardinals are guaranteed to be watching the game at home.
The parallels to business are obvious. The difference between Donald Trump and some other real estate investors is simply that The Donald got lucky on some of his bigger deals (remember, he's had almost as many deals go bad as have gone well). The other investors might be working just as hard as him, and have just as much knowledge as him, but they haven't had the luck to get over the hump. On the other hand, the difference between The Donald and Casey Serin, is that The Donald worked hard to acquire the knowledge necessary to succeed and then worked hard to apply it. Casey, on the other hand, is living in a pipe dream where he can go to a weekend seminar and start earning millions every year. Casey would like to skip the "work hard and watch for your break" step and just get lucky from the get-go. After all, since every deal turns a profit, the more deals the better, right?
So learn your lesson from the NFL. Every owner wants to win the Superbowl. Some owners (ok, I lied, here's another NFL analogy) like Daniel Snyder, owner of my beloved Redskins, try to buy an all-star cast that will shoot straight to the championship. So far that approach has failed miserably (one playoff appearance in 7 years). Other owners like Bob Kraft, owner of the Patriots, just build a good solid team and take advantage of the opportunities that are presented them.
In real estate investing the goal might be to own a Manhattan block. But if your approach is to try to buy 17 houses in your first year and trade to the block in your second, you're not only going to fail but that failure will crush you. If instead your approach is to build up a solid business piece by piece, then watch for profitable opportunities and seize them, you'll be on much more solid ground. And even if you never see your big break that gets you into the wealthiest of investors, you are still likely to do very well.
I'd be remiss not to point out that the lucky rich and the patient rich are not correlated. If Tom Cruise hadn't gotten his big break in Legend would he still be wealthy? No one but him knows for certain, but I'll take a shot and wager that most Hollywood stars wouldn't end up with wealth without their million dollar contracts.
But there are many software entrepreneurs who are already well on their way to great wealth before Microsoft or Google swoop in with multi-million dollar acquisition offers. They work hard and build up a solid business with fair income, and then save a fair amount of that income for the future (since owning your own company is quite risky). Then when Yahoo or eBay make their rich offers, these entrepreneurs just transition from patient rich to lucky rich.
Patient wealth come from how you handle the money you have, lucky wealth comes from being in a position to have large sums of money paid to you. Both patient wealth and lucky wealth require discipline and hard work, but only patient wealth is guaranteed. It's exciting and fun to go after lucky wealth, and I encourage people to go for it. But be smart and hedge your bets, you can play the safe game at the same time that you play the lottery. If you are into real estate investing, put yourself into your ambition and work hard to make the most you can. But also save at least 10% of all your income and invest it in vehicles that you don't directly control (such as stocks or bonds).
It may not be as sexy, but it never hurts to be on two roads to wealth at the same time.
I've written about how to write a lease. I've discussed some of the wild notions associated with leases and breaking them. So I suppose I shouldn't have been surprised when I recently discovered that one of the biggest ways people find my blog is by searching an engine with some variation of the terms "breaking lease". So since I don't have a large quantity of time to blog today, I thought to pontificate upon the terms of a lease and it's legal ramifications.
It seems (based upon the search terms) that there is a lot of confusion on how leases work. Most people seem to have the misconception that leases are covered by general law, and the courts have mandated certain terms and conditions, as well as penalties. In fact, many people who find their way to my blog are curious about the penalty associated with breaking a lease.
What is a lease?
While there are some laws that cover aspects of the landlord/tenant relationship (almost exclusively at the state level) those laws are usually aimed more towards the safety of the tenant, discrimination and eviction procedures. The lease itself is barely mentioned, for example Virginia laws mostly just remark that a signed lease must be provided to the tenant and it can't be changed without every one's consent.
Leases themselves are managed under a branch of law called Contractual Law. A contract, simply put, is an agreement between two people to exchange something, usually exchanging money for some sort of good or service. A great example of this is a mortgage agreement. When you get a mortgage (or any sort of loan) you sign a contract that pretty much states that the bank will give you a large sum of money right now, and you are to pay back an even larger sum, but over a long period of time.
The terms of the lease are strictly between the two parties. For example you could sign a contract to pay Uncle Joe $20,000 to paint your Honda Accord. It might not be a very fair contract (unless Uncle Joe is world-renowned), but if you sign it you've agreed to it. Any goods and services can be exchanged, best shown by this couple's prenuptial agreement in which she must cook 3 breakfasts a week and he must take her to London for her 60th birthday "keeping in mind that London is an expensive city, period".
OK, but what happens when a lease is broken?
Technically speaking a lease cannot be broken. Since a lease is a binding contract, you must fulfill your end of the bargain, regardless of whether you are a tenant or a landlord. If you go to court with a reasonable rental agreement, the judge will almost certain rule that the terms of the lease be enforced.
Most leases have a buy-out clause built into them that allows one party of the other to prematurely end the lease by following a series of steps. These steps most often include paying some sort of premium to the other party, but could also include producing special paperwork (such as a tenant providing an offer letter from a company more than 50 miles distant). This buy-out clause is what we refer to when we speak about "breaking a lease", but it's a perfectly legal method to end that lease early.
It's important to note that lease do not have to have buy-out clauses built into them. If there isn't a buy-out clause in the lease, and the other party is not willing to negotiate then you must fulfill your end of the bargain. Let's pretend that you own a house and rent it out to a nice family who signed a 24 month lease. Two months later you receive an unsolicited purchase offer for a large sum of money. You review your lease and discover that while the tenants can buy their way out, there's no such provision for you. The family is perfectly happy with the home and has no intentions of moving. Depending on the circumstances of the case, it's very likely that the family can force you to legally abide by the terms of your agreement, and not sell.
Whether you are a landlord or a tenant, it's very important to carefully review a rental agreement and understand how the buyout clause is defined. In Biff and I's lease we have chosen to set the buy-out clause (labeled as Early Termination) as follows:
Tenant may choose to terminate the Agreement before the natural expiration of the Agreement. To exercise this option, Tenant must submit his intentions, in writing, to Landlord at least thirty (30) days before termination and must pay a penalty equal to a single monthly installment in addition to their final months rent. In paying this penalty, the Agreement will be terminated and the Landlord will not hold the Tenant accountable for any of the monthly installments remaining in the term of this Agreement.Basically in crafting this agreement, Biff and I have guaranteed ourselves 60 days to find a replacement tenant (30 days notice, plus an extra payment with covers another 30 days). This is good for both parties in that it allows a tenant to leave without too much trouble, and it gives us plenty of time to find a replacement. Of course, in keeping with what was mentioned directly above, we've also included a way by which we can terminate early as well.
The Landlord may choose to terminate the Agreement before the natural expiration of the Agreement. To exercise this option, the Landlord must submit his intentions, in writing, to the Landlord at least forty-five days before the date of termination. The Tenant has the option of moving out at any time before the date of termination. The Tenant is responsible for paying all rents due up until the date he moves out. On the date of the move out the Landlord must refund an amount equal to one (1) monthly installment to the Tenant.If Bill Gates moves to Virginia tomorrow and wants to buy one of our houses for $5 million, then we have a way by which the deal can be completed. Look at the wording again, this clause means that Biff and I can terminate the lease for any reason at all, and the tenants can't object as long as we follow the steps set forth in the lease (giving them 45 days notice and refunding a month's rent).
Alternatively, bear in mind that any contract can be changed at any time as long as all parties agree on the change. In the above example with the landlord reciving a large offer on his house, he could possibly offer money to his tenants. If they agree to it, and sign an agreement to that effect, the earlier lease is then nullified.
As a tenant that same laws apply. You can negotiate your way out of any lease as long as you can convince the landlord. Unfortunately it is typically impossible to neogtiate with a large management firm, in the same way that you usually can't barter with Walmart. However if you are dealing with a small landlord, he might be willingly to allow you out of the lease if you can sweeten the deal enough for him. One possibility could be offering to locate a replacement tenant that meets his criteria.
However, if either party refuses to negotiate, the lease remains.
So I'm taking the lease to court...
So if all else fails and you are trying to escape a lease (or enforce a lease) in civil court, there are several things you need to know about contract law. The first is that you must bring a copy of your lease signed by both parties. If you plan your argument based upon the terms of the lease (such as trying to get a deadbeat tenant to pay up) and you don't have a copy handy the judge will most likely throw out your case. The same goes for tenants, you must have your own signed copy of the lease to present to the judge.
Once the judge has a copy of the lease, it's most likely going to be enforced. If you are trying to escape the terms of the lease, there are a few common defense that are used:
- Lack of Capacity - One of the rules of a contract is that both parties must be capable of understanding and fulfilling their side of the contract. There are many ways to dispute capacity, some of the more common including mental illness, such as Alzheimer's, (proving a lack of understanding of the contract) and bankruptcy (proving a lack of ability to fulfill the contract). Special consideration can be awarded to people (either tenants or landlords) who can claim financial hardship.
- Unconscionability - Simply put this word means that one party used a superior bargaining position to force unfair conditions upon the other party. For example if a landlord rented his unit out to a couple who spoke little English and used their poor understanding to add tremendous fees and dues. Unconscionability is not a guarentee that a contract will be voided, and the court often has great leeway in how it deals with such claims; from voiding the contract to simply amending it.
- Illegality - A contract can be voided if it is ruled to be illegal. For example, Virginia state law clearly defines the maximum amounts that a landlord is allowed to collect for a security deposit. If a landlord collects too much, then that clause is illegal. As I mentioned in "Breaking Down a Lease", one illegal clause can potentially void an entire contract. The best way to prevent a complete dismissal is to add in a clause of Severability.
This is a fancy legal word that means if some part of this lease is invalid for some reason (like a judge throwing out a no-liability clause) the rest of the document is still considered valid, instead of the entire document just getting thrown out.
- Misrepresentation - The misrepresentation argument is used when one party has lied or stated falsehoods before the contract was signed. A tenant could use this argument if the landlord planned some major renovation work before signing a lease, but didn't disclose that fact to the tenants. Alternatively a landlord could use it if a tenant lied on their application, for example with regard to income or number of potential inhabitants.
Never make a promise that you don't fully understand, and never sign a substantial contract (like a lease) without carefully reading it over. Too many horror stories (like the poor guy I wrote about whose lease had a buy-out clause of three months rent (at the very bottom of the article)) could have been avoided if people simply took the time to understand what they were getting themselves into.
at 2:35 PM
In my favorite book, Zen and the Art of Motorcycle Maintenance, Pirsig describes a process he calls analytic description. Such a process "discusses things in terms of their underlying form". He then gives us an example by describing a motorcycle:
A motorcycle may be divided for purposes of classical rational analysis by means of its component assemblies and by means of its functions.
If divided by means of its component assemblies, its most basic division is into a power assembly and a running assembly.
The power assembly may be divided into the engine and the power-delivery system. The engine will be taken up first.
The engine consists of a housing containing a power train, a fuel-air system, an ignition system, a feedback system and a lubrication system....
And so on... This is a classical approach to understanding something. You take it, you divide it up into pieces. Then you divide those pieces into more pieces, and keep going until you feel you can divide no longer. The "it" in this process can be a thing, a role, an idea, or even a process itself. Scientifically the goal of such a practice is to accurately describe the components of whole. Philosophically the process can be used to "Look Closer" and force yourself to see things that your mind has been filtering out.
For example, the goal of real estate investing it creating value. Value can be realized either at the time of purchase or the time of sale.
At the time of purchase value can be realized by purchasing undervalued property, which can be divided into buying from a "motivated seller", buying in a soon-to-be-improved area where prices will climb, and buying a distressed home.
Buying from a "motivated seller" can further be divided into buying a foreclosure from a bank, buying at an auction and buying from a seller in financial trouble.
Of course, once, we've finished dealing with all the subsets of motivated sellers, we have to go back up to describing the process of buying in a soon-to-be-improved area, and eventually we need to go all the way up to the top and describe the means by which value can be realized in selling. I hope you can start to see the interest in such an exercise, because I'd like to stop here and discuss one of the "motivated sellers" I described.
One of the time honored business models for buying discounted homes has been the "We Buy Homes" model. You've all seen the signs on the side of the road, variations of "We Buy Homes in a very short time and pay cash!"The purpose of such a business model is to find sellers in dire financial straits who are either currently facing foreclosure, of will likely be so soon. Then you can swoop in and offer to pay cash for their home (usually at a 70-80% discount, from what I hear). Why would a seller ever agree to that?
Let's imagine for a second that you are a hard working American. You bought your house 10 years ago (say for $100,000) and have seen properties rising all around you. Unfortunately a medical disaster has crippled your finances and the creditors have come calling. You don't have enough money to make your house payments. The bank is threatening to foreclose. The rising property taxes is only making the situation worse.
Then a buyer comes knocking on your door and offers you $200,000 for your house. Other houses in the neighborhood are selling for $250,000. If you accept their offer you will walk away with $100,000 cash (more since you have paid down some principle on your mortgage through the 10 years).
Now the situation is not quite as dire as you think. If the bank forecloses on your home, they will then sell it (first through a realtor, and then at auction), and after they've paid all creditors who have a lien against your home (which it typically just them and any second mortgages), they have to turn over the balance to you. However, it's uncertain on when the home will be sold, what fees will be paid to Realtors/auctioneers, AND there will be a foreclosure on your credit report for the next 7 years.
So by taking the buyer's offer you are trading the possibility at some extra money (depending on the offer, it could be a considerable sum), for the certainty of money now and the prevention of a foreclosure on your credit report. For many people this is a very fair deal, often people in these circumstances have far too much uncertainty in their lives already and could use help in resolving a couple of their issues.
The business models is certainly a sound one, but it relies on a few conditions that are going to be harder and harder to meet in the coming years. It's my belief that this model will struggle greatly for the next 3-5 years, and may never quite recover due to the recent revolutions in the finance industry (and personal financial habits).
First I feel it is my duty to mention that one of the conditions of making this model work is having enough cash to pay for the home outright. Because the deals you are offering have to close very quickly, there often isn't time to bring in a mortgage, and the appraiser, and the paperwork... etc. This is not a model to follow if you have "No Money Down!"
But the number of people with enough money to make this model work is only growing, as is the number of individuals who are unable to make their mortgage payments and are facing foreclosure. So why is this model in trouble? Because it relies on one last, crucial, condition. The distressed home owner must own a reasonable level of equity in their home to make this work.
The home owner's equity is everything. The value you get is the equity that the home owner is willing to forfeit to make the deal go quickly. The value the homeowner gets is the remainder of their equity in cash form. If the home owner has little, or no, equity the deal simply can't be done. What homeowner is going to accept $200,000 for a home when they owe $225,000? At that point you are facing trying to accomplish a short sale, which is a completely different set of circumstances.
So the problem with the We Buy Homes business model is that the number of potential sellers is declining rapidly. It used to be that everyone bought a home with 20% down, guaranteeing a certain level of equity. Today 100% mortgages are one of the fastest growing loan types. Owning a home for 5 years used to mean at least a small level of equity with a fixed rate mortgage. Today, with interest-only loans and negative amortization loans, there's no guarantee. Even someone who has owned their home for 15 years isn't guaranteed to have any equity built up thanks to the proliferation of refinancing and home equity loans...
Since the vast majority of foreclosures we'll see over the next 5 years will tied to people with crazy ARM loans, who bought houses at inflated prices, it's unlikely that a discount investor will find many deals out there pre-foreclosure, if any.
Could this business model make a comeback? Possibly, but that would rely upon two things happening:
- American home prices stabilizing. A wild market (which is what we've had for the past 6 years) is not good for this type of investing. To ensure a profit, we need to understand the home pricing within the area, which means somewhat stable growth.
- Americans getting wise about their finance. We've become too much of a consumer society, where we're completely unafraid to sell our future for a toy today. As long as that mindset persists, the odds of actually finding a distressed seller with actual equity is very slim.
The second is very hard to predict. I would hope that American society at large would eventually settle down from it's consumer binge and enter an era of fiscal responsibility. But trying to predict whether or not that will happen is an exercise in futility. If the above model interests you, then the best you can do is try to build up your cash reserves and prepare yourself for a time when you can find distressed buyers with equity.
So throughout this week I've been dissecting NAR's latest national ad campaign that tries to explain to us why today is a great day to Buy or Sell a House! I've been breaking it down partly because it's an easy target (as I wrote on Wednesday, the ad does more to comfort Realtors than convince a skeptical public). But I'm also breaking it down because it's a wonderful, if clumsy, example of advertising techniques.
A real estate investor needs more than just appraisal skills, they need marketing skills, leadership skills, accounting skills and possibly even handyman skills. In other words, real estate is an entire business. So by dissecting the ad for the tricks they use to persuade, we can learn how to use these tricks ourselves and become better marketers.
Now I admit that using words like "tricks" and "propaganda" sounds awfully evil. But I assure you, all advertising is propaganda, it's all designed to influence your beliefs. "Trust the Midas touch" encourages you to trust total strangers with your brakes. "The quilted, quicker picker-upper" implies that Bounty paper towels are better designed than others, without providing any evidence to support such claims. Even a Happy Meal is named that way for a reason.
These tricks, while they truly are propaganda, are simply used to best promote their product. And there is nothing evil in using them. I admit that it's one thing to outright deceive a person into believing something that's not true (which I would agree is a bad thing to do), but it's another to help a potential buyer to help envision themselves living a wonderful life in the house you just happen to currently have for sale... What do you think staging a home is, but propaganda?
Back to the conclusion of our dissection of NAR's national ad campaign:
REAL ESTATE IS A GREAT INVESTMENTNow I obviously can't argue with the title here, can I? I mean I'm invested in real estate! Obviously I think there are good investments to be found within real estate. However, there are some clever techniques used here to promote their cause.
Homeownership is a safe, secure way to build long-term wealth. The national median price of homes bought ten years ago has increased 88 percent. The number of US households is expected to increase 15 percent during the next decade, creating a continued high demand for housing.
The first is oversimplification. They begin with the claim that owning real estate is a safe and secure way to build long-term wealth. First of all, they are being redundant, simply because they want to use as many emotionally-charged words as possible. Safe and secure, within this context, mean exactly the same thing, "risk-free". If I were nit-picking I'd go into a bit of a rant about how borrowing money for an "investment" is never safe. When you play with other people's money, you always run the risk of over-extending yourself and being unable to pay that money back.
In addition "safe" is only useful as a means of comparison, by itself it's an empty word. The "safest" investment is generally considered to be a Treasury Bill, which is guaranteed by the US Government. But what if the government fell next year? I'll agree that my scenario is tremendously unlikely, but it's possible. Nothing is "safe". They also use the phrase "long-term wealth". What does that mean exactly? Do they mean wealth that takes a long time to build? Wealth that lasts a long time? I'd spend some time thinking about it if it actually mattered.
So why do they use these words that have no real meaning behind them? Simply because these words are emotionally charged, that is, they invoke emotions within the reader. They specifically chose these words, "Safe" and "long-term", because they are trying to appeal to the American public which has just suffered through two bubbles in a row. If NAR had advertised real estate as "safe" in the late 90's everyone would have laughed. The public wanted "explosive" like eBay or Yahoo, not "safe". But now that we've suffered through two tremendous setbacks, the public is yearning for words like "secure".
Real estate is a very emotional product, evoking intense reactions from both buyers and sellers. So it's not a surprise that Realtors are pros at using emotional words. Look at your local listings and you'll undoubtedly find them peppered with such meaningless descriptions as "warm", "fantastic", and "luxury". These types of words are especially useful when accurate descriptions might not suffice.
However, they can backfire on you too. As propaganda has evolved, people have become more sensitive to it (consciously or subconsciously). Sometimes people will see emotionally charged words for what they are, words without substance, and count it negatively against you. In his famous book Freakonomics, economist Stephen Levitt noted the use of emotionally charged words in real estate:
In fact, the terms that correlate with a higher sales price are physical descriptions of the home itself: granite, Corian, and maple. As information goes, such terms are specific and straightforward - and therefore pretty useful. If you like granite, you might like the house; but even if you don't, "granite" certainly doesn't connote a fixer-upper. Nor does "gourmet" or "state-of-the-art," both of which seem to tell a buyer that a house is, on some level, fantastic.
"Fantastic," meanwhile, is a dangerously ambiguous adjective, as is "charming." These words, it turns out, are real estate agent code for a house that doesn't have many specific attributes worth describing. "Spacious" homes, meanwhile, are often decrepit or impractical. "Great neighborhood" signals to a buyer that, well, this house isn't very nice but others nearby may be. And an exclamation point in a real estate ad is bad news for sure, a bid to paper over real shortcomings with false enthusiasm.
If you study an ad for a real estate agent's own home, meanwhile, you see that she emphasizes descriptive terms (especially "new," "granite," "maple," and "move-in condition") and avoids empty adjectives (including "wonderful," "immaculate," and the telltale "!"). She patiently waits for the best buyer to come along. She might tell this buyer about a house nearby that just sold for $25,000 above the asking price, or another house that is the subject of a bidding war. She is careful to exercise every advantage of the information asymmetry she enjoys.
He's really just confirming what most of us already knew. That real estate agents have honed their craft to a fine edge, and have used words like "charming" so often that we have become numb to their effects.
Of course that doesn't mean that there isn't a place in real estate for the emotional appeal. It just means that the place to tug their heart strings just isn't in a printed advertisement. When walking a prospective buyer through a house it's easy to toss in a liberal number of adjectives designed to open your customers hearts, and their wallets:
"And if you'll come in the kitchen you'll see a beautiful breakfast nook that is a perfect place for the family to gather and share informal meals together. And you can see a large window, which not only lets the sunlight in, but also allows you to keep a close eye on your kids as they play in the spacious backyard from the comfort of your kitchen."
The next trick they employ is selective sampling. This is a trick used almost every time you see a statistic. They claim that housing has increased by 88% nationally over the last 10 years. They exercise selective sampling in two different places in this claim.
Have you ever watched a sports game where the commentators came out with the craziest comments? Like "this team has scored more than 20 points in their last 17 games against left handed quarterbacks when playing south of the Mason-Dixson Line"? The unstated assumption is that they will then score more than 20 points in this game as well (assuming that they are facing a left handed QB, and playing in the deep south). But even your math-impaired viewer realizes on some level that that statistic seems to be somewhat doctored. And it is, the announcers (and their stat doctors) are simply choosing data points that best fit their claims. Playing in the south may or may not have had anything to do with the team's ability to score points, but it fits their model.
The claim by NAR is the exact same situation. They are choosing the data that best fits their model (in this case, that houses are growing rapidly in value). First we need to translate that very large number (88%) into a more useful form. Using some simple calculations we can turn 88% over a decade into 6.5% a year. That's not a terrible return.... for that period of time. But since NAR selected the 10 year period, we can assumed that that's about as good as it gets.
Indeed, MSN Money columnist Liz Weston wrote:
In the past 40 years, the average appreciation for homes has exceeded the inflation rate by only a percentage point or so. Compare that to stocks, which have bested inflation by 7 percentage points in the same period.I don't know for certain, but I'm relatively sure that her value for inflation is annualized to about 3% or so, giving us a typical real estate growth of 4%.
Of course a selective sampling then implies an unstated assumption. In this case the assumption is that real estate goes up a lot and will continue to go up. Consider that during the 10 years between 1989 and 1999, the S&P 500 (an index of stocks) grew by 429%! That's an annualized return of over 16%! Does that mean that 1999 was a great year to buy stocks? Obviously not, since over the next 5 years the S&P returned an annualized -2.7%.
If anything, the increased appreciation over the last 10 years should make you more cautious, not less, when looking into buying a home. If the housing market has under-performed it's average for the last 10 years (say only returning 2%), then that should make you more bold in entering the market.
Of course all of this is relatively moot because of their second selective sampling choice. They chose to use a national average for a market that is extremely local. If you are looking into buying a fund that owns houses all across the nation, the national prices changes may interest you a great deal. But for your typical home buyer the national average means little to nothing.
Consider this chart from CNN. They claim that home prices in the Virginia Beach/Norfolk/Newport News area (where I own) rose almost 24% from a year ago. And at the same time Minneapolis fell almost 2%. Aside from the fact that I haven't witnessed any of this magical appreciation in the Virginia Beach area, how's a homeowner in Minneapolis supposed to think when a Realtor tells him that the average American home appreciated almost 4% from the year before? How does that impact him?
So we've discussed, today, two of the most powerful tools of propaganda, selective sampling and emotionally-charged words. Selective sampling can be used in our favor, especially when we tell a potential buyer about the house down the street that just closed for $15,000 more than we're asking (assuming, of course, that it's true). We don't have to tell them that the house four doors over just sold for $5,000 less than our asking price.
Emotionally charged words can also be a very useful tool, but also a dangerous one. Trying to convey emtion through a printed word is a very bad idea, unless you happen to be John Steinbeck. Printing emotionally-charged words is a bad idea for two reasons. First, people like to connect emotions to people. When someone tells them "commune with friendly neighbors in your landscaped front yard" or that they can "OWN YOUR OWN BACKYAD OASIS !!!!!" they want to connect with a person, not an anonymous sales rep typing generic things down.
Secondly, the written word is apt to be read over and over again. Words that try to provoke images in your buyer's mind may work beautifully the first time through. But as humans, we go back to things we like over and over again. If it's written, we'll read it again. And the second or third time through, they become more likely to see empty words for what they are. When those same words are used verbally, all the buyer has to go back to is his own memory. And they're more apt to remember the image they created in their mind around your words than your words themselves.
at 11:51 AM
I had an epiphany this week. While taking apart NAR's latest national ad campaign, and criticizing it for it's ineffectiveness, I realized that I had completely misunderstood the ad.
You see, I had been operating under the assumption that the ad was designed to get people inspired to go out and purchase new homes. If that were true, this would go down as one of the all-time worst ad campaigns ever. But as much fun as it is to pretend that the reason the ad was so poorly designed was because the folks at NAR are idiots, the truth probably lies closer to Congress.
Just as Congressman, in an attempt to please all of his constituents, will go at great lengths to say nothing at all, NAR is stuck trying to please it's constituents (the Realtors). It's ad is certainly more aimed at convincing Realtors that it's working hard for them, than convincing people to actually buy homes. There's evidence of that in it's very title "It's a Good Time to Buy or Sell a House". As I wrote last time, they'd have done better to simply say it's a Good Time to Buy a House (since buyers are what they need in the market right now), such a message might have upset a number of Realtors representing sellers.
While their ad pretends to be convincing people to go out and buy, what it's really doing is screaming to the Realtors "Hey, we're on your side and working hard for you! Look! We support all of you and your varied positions!" You'd think that they'd please their Realtors more by actually working hard to drum up real buyers, and thus increase business. But like politicians, making a high-profile short-term gain that provides little lasting benefit is preferable to laying quiet groundwork for real gains. In other words, a real ad campaign might have upset some of their Realtors, so it's better to throw money at making Realtors feel good about themselves.
On with the review of NAR's new national ad:
PRICES OVERALL HAVE STABILIZEDThis is a classic bit of propaganda right here. Let's start with the considering the title and the first sentence. The title claims that prices have stabilized. The next sentence claims that sales are up. The two are only loosely related. Maybe the sales are increasing because more homeowners are finally dropping their prices! Trying to prove an argument with irrelevant information is called a red herring.
Contract for home sales in August are up 4.3 percent and the outlook is for home prices to increase next year.
They follow that up with some more intentional vagueness. The "outlook" is that prices are going "up"? Whose outlook? Why are they expected to go up? And up by how much? After all, if housing goes up by 1% and stocks go up by 30%, houses still increased in value, right? Also note that in a couple of places they actually provide a footnote to tell you where their data came from, but not here, indicating that their information is either made up, or considered unreliable.
POSITIVE OUTLOOKRed herring alert! Did you find it? What do you think "third-best year... for home sales" really means? I'll give you a clue, it's not about price or good deals. It's solely about volume. Basically they are claiming that they'll sell more homes this year than any other year, save two. And while that's tremendous news for Realtors, who love volume because it's more 6%'s to enjoy, that means nothing for people like you or me. NAR is assuring their members that there's still plenty of sales to go around for everyone. This number, by the way, comes to us courtesy of, you guessed it, NAR itself. NAR released a report claiming that the number of homes sold is expected to drop by over 8%, yet be the "third-best" on record.
Former Federal Reserve Chair Alan Greenspan recently said that housing prospects are looking up. "Most of the negatives in housing are probably behind us. The 4th quarter should be reasonably good, certainly better than the third quarter." According to industry estimates, 2006 will be the third-best year on record for home sales.
Now let's consider, for a second, the claim of a third-best year. Between 1939 and 1944, Gone with the Wind grossed about $9 million at the box office. This weekend Santa Clause 3: The Escape Clause grossed $16 million in 3 days. Does that mean that Santa Clause 3 is a better movie? OF course not. Just as the economy is inflating (and prices go up) every year, our population climbs as well, and we'd expect to see house sales rise. But most trade groups just ignore inflation, because it's much more uplifting to say ever year "More money made this year than last!".
In addition they use a tactic here called argument by authority. Simply put, that's just name-dropping. In this case it's Alan Greenspan, which is a great deal better than quoting, for example, Ben Affleck. But first you have to examine the credibility of the authority. Greenspan, while a prominent economically figure, presided over two major bubbles, first in stocks and then in housing. He also claimed in 2005 that:
"Relying on policymakers to perceive when speculative asset bubbles have developed and then to implement timely policies to address successfully these misalignments in asset prices is simply not realistic."In other words, he had no idea the bubble were coming, and no idea how to fix them. In his opinion, such speculation is impossible. Yet he's being quoted as claiming the worst is behind us? Let's assume for a minute that he knows what he's talking about (because, to be fair an honest, most people think Greenspan was a pretty good chairman of the Fed). If what he says is true, then.... well we need to look at what he says. "Most of the negatives... are behind us". There's a glowing review for you.
Now look at the overall pattern. They start with the name dropping, Good 'ole Greenspan. But they don't want to end on him, since his wording wasn't terribly good (just not bad). So they follow it up with a strongly positive sentence that is both conjecture AND unrelated. So when you finish reading the paragraph, what will you remember? Greenspan and 3rd-best year.
Writing an ad rarely just happens. A tremendous amount of work goes into each word, much less each paragraph. If you think it's simply a coincidence they put Greenspan's name and third-best year into the same paragraph, when they're not very closely related, think again. It's 100% intentional.
Today we've talked about multiple techniques of propaganda, but I want to revisit the red herring for a second. As with all sales techniques, you have to craft your message for your audience. But I think the red herring can backfire more easily than the others. When you try to use a red herring (for example: "Tomorrow will be sunny because it didn't rain today!"), and it's noticed by the audience, it's easy for people to simply discredit anything else you say without a word. Of the many tools of sales, the red herring is one of the most risky, in that you can easily turn your audience off.
Name dropping, on the other hand, is a relative safe way to promote a sale. If someone tells me that Ben Affleck voted Democrat, I can easily recognize that it's name dropping. However, that doesn't discredit the person, I simply brush the information off as uninteresting. The reason name dropping doesn't offend while a red herring can is simply a distinction of fact.
Ben Affleck voting Democratic is a fact (at least in our hypothetical example). Whether or not it sways me, I still accept it and continue to listen. A red herring is a false fact. You make an incorrect correlation, and when an audience catches it they will be more interested in finding further errors than in hearing what you have to say.
at 11:19 AM
I started examining NAR's latest ad last week, and I'd like to continue to examine their campaign. We're looking at the tools of propaganda they use (the same tools every advertisement uses), and the facts behind their claims. One of the lessons we can pull from this ad is simply how propaganda works and how we can use it to become more effective salespeople.
So let's move on to the second bullet point found on NAR's national ad.
LARGE INVENTORY WON'T LASTNAR tries to appeal to our fear. They warn you, the consumer, that the inventory of houses "won't last". Obviously, the command that you need to go out and buy a house right now goes unspoken. A similar tactic was used over the last couple of years when Realtors tried to convince us that real estate was climbing fast and if we didn't get in right away we'd be priced out forever. Note that the following sentences do help justify the "large inventory" but there is absolutely no evidence included which supports the idea that the supply "won't last".
There are currently 3.75 million homes for sale. We have had a record inventory of homes on the market in recent months offering consumers the greatest choice in decades.
At this point I'd like that take a quick look at the theme of their overall campaign, "It's a Good Time to Buy or Sell a House". Now most college educated folk might recognize that it's rarely a good time to buy AND sell anything. So you'll note that almost every point they make is aimed towards buyers. For example, when they mentioned that there is a record number of houses available right now, that's not much encouragement for the sellers that they want to encourage.
Now the reason they seem more interested in attracting buyers than sellers is simply that right now there seems to be a shortage of buyers. If that's the case, they simply should have stuck to the message "It's a Great Time to Buy a House!". That would have been more direct (they are looking for buyers anyways), and would have lent a lot more credibility to their ad (right now their claims that it's a great time to both buy AND sell suggests that they are fools).
One important lesson that we can learn from this is that we need to tailor our message to our clients, lest we come out looking like fools. If we are trying to pitch a property as a "great investment", it'd help to have number prepared to support your claims, and research to support your numbers. Otherwise you could end up looking like a fool.
So they claim that it's a good time to buy AND sell, but in this bullet they clearly indicate that the selling is tough right now. The record number of homes is directly tied to the simple fact that homes aren't selling well, and staying on the market longer. Competition for buyers hasn't been this fierce in a decade. So if it's not a good time to sell, it must be a good time to buy, right?
In economics there's a theory on efficient markets. Essentially the belief is that in a healthy mass market there's always one buyer for each seller. If there are too many buyers, the price of the good rises until enough buyers lose interest to maintain the ratio. If there's too many sellers, the price keeps dropping until they are so cheap that buyer's renter the system.
From the view of real estate this means that, in practice, if there are too many buyers (think back to 2004), they will bid each other up until many are priced out. This is exactly what happened during the boom. If there are too many sellers, however, they will undercut each other until the price is low enough that the buyers will purchase.
Now if efficient market theory is applicable (as it seems to be with stocks), we would see a very close relationship between the number of people selling (the green line) and the number of buyers (as represented by the number of successful sales shown by the red line). As fewer houses are for sale, prices increase and few buyers buy. On the other hand, as more houses are for sale, then prices drop and more buyers enter the market.
We can clearly see that strong correlation between the number bought and the number for sale during the boom period on the above graph, with both the green line and the red line peaking and bottoming out at the same time between 2001 and the end of 2005. However in 2006 we see the number of active listings skyrocket, while the buyers are shying away. With that many active listings we should see home prices being slashed to compete for buyers (thus drawing in new buyers), but that's not happening. As I wrote last month selling is often ruled by emotions, not reason. The result is a market where sellers won't bargain, and so no new buyers enter the over-priced market.
This is an example as to why there is such a time as a market that is bad for both buyers and sellers.
at 10:29 AM
Propaganda was formalized into the form we're familiar with now during World War 1 when then-president Wilson formed a committee to help sway public opinion towards entering the war. The rest, as they say, is history. Today every company on earth uses the lessons taught by the Creel Commission to sway the public into buying their wares.
A wide range of tricks are used, from the tireless repetition of the jingles we hear on TV to intentional vagueness, "Colgate! 9 out of 10 dentists recommend it!" (but do they only recommend Colgate? Or do they also recommend Crest as a viable alternative?). Of course, unlike a government, advertisers' goals aren't to subjugate your will, but simply to make their product indispensible.
Now the main difference between an investor and a speculator is that a speculator believes what he is told, while an investor believes what he tells himself. In other words, a speculator is a sucker, while an investor looks past the smoke and mirrors to make up his own mind.
The National Association of Realtors is trying to sell you the idea that you should be house hunting right now. Just for kicks, let's take a look at their claims and figure out the mean and nasty tricks they are trying to play on the unprepared.
*edit - This was originally going to be one post, but I had too much fun writing it and it got far too lengthy. So instead I'm going to break it up into more manageable pieces. It's easier to edit, and easier to read.
Right now may actually be one of the best times to buy a home. Consider these facts:Even when they've begun, they are already started their little game. Look carefully at their claim, because one single word changes the entire sentence. If you said that word was "may", go get yourself a cookie. Anytime you see the word may, you can completely ignore whatever the claim is. Afterall, 50 years from now we may actually find out that President Bush is actually an alien.
Yes, I've used that word before myself, typically at the conclusion of an argument when I've laid my facts before you. However it is perfectly fair for you to read my articles and immeadiately eliminate any sentence with the word may in it, because in the end it's simply conjecture and worthless.
INTEREST RATES NEAR RECORD LOWSThey have their facts right on this. Look at a graph of average mortgage rates over the last 35 years, as found on Mortgage-X;
Today's interest rates are comparable to 40-year lows, offering homebuyers a once-in-a-lifetime opportunity.
As we can clearly see, mortgage rates are nearly as low as they've ever been. Here NAR uses the tactic known simply as inference. What they lead you to believe, but never actually say, is that if you don't get a loan right now your rates will be much higher. It would be too much for them to actually suggest that mortgage prices were going higher, there is not evidence that supports that. But they phrase their words to say it without actually saying it.
You can use these tricks too
While there are some that believe such tricks are unethical, most simply believe that it's stating your case as best possible. All methods of persuasion involve some sort of word manipulation. What NAR is doing here isn't illegal or unethical, it's simply advertising.
As investors we wear a variety of hats, from CEO to accountant, from secratary to marketer. Yes, if you don't consider yourself to be in sales, you aren't going anywhere as an investor. We have to sell our homes to tenants and to buyers, we have to sell our sales pitch to sellers. And we can learn a lot from studying a simple ad such as NAR's.
What did we learn from today?
- It's always safe to qualify statements with "may"
- Sometime you can say something very clearly without actually saying it.
at 11:46 AM
Anesia, at The Landlord Blog, has another post about how her neighbors are getting screwed because they chose to use a Property Management Company(PMC) instead of taking care of the property themselves. From her post:
They gave the rental listing to one of the largest property management firms in Phoenix after seeing a sign in another yard on our street. They instantly knew the management company was terrible but didn’t want to deal with negotiating their money back or taking a loss and changing companies. They had no input into the tenant screening, aren’t aware if any was done, and didn’t realize the tenants moved in with two dogs. They’ve already been cited by the HOA because of the overgrown landscaping.I've written several times about how poor management companies are. DO NOT USE THEM! Using a PMC is like trusting a used car salesman to pick out a car for you and set up the financing. There's an outside chance that he might be really, really honest and give you a fair deal, but you almost certainly going to be screwed.
If you deperately want to avoid dealing with your tenants, hire a personal Property Manager.
As I briefly mentioned in my last column, I'm not a fan of investing in condos. I dislike the troubles behind owning them, and I dislike them as an investment. Although there are a few exceptions to the rule, I will probably never own a condo as an investment.
The first set of concerns weigh on all who buy a condo, not just investors. These are the costs of owning a condominium. For starters there is the condo association fee. Most home purchases are part of an association, which tends to all of the common areas My parents pay less than $100 a year for their single family home. Biff and I pay, on average, about $70 a month for each of our town homes. The condo owners I know pay between $200 and $400 a month in condo association fees.
Why so high? For one thing condos have a great deal more common area than single family homes. There are lobbies, offices, exercise rooms and pools, not to mention the common roof. All of these things must be maintained, and the maintenance will climb every year. Unlike the 30-year fixed mortgage that charges you the same amount every year (and therefore decreases every year when adjusted for inflation), condo association fees will rise over time.
But sometimes that association fee isn't enough. If too many repairs hit in too short a time, the condo association can extract that payment from the owners, which can sometimes cost in the tens of thousands of dollars for each owner. This comes in liu of having to pay for repairs to a single family home, by yourself. But with a house you can control the care and the abuse it encounters (to some extent).
Condos are a pain for everyone who owns, but they have even more added pains for investors. Condos (outside of any bubble) tend to appreciate extremely slowly in most areas of the country. There's a very good reason for this. Consider, if you will, this "real estate expert" and his view on why condos are an extremely good investment (as always, emphasis mine, bad grammar theirs):
Could you explain to me that condo and townhouse and what the benefits are of buying a condo our town house because I am not sure which one to buy for an investment?
One of the advantages of condominiums is that in the future, the growing trend will be as the baby boomers get older, they will be seeking to downsize from what they are currently living in and going into low maintenance structures.
Condominiums are popular and will remain so and grow in popularity in the future. You’ll have to take my word for that. All you have to do is look around and see the growth of condominium developments that are spreading out everywhere. That’s because statistics show that the baby boomer generation as we get older is going to want smaller, easier, affordable, maintenance-free housing.
He's right about one thing. Look around you at the new condominiums springing up all around you. That's your future competition for sale, rent and every other business transaction. Then look around at all the empty space, the old houses that are falling apart and will probably be bought by a developer in the next 10 years. That's your competition for sale and rent 10 years from now. Of course, at that point your competition has brand new condos and you just have an old one.
Take another look at that plot of land. How many houses do you think could be built there? 10? 25? Against how many condos? 100? 500?
Unlike houses, which are all relatively unique (due largely to the plots of land they are on), condos are all the same. The only thing that is unique to a condo is the view it offers, and that's out of your control. Aside from the view, why would anyone choose your condo over the one two floors higher that's also for sale? What? You didn't realize that no matter when you sell, you'll likely be competing with other people in your same building? During a normal time (not the current crash certain areas are in) you probably won't be selling against 30 owners, but almost always certain to be selling against one or two. And what advantage can you use against them except lower price?(Photo taken from the Bubble Meter, also the source of my previous bubble pic here. All were taken in Northern Virginia)
With a house you can make improvements, maybe finally get around to building that deck. Then when you sell, you can try (or your realtor can try) to convince potential buyers that your house is worth maybe a little more than the one that just sold down the street last month, because yours has "features". Try doing that with a condo. If John Doe down the hall has an emergency and sells in a hurry for $50,000 lower than expected, your buyers are going to look at the comparable and ask "His unit is just down the hall, with the same floorplan. "Why is your place worth $50,000 more?"
But at least you can rent the condo out, right? The answer is a firm maybe. Your fellow condo owners are not fans of investors, those who buy and then rent out. Doing so lowers their property values. From a realtor website (with several other good questions to ask):
What percentage of units is owner-occupied? What percentage is tenant-occupied? Generally, the higher the percentage of owner-occupied units, the more marketable the units will be at resale.The New York Times reports that condo buildings that have too many rented units could have trouble qualifying for mortgages! Try selling a condo when your buyer can't find a bank willing to back the mortgage.
Mortgage brokers and loan officers interviewed stressed that to lend money to the co-op corporation, for the underlying mortgage, or to individuals purchasing co-ops or condominiums when owner-occupancy is below 50 or 60 percent, certain conditions must be met. They explained that without these conditions, the risk of an investor who owns a lot of apartments going bankrupt -- and leaving the co-op in the lurch -- was just too high.As a result, owners in condos are pushing their associations (and rightly so) to limit the number of units avaiable for rent. It is within the rights of the condo association to restrict you, the owner, from renting out your condo. (If you read the link, the answer that the columnist gave the owner is that since his association's By-Laws allow renting, they'd have to amend the By-Laws to pass any rules restricting investors).
So are condos all bad? Of course not, and in some areas of the country they make great investments. Where are those magical areas, you ask? Where there is no land available to build more.
I believe strongly that if you are interested in investing in condos, that you look to urban settings. Chicago, New York, San Fransisco, these are places that don't have any room for more condos. Alternatively, certain amentities, such as oceanfront properties, simply can't be replicated 2 miles inland. In both of these situations, basic economics tells us that if the demand grows, and no one can increase the supply, the price will go up. Buying condos in areas (such as the suburbs around any major city) where developers can add supply by the hundreds simply doesn't make sense.
The problem is that condos in areas like these can go for more than single family homes in most other areas. If you can't afford to buy a condo in those super-hot markets, look elsewhere. Town homes sell well as starter homes (unless in dowtown areas, then they are expensive homes), have no restrictions on renting and many families who can't afford to buy love the space and the yard afforded by a town home. Instead of buying a condo, why not buy an apartment complex? If you look to invest in a college town, look at buying one of those 6-8 unit complexes. No fees (since you control the entire building), no restrictions, and few competitors when buying. And they can often be purchased for less then the price of a condo in one of the major US cities.
Keep all of this in mind the next time you're looking at making that investment. The people who make the most from condos are the developers. And even they lose money sometimes.