The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (25 page)

It is only a distant memory now, but prior to 2007 rarely did the media even mention the term
real estate bubble
. Now, of course, it is a household phrase.

If you want to spare yourself any further losses from the falling real estate bubble, the first thing you must do is be willing to face facts, without influence by the CW cheerleaders who want you to believe we are on the verge of a lasting recovery. While falling prices may have stabilized or even risen a bit in your area, there is no credible reason to believe that there will be a big rebound to previous real estate values in the near future. Instead, prices will eventually fall even further. This bubble has not fully popped.

Between now and then, real estate owners have a choice: See the falling bubble before it’s too late to protect what is left of your equity, or see it later, after everyone else sees it, too, leaving very few buyers to whom to sell your property. At that point, you will either have to sell at a significant loss or hold on to the property for many, many years.

Unlike stocks or bonds, real estate is more than just an investment; it is often an important part of our personal lives. We may live and raise our families in these properties, or perhaps our parents did. We may have built businesses under some of these roofs. So there is often more to making real estate decisions than just a consideration of finances. You may also need to think about sentimental value, school districts, distance to work, and a variety of other issues. In a book, we can’t really help you much with that. However, we can help you analyze the future prospects for real estate and your current options. Our advice depends on the type of real estate you own:

• Your primary home
  
• Second homes and vacation properties
  
• Income-producing rental properties
  
• Commercial real estate
  
• Farmland
  

Everyone has to live someplace. If you decide to keep your current home, be sure that you understand that you will not be able to sell it in the next 5 to 10 years without taking a big loss compared to what you could have sold it for earlier or today. Its price may remain stable or even go up a little in the next couple of years, but after that, the next big drop is coming.

Therefore, from this point forward, think of your mortgage payment as if it were rent because, just like rent, you are not going to get it back later. Even though paying a mortgage does have some advantages over paying rent, the basic point here is that you are
no longer building equity
; you are simply paying for a place to live. Therefore, ask yourself, “Is this someplace I would like to live for the next several years at my current mortgage payment, without building equity and without the ability to leave unless I take a big equity loss?” If your answer is yes, you might as well stay. If the answer is no, you will do better to sell now and find a rental so you will have the flexibility to move later if you wish, without a big equity loss.

But it’s really not that simple, is it? You may have children in a school district you like or a good job nearby, and a suitable rental in your area may be hard to find. Maybe this house was your parents’ home, or maybe you just love the place and want to spend the rest of your life there. We understand there are many good nonfinancial reasons for keeping your current home. (All three coauthors of this book own their homes and don’t plan to sell, each for different reasons.)

But whether you decide to stay or to sell, here are some important points to keep in mind:

• All mortgages should be fixed-rate loans, not adjustable rate
  . As inflation rises, you will pay back fixed-rate loans with cheaper and cheaper dollars as the value of the dollar falls, while adjustable-rate loans will become increasingly more expensive. If you currently have an adjustable-rate mortgage that you don’t intend to pay off in the next two years, now would be a good time to refinance to a low
  fixed-rate
  loan.
  
• Don’t make more than your minimum payment
  . Inflation will allow you to pay off your loan later with cheaper dollars. Accelerating your payments means you are paying off your loan with more expensive dollars. No point in doing that.
  
• Avoid an adjustable-rate home equity line of credit (HELOC) for more than short-term loans
  . If your HELOC loan is at an adjustable rate, your payments will get increasingly larger as inflation and interest rates rise. If you have a fixed-rate HELOC loan, your monthly payments will remain the same. So if you have an adjustable-rate HELOC loan, either pay it off in the next couple of years or refinance it as soon as you can to a low fixed-rate loan.
  
• Don’t exaggerate the value of the mortgage interest tax benefit
  . Since the amount of interest paid declines as you pay down your loan, the tax benefit also decreases over time. More important, the gain of that tax benefit will be entirely erased by the loss of your home’s value as real estate continues to fall, before and during the Aftershock.
  
• Don’t assume that a reverse mortgage is a good idea
  . The equity in your house will decline as the real estate bubble falls further, so borrowing against your equity now and using it for living expenses over the next few years could leave you with a lien against a greatly reduced-value house. Even worse than the lien, your payments will likely stop because the company won’t be able to keep them up when things go bad in the Aftershock. However, if you borrow money against your current equity and invest it well, you could come out ahead. The key is investing it well, not living on it.
  
  Your Pool of Potential Buyers Is Not Infinite
  

  It is easy to assume that whenever we want to sell something, there will always be a buyer. If you are considering selling your home or other real estate in the future, here’s a new way to think about it. Your pool of potential buyers for your property is not infinite. At any given moment, there is only a finite number of people who might want to buy your property, and as the bubbles continue to fall, that pool of potential buyers will shrink.
  

  While it is true that you only need to find one buyer to sell your property, the smaller your pool of potential buyers, the less likely you are to find that person. As time goes on, your pool will shrink each time someone figures out that this “recovery” is not real. Your pool shrinks when they can’t get credit or they don’t have the down payment. Your pool will shrink each time someone climbs out of the pool because they don’t want to risk more price drops later. And, eventually, as inflation and interest rates go up, your pool will shrink each time someone gets kicked out of the pool by higher mortgage rates and stricter credit terms. The longer you wait to sell, the smaller your pool of potential buyers will become. Eventually, the only way to get someone to jump back into the pool is to drastically lower your asking price, which, if you need to sell, you will eventually do.
  

  So if you are thinking of selling, you can either go fishing in your pool now, while it is still stocked with potential buyers, luring them in with a reasonable selling price, or you can wait too long to go fishing or not make the bait attractive enough, and never catch a buyer.
  
• If you decide to sell, don’t stubbornly hold out for your top price
  . Lower your asking price sooner rather than later so you can find a willing and able buyer while there are more of them still around (see sidebar). There is no panic now, and you can still hold off for a while if you wish, but selling sooner is better than waiting too long.
  

Depending on your circumstances, you may qualify for one of the new programs now available to help homeowners refinance if their mortgages are greater than their homes are currently worth, especially if you can’t make your payments. The web site
www.makinghomeaffordable.gov
has information about government programs.

If you don’t qualify for any government help and you are behind on your payments, you may be able to fight foreclosure and eviction on technical grounds. This could involve spending some money on legal services, but it may be worth doing because sometimes homeowners discover that their loan documents were not properly created or procedures were not properly followed by the lender, which makes it very difficult for a bank to foreclose.

Even without a technicality like that, it takes a lot of time for foreclosures to finalize. The national average is 674 days. In New York, the average time is 900 days, and in Florida, the average time period is now 1,000 days. Banks are not enthusiastic to foreclose because it forces them to try to sell the real estate and take a loss. So you may be able to negotiate with the bank to give you a new and better arrangement, perhaps making smaller, fixed payments over time.

Failing that, you may have to walk away from the property, but only when eviction is imminent. If you do that, the bank may be able to get a deficiency judgment against you, which varies from state to state. In a deficiency judgment, the lender can come after you for any losses they sustained in the foreclosure proceedings. Of course, this may not matter much if you don’t have any assets to be seized. Not paying your mortgage will certainly damage your credit score, but during the Aftershock lots of previously creditworthy people will have poor credit scores, and there won’t be much credit available anyway.

If fighting foreclosure or walking away is not for you, another option is to try to get the bank or lender to agree to a “short sale.” It’s called a short sale because the property is sold for less than the loan, and the lender forgives the difference. Banks won’t always agree to this, but if they think the only other option is foreclosure, they may consider it the cheaper of the two losses. If you do a short sale, keep in mind that the amount of debt that has been forgiven is typically counted as
taxable income
when you file your federal and state tax returns.

There are two schools of thought on this. Some people decide to stop making payments on an underwater mortgage and do one of the options described in the previous section so they can get away from their bad investment and stop throwing good money after bad. Others decide to stay in their homes and keep making their payments. If you can make your payments without hardship, and if you have a low,
fixed-rate
loan (or can get one), you will find that rising inflation over the next 5 to 10 years will eat away your mortgage payment. This assumes that your income will go up more or less with inflation, while your mortgage payment stays the same, making it relatively easy to pay off your home, despite its being underwater now. But remember, you may not be able to count on uninterrupted income for the life of your mortgage, so having a cash cushion is important. (Also, having a diversified Aftershock portfolio of other investments that keep pace with or outpace rising inflation is important, too.)

Yes, inflation will make the
nominal price
in dollars rise. But high interest rates and the crashing real estate bubble will make the
real value
of homes (in inflation-adjusted dollars) go down. For example, it won’t really matter if your home is worth twice as many dollars as it used to be if it costs four times as many dollars to buy groceries or fill up your car. Furthermore, when the real estate bubble fully pops, expect it to happen very quickly. Inflation may push up prices over time, but the crash could easily devastate the value of your real estate nearly overnight.

In general, we say
stay away
from buying real estate now. This bubble is still popping and prices will only fall lower later. Don’t let the cheerleaders talk you into seeing bargains where there really aren’t any. Premature real estate “bargains” are the false mirages of the bubble blind.

However, there are two exceptions to our general Don’t Buy rule:

• If you want or need to buy a primary residence (not investment property), then this could be a good time to buy, while mortgage interest rates are still very low. But only do this if you are prepared to own the property for at least 10 years; otherwise, you will take a big hit later when you have to sell it at a loss or walk away. And, of course, take out only a
  fixed-rate
  loan, no adjustable-rate debt.
  
• In the rare case when you can buy a property at well below current market value and resell it quickly to a willing and able buyer for a profit, then this could be a good time to buy. The danger is that you will get stuck holding the property for too long, prices will drop again, and your potential profit will evaporate. If you never flipped a property before, now is not the time to start your learning curve. If you are a seasoned flipper, it would be wise to tighten up your criteria for what you identify as a “good deal.”