"The Dumbest Reason to Buy is When Prices Are Going Up"

I originally found this article posted on today’s Housing Bubble 2 blog. I try not to post articles that other blogs are posting unless the article makes some really good points (at least in my opinion) and is applicable to Marin. This article is just such a one as it addresses the meaning of value in the RE market and investor psychology.

First some quotes from the article:

Warren Buffett said: “For some reason, people take their cues from price action rather than from values. What doesn’t work is when you start doing things that you don’t understand or because they worked last week for someone else….The dumbest reason in the world to buy a stock is because it’s going up.”

Personally, I would say, “The dumbest reason to buy anything is because the price is going up.” Yet that’s what people do when they invest. They generally don’t buy high-priced things when they shop.

For example, if Safeway had a sale — 25% off everything in the store — the supermarket would be swamped. Yet, when the stock market or real estate market has big discounts (often called a crash or a burst bubble), that same shopper runs away from an asset sale. Instead, they wait until prices are high and other fools are bidding them up further to finally buy.

I estimate that 90% of all investors invest for price movement, not value. If prices begin to escalate, as they did in real estate from 2000 to 2004, amateurs turn pro and begin buying real estate to flip…

Most stock market investors do the same thing. In investor language, flipping is known as “the greater fool theory of investing” — you’re buying something not to own, but in the hope of selling it to someone who’s a greater fool than you.

But such rumors [of an impending decline in housing prices] only affect those investors who, as Buffett says, “take their cues from price action rather than from values.” During such periods of high prices and volatility, it’s even more important to pay attention to value, more than price.

The fact that the author of this Yahoo article, Robert Kiyosaki, was a very recent housing cheerleader might lead you to dismiss him as a hypocrite. That may be true and you may be right, but I think what he has to say now is relevant (if not too late).

I think a lot of people have been buying houses because they see their friends and neighbors making a lot of money (at least on paper) by buying and selling property or read volumes of articles about folks making money from property. People are not asking themselves “Gee, is this house really worth the price?” Instead, they are thinking to themselves “It doesn’t matter what the price of this house is relative to its value; all that matters is if I can pay the monthly mortgage because the selling price is only going to go up and I can flip it in a week, month, year, whatever, for a small fortune“. That is typical investor (not owner-to-live-in) psychology.

The sad thing is even if someone is only buying a house “just to live in” the chances are they are still speculating whether they know it or not. They are speculators because of the fact that they are willing to pay an exorbitant price for a house not because they think the price accurately reflects its value, but because they see other people making a lot of money when they sell and they have heard, with recent (and I’d wager temporary) confirmation from the market, that “housing only goes up.” The fact that history says otherwise is irrelevant to them.

Now you say “Hey, Marinite, isn’t this obvious? What rock have you been living under?” And I say, it is obvious and has been for some time but it is clearly not obvious to a lot of recent buyers. The typical house buyer probably does not think of himself as a housing speculator per se. But depending on what the thought process was that led to the decision to pay an inflated price for a house (as opposed to just renting an equivalent house), I argue that they probably are speculating. If so, that means the recent “official” estimate that roughly 40% of recent California house buyers are speculators probably greatly underestimates the true percentage.

It doesn’t matter that current lending standard are so loose that even a [insert some low wage job here] can get a loan for a half a million dollars with a small monthly payment (at least for a while). The majority of people are still buying with the expectation of making a small fortune by selling sooner rather than later.

Housing prices are very likely to correct. Not all at once, not overnight. Rather, housing prices will likely erode over the course of quite a few years. There will be some minor up ticks in prices (i.e., “dead cat bounces”) along the way down and some people will jump in at those points thinking the bottom has been reached just like they recently did as the NASDAQ crashed. But the true bottom won’t be reached for quite some time I think. Some people are calling for the bottom in five years; others predict it will come in ten years or even more. I don’t know when the bottom will be reached, but given that your typical house owner sells (for whatever reason) on average every five years or so, this means a lot of folks are going to be “under water” or else be trapped in their mortgage for like the next 25 years.

But that’s just the way markets are. Sometimes you win, sometimes you lose.” I say “wrong”. This is going to be a bigger problem than it would otherwise have been because of the generalized speculative environment that we find ourselves living in today. First it was the dot com bubble and on the heels of its spectacular decline came the housing mania. And is it a coincidence that casinos are on the comeback? What’s next? What’s the next speculative mania that we have to suffer?

Up to now we have had to endure a seemingly endless stream of articles and stories about the “shrewdness” of average people who reaped huge rewards due to their financial “acumen” for having bought a house and the resultant lavish vacations, plasma TVs, new SUVs, their vacation house in [name some glorious vacation locale], etc. If it were true, that’s great. But these endless upbeat articles have helped to further the housing myth and the speculative thought process. Are we to soon have to suffer endless articles and stories about the sad tales of the financial misfortunes of these formally shrewd Americans as well as their resultant law suits?

One thing seems certain, if you buy a house now or do so in the immediate future you have to ask yourself “Can I stay in this house for the next 20 years or so or can I afford to take the capital loss?” People are going to be rudely reminded that the mortgage debt is real and the price is a matter of opinion; what matters most is the balance on the loan and not the monthly payment if for no other reason than the life of the loan is almost certainly longer than the life of a speculative frenzy.