Category Archives: House Flips

Long-Term Appreciation

Most people vastly overestimate the actual long-term appreciation of real estate. Today, we will look at a condo purchased originally in 1990 that has appreciated at 4% per year to reach today’s still-inflated pricing.

Irvine Home Address … 90 LAKEPINES Unit 5b Irvine, CA 92620
Resale Home Price …… $195,000


Looking out at the road rushing under my wheels
I don’t know how to tell you all just how crazy this life feels
I look around for the friends that I used to turn to to pull me through
Looking into their eyes I see them running too

Running on – running on empty
Running on – running blind
Running on – running into the sun
But I’m running behind

Running on Empty — Jackson Browne

Appreciation seems to be running on empty, or has the Federal Reserve permanently refilled our tank?


I covered the various methods of predicting where prices would bottom in The Great Housing Bubble. The chart below comes from Future House Prices – Part 1:

Figure 37: Irvine, CA, Projections from Historic Appreciation Rates, 1984-2026

The story for the most inflated markets such as Irvine, California,
is much the same as the national forecast. If the 4.4% rate of
appreciation seen from 1984-1998 is repeated, then prices will decline
45% from the peak, bottom in 2011 and return to the peak in 2023. Since
prices peaked in 2006, this method of price projection shows an 18 year
peak-to-peak waiting time: not a comforting forecast for Irvine

Most people assume California real estate appreciates 6%-10% per year with some years being even better. This fuzzy thinking becomes an obvious absurdity when projecting large rates of appreciation because the prices quickly become so large that people could not make payments with a 100% DTI. Trees cannot grow to the sky, and prices cannot exceed income growth in the long term.

Of course, most people don’t really analyze the implications of what they say or think, they just accept the conventional wisdom of the masses even when this information is wrong. Worse yet, people then act on this information, buy overpriced property, and end up losing money or waiting a very long time for prices to come back. Knowledge is power.

IHB Library

For those of you who have not discovered our library, we have all the analysis posts I have written for this blog in one organized location:

And for those who missed the announcement, I have uploaded the full content of the Great Housing Bubble to the IHB:

Irvine Home Address … 90 LAKEPINES Unit 5b Irvine, CA 92620

Resale Home Price … $195,000

Income Requirement ……. $36,712
Downpayment Needed … $39,000

Home Purchase Price … $110,500
Home Purchase Date …. 1/25/1990

Net Gain (Loss) ………. $72,800
Percent Change ………. 76.5%
Annual Appreciation … 4.0%

Mortgage Interest Rate ………. 5.20%
Monthly Mortgage Payment … $857
Monthly Cash Outlays ………… $1,320
Monthly Cost of Ownership … $1,050

Property Details for 90 LAKEPINES Unit 5b Irvine, CA 92620

Beds 1
Baths 1 bath
Size 710 sq ft
($275 / sq ft)
Lot Size n/a
Year Built 1978
Days on Market 5
Listing Updated 11/2/2009
MLS Number S594735
Property Type Condominium, Residential
Community Northwood
Tract Lk



This property records for this post show the 1990 purchase to illustrate the long-term rate of appreciation. The property was most recently purchased from a lender on 9/30/2009 for $160,000. This is a quick flip to make about $30,000.

  • The owners who were foreclosed on had a more interesting story. They purchased this property on 4/17/2003 for $183,000. They used a $173,850 first mortgage and a $9,150 downpayment. Then the fun begins….
  • On 11/30/2004 they refinanced the first mortgage for $213,750.
  • On 11/7/2005 they refinanced again for $260,000.
  • On 3/31/2007 they refinanced again with a $244,000 Option ARM and a $30,500 HELOC.
  • Total property debt is $274,500.
  • Total mortgage equity withdrawal is $100,650.

This borrower gave up in late 2008…

Foreclosure Record
Recording Date: 07/10/2009
Document Type: Notice of Sale (aka Notice of Trustee’s Sale)

Foreclosure Record
Recording Date: 04/03/2009
Document Type: Notice of Default

One hundred thousand dollars is a good HELOC take from this property.

In case you missed this great post over at Housing Doom yesterday…

Where have all the bubble bloggers gone?

Bubble bloggers were for the most part, regular folks who saw an insane real estate market and said, “It’s going to crash, and someone should say something“. Some, like HousingPanic, Ben Jones and Patrick had inspired a national audience, others were smaller and more local.
There was a lot of comradery in those days. We’d check each others
posts, and add each other to the blogroll. We had fun taking potshots
at the likes of Lereah and Mozillo and watched the data in our local

This morning I read Chuck Ponzi’s Top 10 signs you’ve been following the housing bubble too long. Chuck, we’re you writing about me?

10. You kinda miss the days when everyone was still on blogspot. Uh… except for that Ritholtz guy.

9. Everything looks like a bubble now. Even bubbles.

8. Oompa Loompas and “The Tan Man” evoke feelings of intense disgust.

7. You know who Tanta and the Mortgage Pig are and you miss them.

6. You KNOW Neil has got popcorn.

5. The inflation vs. deflation argument was sooo 2007.

4. You wonder if Schiller has a time machine.

3. You know the rental multiplier for your neighborhood.

2. You think the Flying Monkey Warriors vs. Greg Swann battle was epic and you totally know who won.

1. Hoodoodanode?

Frustrated with trying to buy a home? (funny)

Ownership Cost: Interest Rates and Downpayment Requirements

Federal Reserve interest rate support is a major reason not to buy a home. When these supports are removed and interest rates rise to market levels, loans will get smaller and prices will go lower — when the shadow inventory finally arrives.

4 EARLYMORN Irvine, CA 92614 kitchen

Irvine Home Address … 4 EARLYMORN Irvine, CA 92614
Resale Home Price …… $1,150,000

Darkness falls across the land
The midnight hour is close at hand
Creatures crawl in search of blood
To terrorize y’alls neighborhood

I’m gonna thrill ya tonight, ooh baby
I’m gonna thrill ya tonight, oh darlin’
Thriller night, baby, ooh!

The foulest stench is in the air
The funk of forty thousand years
And grizzly ghouls from every tomb
Are closing in to seal your doom

And though you fight to stay alive
Your body starts to shiver
For no mere mortal can resist
The evil of the thriller

Thriller — Michael Jackson

The foul stench in the air is the fetid paper on the books of the Federal Reserve.

Today is part 2 in the ongoing series on Ownership Cost:

Ownership Cost: Income, Payments and House Prices

Ownership Cost: Interest Rates and Downpayment Requirements

Ownership Cost: Property Taxes and Mello Roos

Ownership Cost: Taxes and Opportunity Costs

Ownership Cost: Homeowners Associations

Four Major Variables that Determine Market Price

Yesterday, we discussed the four variables that determine the purchase price of a property:

  1. borrower income,
  2. allowable debt-to-income ratios,
  3. interest rates, and
  4. downpayment requirements.

Today we are looking at interest rates and downpayment requirements.

Interest Rates

Interest rates go up, and interest rates go down. Interest rates are
the yield on debt instruments. If investors lose their appetite for
mortgage debt, prices of mortgage-backed securities goes down, payment
yields go up, and mortgage interest rates go up with them. This concept
is important to understand because right now, the Federal Reserve is the only buyer of agency paper at price levels yielding 5%.

Private investors are demanding higher returns due to the obvious
risk of loss in a declining market. The Federal Reserve feels it needs
to step in to stabilize crashing markets by preventing an
over-correction in risk premiums to make the free-fall worse. In
crashing markets, 8% mortgage interest rates probably do not warrant
the risk of default loss.

The FED will retain this defensive market safety net until risk
premiums and market mortgage interest rates get close enough to their
support price that they can begin to unwind the program. It isn’t
likely that private investors will return to buy mortgage debt at 5%
yields any time soon, so the FED will have to be cautious in how it
unwinds its supports.

This government intervention underscores the difficulty of
forecasting interest rates and how fluctuations will impact the housing
market. Think back to early 2008 when there when people still denied
the housing bubble. Nobody imagined the Federal Government would assume
ownership of the GSEs (at the time they were private companies), and
that the Federal Reserve would be buying GSE paper at over-market
prices. These unprecedented events would suggest a market cataclysm —
the fodder of conspiracy theory nutters. Yet, here we are.

Interest Rates have a major impact on how much someone can borrow.

The big fear rational people have is that mortgage interest
rates will rise back to historic norms of 8% or go even higher. If this happens, the
housing market can easily drop another 30%. This may be the fate of
Irvine. As I look around at other nearby markets, they have already
fallen to the point where nice properties that would be above rental
parity here are trading for cashflow investor levels. A 30% drop in
affordability in beaten down markets will not necessarily push prices
lower because they have already overshot fundamentals. Irvine is not
trading below rental parity or below historic norms; it has a long way
to fall.

The chart above illustrates an important financing point and a legitimate reason not to buy a house.

it will be interesting to track the future and see where mortgage interest rates peak during the next cycle. If we really do get a 2011 Inflation Spike, it will be much higher than 8%. It is realistic to believe mortgage interest rates will hit 7.5% at the peak of the next cycle in 2013. Are they staying at 5% forever?

The table shows how rising interest rates will effect median price in Irvine at rental parity. What happens if mortgage interest rates are allowed to find a natural market? How do we know where the natural market is?

Currently, prices yielding 5% do not catch the long tail of market demand. The Federal Reserve is buying 100% of the agency paper. If prices were at market clearing prices, the Federal Reserve would be buying 0% of the agency paper market. The long tail of demand may be very near the natural market clearing price, or it may be very far away.

I am inclined to believe it at least as far away as the 6.76% peak of the last cycle in July of 2006. At the peak of that cycle, financial markets were delusional about mortgage risk at the peak of the housing bubble. Risk premiums are certain to be higher now.

If interest rates merely reach the previous peak, it removes 15.1% of the borrowing price support. If interest rates move back to their 37-year mean of 8%, 26.8% of the borrowing price support is removed from the market.

Do you realize that prior to 2002, mortgage interest rates had only been under 7% one time in the previous thirty years? It hit 6.9% in 1998. During our last interest rate cycle during the wild credit expansion of The Great Housing Bubble, the peak did not reach the previous 30-year low.

Mortgage Interest Rates, 1972-2006

I think it is very reasonable to assume mortgage interest rates will move higher, perhaps much higher.

Are you comfortable buying with that much of the price support is air from the Federal Reserve?

Downpayment Requirements

Downpayment requirements have traditionally been very high. During the 1920s, interest-only loans with 50% downpayments were the norm. Very few people owned their houses. By the 1950s, conventionally amortized loans with a 30-year term and 20% downpayments became the norm, and house prices rose significantly from the bottom of the Great Depression to the 1950s due to the increased use of leverage in real estate.

That is the end of the road for financial innovation. All attempts to tinker with the stability of conventional financing have failed because they are all Ponzi Schemes. People must have a reasonable expectation of paying off a loan in their lifetime. Multi-generational debt is frowned upon here in the United States, so any term beyond 30 years really doesn’t make sense. If you feel like you will never pay it off, you will not try, and you fall into Ponzi thinking and borrow in terms of maximum debt service. It is crazy.

By 2005, Option ARMs and 100% financing left us with 0% downpayments as the cycle reaches its ultimate limitation — they are giving it away. Not surprisingly, prices skyrocketed; unfortunately, the terms of the Option ARM were not stable and the Ponzi Scheme blew up. We are back to the 1950s in the world of mortgage finance — that is a good thing.

The 30-year fixed-rate fully-amortizing loan is the only stable loan product, and a significant downpayment is required to keep down speculation. As downpayments get smaller, the incentives to speculate with lender money get larger. With no-money-down the incentive to speculate hits infinity. One-hundred percent financing with no qualification is a free-for-all no-limit housing market casino.

Savers gain advantage bidding on real estate.Biggest Saver

My calculations of value in the table at the top of the post assumes the downpayment added to the loan to obtain value is 20%. Irvine buyers are unique in that they put in very large downpayments. Most buyers don’t have 20% down. Most buyers don’t have the current FHA standard 3.5% down either, or we wouldn’t have tried 0% down to begin with.

When it is an FHA buyer — which 21.5% of buyers are again — they generally only put the minimum 3.5% down. The loan plus the downpayment is about 16.5% lower for an FHA buyer than it is for a conventional borrower putting 20% down, assuming both are qualified using the same income and same DTI.

In the real world, the conventional borrower is also utilizing a higher DTI ratio. Instead of being limited to the FHA 31% front end DTI, conventional borrowers are often allowed to go into dangerous waters with 32% to 38% DTI levels. This additional money put toward debt service makes for larger loans.

The borrower with enough cash to put 20% down has a significant bidding advantage over the FHA buyer. The lower downpayment amount and the smaller loan balance make FHA less desirable than conventional financing for borrowers looking to bid up prices. FHA financing can be looked at as training wheels for mortgage borrowers.

After some period of time in a normally appreciating market (if there is such a thing), the combination of loan amortization and home price appreciation results in home equity exceeding 20% of the resale value of the property. When there is enough home equity that a more expensive house than your own house could be purchased with 20% down using your equity as the downpayment, you cross a threshold; you have access to the higher DTIs, and you can borrow more money to take the next step up the property ladder — if you are willing to give up some disposable income to have the house.

In the end, it is not the highly leveraged that gain the upper hand in real estate, it is the savers. The real estate market will always boil down to loan plus downpayment. The more money you have saved, the greater your downpayment and the more you can bid to compete with others at your income level. The saver always comes out ahead.

4 EARLYMORN Irvine, CA 92614 kitchen

Irvine Home Address … 4 EARLYMORN Irvine, CA 92614

Resale Home Price … $1,150,000 WTF

Income Requirement ……. $214,077
Downpayment Needed … $230,000

Home Purchase Price … $900,000
Home Purchase Date …. 9/8/2008

Net Gain (Loss) ………. $181,000
Percent Change ………. 27.8%
Annual Appreciation … 13.0%

Monthly Mortgage Payment … $4,995
Monthly Cash Outlays ………… $6,430
Monthly Cost of Ownership … $4,820

Redfin Property Details for 4 EARLYMORN Irvine, CA 92614

Beds 4
Baths 2 full 1 part baths
Size 3,068 sq ft
($375 / sq ft)
Lot Size 6,270 sq ft
Year Built 1980
Days on Market 4
Listing Updated 10/22/2009
MLS Number S593193
Property Type Single Family, Residential
Community Woodbridge
Tract Ld

WOW! If you want Woodbridge, you have to see this home! Right across the street from Meadowpark Elementary, gorgeously upgraded and with an unusually large lot; it really doesn’t get any better than this! With 4 bedrooms, 2.75 bathrooms and a huge bonus room across the top of the 3 car garage, this floor plan is family friendly. The entire downstairs has been remodelled with new front door, gorgeous cherry wood built-ins in living room/dining room, all new kitchen with everything-granite counters, added built-ins in the kitchen nook and all new top-of-the-line stainless steel appliances. All new windows & doors throughout, updated paint colors, this home is move in ready! Add your own private spa in your huge back yard & this one is an all around, hard to beat Woodbridge FIND!!! Serious EQUITY seller has priced this home right at the last sale of a comparable home so don’t procrastinate because this one will go!

Serious equity seller? You mean a delusional flipper who only believes he has equity. Based on when he bought, he would be lucky to get out at breakeven. You never know with today’s market though.

The 2011 Inflation Spike

The Federal Reserve will not be raising interest rates for quite some time. When inflation takes off, I believe they will let it go for a while.

1 Blackswan   Irvine, CA 92604  kitchen

Asking Price: $649,000
Address: 1 Blackswan Irvine, CA 92604

Extreme ways are back again
Extreme places I didn’t know
I broke everything new again
Everything that I’d owned
I threw it out the window; came along
Extreme ways I know will part the colors of my sea
perfect colored me

Extreme ways they help me
They help me out late at night
Extreme places I had gone
That never seen any light
Dirty basements, dirty noise
Dirty places coming through
Extreme worlds alone
Did you ever like it planned?

Extreme Ways — Moby

During the Cold War, we were taught to believe that centrally-planned economies like Communist Russia or China were bad. The Cold War economy in Communist countries was certainly awful, and the Great Leap Forward did cause millions of people to die a preventable death of starvation. The toll a centrally-planned economy takes on its citizens is enormous.

We like to think our economic system is superior here in capitalist America. Capitalism is certainly superior to Communism at delivering goods and services to the populace, and it is unlikely that millions of people will die of starvation during the Great Recession; however, we have our own version of central planning with the Federal Reserve. We do not have a free market, we just have a lesser degree of central planning and regulation than Communism.

We are starting to look more Communist every day:

  • Federal Reserve is holding interest rates far below free-market levels.
  • The US Government through the GSEs and FHA are also holding down mortgage interest rates.
  • The US Government is providing tax credits to buyers to stimulate demand.
  • Private lending outside of Government insured entities has declined dramatically.

Where is the free market? Don’t expect to see its return any time soon.

US Federal Reserve 1913-Present

The Federal Reserve in the US was formed in 1913. It was thought that central control of the currency would provide greater stability to our economic system and soften the extremes of the boom and bust periods the United States endured in the 19th century. The Federal Reserve didn’t prevent the Great Depression; some would argue it didn’t even mitigate the effects and may have even made it worse.

There is one thing the Federal Reserve has accomplished that is not in dispute; since 1913 the Federal Reserve has inflated away about 95% of the value of our currency as evidenced by the Consumer Price Index. Inflation is the theft of savings; it is a stealth tax on everyone. When money loses buying power, wealth loses value.

Consumer Price Index 1913-2009

Price and Wage Inflation

When the Government measures inflation, they use the Consumer Price Index (CPI). The CPI measures the change in price of a representative basket of goods that is supposed to reflect the general level of price change in the whole economy (it isn’t very accurate). It is not measuring money supply (another measure of inflation), economic growth or anything else; the CPI measures changes in consumer prices. So what causes prices to go up?

Prices can rise for many reasons, but there are two I want to examine closely today; currency devaluation and wage increases. If the currency declines in value, foreign goods become more expensive to import, and prices rise. If wages go up, people have more money to bid on goods and services, and prices rise. A wage and price spiral coupled with a devaluation of its currency is a dangerous economic trap. Argentina, Brazil, Chile, and Mexico experienced these conditions in the 1980s, and Argentina experienced another in 1998-2002.

Devaluation of currency has the biggest impact on a population’s standard of living. A decline in foreign buying power means fewer imported goods for consumption. Without increases in wages, people learn to live with less. This is the road we are heading down.


When the credit crunch hit in August 2007, the Federal Reserve responded by lowering the interest rate from 4.75% to 0%. When interest rates first went down, so did the value of our currency. This caused a brief episode of inflation followed by the ravages of deflation due to the losses in the lending industry from The Great Housing Bubble.

The primary cause of deflatioin is the destruction of money through bank losses. When banks lose money, it ceases to exist. Fewer dollars chasing the same amount of goods and services makes for an increase in buying power; deflation. Greater buying power sounds good, but the spectre of a deflationary spiral like the one that caused the Great Depression is very real.

Consumer Price Index September 2004 to August 2009

What Would Ben Do?

Ben Bernanke has written a number of scholarly papers in his life as an academic. He is drawing on this research to weather
this storm in our financial markets. He will likely keep the Federal
Funds Rate as low as he can for as long as he can in order to avoid repeating the mistake policymakers made back in 1937. The Federal Reserve will not raise interest rates in the face of increasing inflation — at least for a while.

If we assume the Federal Reserve will allow inflation to take off — something which it is not supposed to do — then how bad will they let inflation get, and why would they do that?

The first argument the Federal Reserve will make is that the CPI is “behind.” In other words, the deflation we experienced has left the CPI at too low a value. We need inflation to revive the economy with inflation just like we did in 1933. I think this argument is specious, but the Federal Reserve will make it anyway. It is unlikely the FED will be afraid of inflation until well after the crisis passes.

Projected Consumer Price Index 2007-2011

To “catch up” with what inflation should be — at least in the eyes of the Federal Reserve — how high might inflation get?

Projected Inflation Rate 2009-2014

The actual rate of inflation at the peak is anyone’s guess. The Federal Reserve will allow it to go up until long-term inflation expectations begin to rise significantly or until the member banks of the Federal Reserve are solvent again. Solvency should take until the first or second quarter of 2010; if banks earn $250,000,000,000 per quarter, it will take them a year to make the $1,000,000,000,000 is is speculated they lost in total.

Making Up for Deflation

I am projecting a 12% rate of inflation as measured by the CPI in the summer of 2011. It will not peak until the Federal Reserve raised the Federal Funds Rate, and I as I outlined above, that is not going to happen soon. This will lead us to the second argument I believe the Federal Reserve will make; we need to “make up” for deflation.

Since we were behind the desired rate of inflation for so long, the Federal Reserve will justify the high inflation rate by claiming we need to get back to normal levels. This argument is also ridiculous, but it is what I believe the Federal Reserve will sell to us.

The result will be medium-term price inflation.

Projected Consumer Price Index 2007-2014

Long-Term Inflation Expectations

The Federal Reserve does not want to allow the world to believe that they have lost control of inflation again. If long-term inflation expectations become elevated, interest rates will go sky high just like they did in the 1970s. Unfortunately, when Timothy Geithner went to China to make the case that we will not inflate away our debts, the Chinese actually laughed at him. Can you imagine that? A US official has to tell a lie so transparent that the audience actually laughs?

Homedebtors will like inflation because the value of the currency they will be repaying has declined in value. Lenders hate inflation, and so do the wealthy. The Federal Reserve will do everything in its power to control long-term inflation expectations.

Impact of Medium-Term Inflation Spike

High inflation will burn off the mountains of bad debt we created during the Great Housing Bubble. We have a problem of insolvency. The only ways to solve it are (1) to increase people’s ability to pay, or (2) decrease the value of the money repaid. Since wages are not going up in the Great Recession, the value of currency must decline for the insolvency problem to be solved.

The net effect will be a lowering of our standard of living. When inflation is running at 8% and you get a 3% raise at work, your buying power has actually decreased by 5%. It looks like you are getting ahead because your pay increased, but in reality, you are falling behind and your standard of living is declining. The slow erosion of US buying power will be transferred to China as the country develops and local wages move higher there.

Since home prices are linked to wages, high inflation as measured by the CPI will not cause home prices to rise.

Real Estate is not necessarily an Inflation Hedge

The old adage about real estate being a hedge against inflation needs to be refined. Real estate as an asset class is a great hedge against wage inflation but not necessarily against price inflation. Since price inflation can be caused by wage inflation, people do not see that there is a distinction between the two. It is possible to have price inflation without wage inflation — which is what we will see from 2011-2014. When there is price inflation without wage inflation, our standard of living declines.

Government Conspiracy

I find most conspiracy theories to be crazy, but there are times when our Government lies to us, and we feel good about it. Every national recession is greeted with denial until the crisis is past. As a people, we like being lied to; if we didn’t, we would stop electing politicians we know to be liars. There must be a greater good that comes from the nonsense.

For instance, the Warren Commission reported that John F. Kennedy was assassinated by a lone gunman, Lee Harvey Oswald. Many people believe this is not true. Why would the Government lie? Well, let’s assume that JFK was assassinated by a Cuban-led hit squad, and that we learned the truth almost immediately. If the government lets this information out, we would probably have invaded Cuba (rather then embargoing them for 50 years). In the wake of the Cuban Missile Crisis, this would have started World War III. Do you tell the American public a flimsy lie about a President’s death? or do you start WWIII?

When we look back on the actions of the Government and the Federal Reserve in their handling of this crisis — which has either been necessary lies or gross incompetence — some will conclude the lies told by our officials was necessary and appropriate. The general public cannot handle the Truth.

1 Blackswan   Irvine, CA 92604  kitchen

Asking Price: $649,000

Income Requirement: $122,873
Downpayment Needed: $129,800

Purchase Price: $530,100
Purchase Date: 9/4/2009

Net Gain (Loss): $79,960
Percent Change: 22.4%
Annual Appreciation: 390.1%

Address: 1 Blackswan Irvine, CA 92604

Beds 3
Baths 2 baths
Size 1,506 sq ft
($431 / sq ft)
Lot Size 5,100 sq ft
Year Built 1976
Days on Market 7
Listing Updated 9/18/2009
MLS Number P703830
Property Type Single Family, Residential
Community Woodbridge
Tract Pt

This is a beautiful 3 bdrm/2 ba home with all new interior/exterior paint, new carpet, new kitchen appliances and new landscaping. Home is ready for move-in.

Do you wonder what happened to the bigwigs from IndyMac? Some of them have gone into flipping houses…

Real Estate, Cashflow Investment and Retirement

Real estate can and should be a part of your retirement plan, but don’t bank on appreciation. Cashflow is the key.

34 Ardmore Irvine, CA 92602 kitchen

Asking Price: $429,000
Address: 34 Ardmore Irvine, CA 92602

Frank Sinatra

Come fly with me, let’s fly, let’s fly away
If you can use some exotic booze

Once I get you up there where the air is rarefied
We’ll just glide, starry-eyed

Come fly with me, let’s fly, let’s fly
Pack up, let’s fly away!!

Come Fly With Me — Frank Sinatra

Now that the high-flying real estate market of the Great Housing Bubble has crashed, let’s look back to an investment style of yesteryear to provide for retirement. Cashflow investing is the idea that stable inflows of money can be captured and diverted to you for a price. If you accumulate enough cashflow, you can retire.

Stable Sources of Cashflow

In retirement, what determines the amount of money available to enjoy for lifestyle expenses? Is it your wealth? Is it the equity in your home? Not really. It is the stability of the sources of cashflow you control.

Many are obsessed with being rich when what they really want is unlimited spending power. People who have attained great wealth may have amazing spending power, but they seldom use it. If they did, they would not be rich.

Being rich is about forming a habit of saving and consistently spending less than you earn. It is about having the self-discipline to limit your spending voluntarily rather than being forced to by a lender’s credit limit.

You and I work because we need a large amount of stable cashflow to cover personal spending and provide a balance to save. We need to work until we acquire enough assets to provide a stable source of cashflow from another source — our investments.

The quality of our lifestyle and the quantity of our available spending money in retirement is directly related to the sources and stability of cashflow you control and direct. The quantity of money or total net worth is not as important as the ability to convert it to cash.

Cashflow Investments

The problem with asset appreciation as the primary method of funding retirement is that this appreciation must be converted to cash in order to be used. This cash can be obtained through sale or through borrowing. Sale is the cleanest, and it is simple with stocks or other securities that you can sell part of, but houses are different. It is difficult to sell part of your interest in a house. Usually, you will need to borrow the money to stay in your house. This means either a reverse mortgage, or HELOC dependency.

Borrowing money is a bad way to go because you have compound interest working against you. The longer you live, the more you borrow, and the more interest on interest you pay. It is an airplane in a nosedive picking up speed heading to certain doom.

Cashflow investments like (1) dividend stocks, (2) bonds and other debt and (3) real estate are all worthy components of a balanced portfolio. Realistically, few people actually hold stocks or bonds for their cashflow. Most will trade these instruments if only by proxy through a mutual fund.

Real estate is the one cashflow investment that people are more familiar with because we all have homes, even if we rent them. It is also a great cashflow investment. Everyone should consider strategies for owning real estate as part of their retirement savings.

What I am proposing is different than what most people think when they invest speculate in California real estate. It doesn’t matter what it it resells for; appreciation is not important. Buy to obtain maximum future cashflow.

Real Estate as Cashflow

Real estate provides cashflow either through (1) renting the property or (2) living in it and saving the cost of a comparable rental. If you assume most people are putting about one-third of their income toward their housing expense, you see the expense is quite significant. If you own the property with no debt, you can enjoy the benefit of that money for yourself in other ways.

When you look at cashflow rental properties, you want to get the largest possible cashflow for the least amount of money. Don’t focus on appreciation potential unless you want to overpay and dilute the cashflow returns.

If you owned three properties with no debt where each one represented a market rent equal to one-third of your yearly income, you would have a stable income without having a job — other than perhaps property manager… if you want…

The retirement hurdle: own three properties of equal quality to what you rent or own today with no debt.

Living in Retirement

If you look at the fate that awaits us all as seniors, you can see distinct boundaries between the styles of life of various people based on how they lived and how they saved.

There is one group that will save nothing. They will have to chose between working until they die or living on about one-third of their lifetime wage average through Social Security. This is the minimum entitlement in our society as granted in the Social Security Act of 1935.

According to Wikipedia, “… the Social Security program began as a measure to implement “social insurance” during the Great Depression of the 1930s, when poverty rates among senior citizens exceeded 50%.” Social Security is the collective price of societal compassion to its senior citizens. I am glad it’s there.

How well you live above and beyond this minimum entitlement depends on your stable future cashflow from your investment savings.

The conventional wisdom among financial planners is that you need about two-thirds of your work salary as monthly spending to live comfortably in retirement. Social security gets you one of those two-thirds. If you can pay off your primary residence, you get the remainder. Paying off a home and living on Social Security in retirement is still an option in the United States.

Paying off Your Home

Paying off a Home mortgage became passe during the Housing Bubble. People had better things to do with their money than retiring debt. Debt was cheap and abundant; why pay it off under those circumstances? Paying off a house as an investment strategy nearly died. Did anyone keep their conventional mortgages during the bubble?

If you retire debt, you no longer have to service it. For those that keep a revolving credit line at its limit, this is a strange concept, but retiring debt is fundamental to having a stable retirement. Do you want to work and service debt forever? Who is the slave and who is the master?

Paying off your home mortgage removes an enormous financial drain from the family’s balance sheet and greatly improves an income statement; it is an historic measure of success.

Paying off Your Investment Property

If you pay off your home plus one other investment property — like perhaps your starter home — you have more than enough stable cashflow to live comfortably in retirement. (1) Social Security plus (2) a primary residence with no debt and (3) a paid off starter home as an investment equals (=) a prosperous retirement.

It is an old investment strategy to keep a small condo or first-rung property, and it is a good idea if the property is financed with a conventional mortgage. Unfortunately, most people simply used these properties as sources of additional leverage in building their speculative empires.

Remember the Emperor? He levered up and bought 15 properties with hugely negative cashflow and no equity. He will be wiped out. If he had purchased for cashflow, he may have obtained 5 properties up through about 2001, and spent the rest of the housing bubble paying down mortgages. He probably could have owned $3,000,000 in property free-and-clear; instead, he owns $12,000,000 worth of debt and $10,000,000 worth of property — on its way to being $7,000,000. He will be crushed.

When you purchase your first property, it should be near rental parity (at least it will be if you are an IHB reader). Ten years later, that property should have a positive cashflow due to 10 years of escalating rents.

If you keep the property, you can take the excess rent and put it toward the mortgage paying off the debt more quickly. Remember, the goal is to have maximum free cashflow in retirement, so you want to pay off those debts.

Debt equals delayed retirement.


If you (1) save money, (2) acquire assets with maximum cashflow and (3) pay off debts, you will be successful and enjoy a very comfortable retirement. Real estate should not be the only component of your retirement savings plan, but it will be an important one. I hope this provides a way of looking at real estate that benefits you. Cashflow is King.

Your cash is king,Sade
Keep you in my bank.
Your cash is king,
never need to thank.
Your diamond ring,
round and round and round my head.

Wiping all the debt from me.
It’s making my soul sing.
Having the very best of things.
I’m crying out for more.

Your Cash is King — IrvineRenter

34 Ardmore Irvine, CA 92602 kitchen

Asking Price: $429,000

Income Requirement: $107,250
Downpayment Needed: $85,800

Purchase Price: $339,000
Purchase Date: 8/12/2009

Gain (Loss) after 6% Commission: $64,260
Percent Change: 26.5%
Annualized Return: 319%

Address: 34 Ardmore Irvine, CA 92602

Beds: 2
Baths: 2
Sq. Ft.: 1,300
$/Sq. Ft.: $330
Lot Size: –
Property Type: Condominium
Style: Other
Stories: 2
Floor: 1
Year Built: 2000
Community: West Irvine
County: Orange
MLS#: P702480
Source: SoCalMLS
Status: Active
On Redfin: 2 day


Today’s featured property has an interesting history. It stands for everything opposed to the point of my post today. You have an owner who bought for appreciation, converted every penny to cash, and defaulted on his loans to IndyMac which you and I will pay for. Then you have the flipper who stepped in to make a quick buck at our expense.

  • The original owner paid $231,500 back on 6/28/2000.
  • After a series of refinances, he ends up with a $397,500 Option ARM first mortgage, and a $79,500 HELOC.
  • Total property debt is $ 477,000.
  • Total mortgage equity withdrawal of $245,500 plus his downpayment.

He had no problem converting appreciation to cash. Do you think lenders will be that stupid when you want to retire? Are you counting on it?

astute observation

Since so much of today’s post was about real estate investment and success, I want to direct you to John T. Reed’s website. If you have never heard of him before, he is a real estate expert and author whose work I admire greatly. I recently purchased Succeeding, and I enjoy his no-nonsense writing style. Check out his Guru Ratings.

Flippers Are Back!

Our bear rally is bringing out the flippers. Will they turn a quick buck? or will they get stuck with overpriced properties due for another fall?

11 LAURELGLEN   Irvine, CA 92614  kitchen

Asking Price: $875,000

Address: 11 LAURELGLEN Irvine, CA 92614

Remember when you were young, you shone like the sun.
Shine on you crazy diamond.

Come on you target for faraway laughter,
come on you stranger, you legend, you martyr, and shine!
You reached for the secret too soon, you cried for the moon.

Come on you raver, you seer of visions,
come on you painter, you piper, you prisoner, and shine!

Shine On You Crazy Diamond — Pink Floyd

Some people get worked up about property flippers and some do not. Some flippers improve properties and make money through creating value (I am talking about real improvements, not pergraniteel).

Personally, I think flippers who buy properties, do nothing to them, and offer them for sale at higher prices are leaches sucking the value from the housing market. Every penny of profit those flippers make comes at the expense of a normal family that might have save money buying a house. I have reserved a small measure of schadenfreude for these idiots as the market crushes the money out of them.

Yesterday, when I wrote about short sales, I talked about the flippers who are buying at auction. Those flippers are at least providing market liquidity, so there is some value in the service they provide. Flipping an auction property is a profit opportunity even in a declining market because the strategy obtains real estate for under current market value (like today’s featured property).

People who flip in the open market simply rely on increasing prices to make money. Now that our bear market rally is in full motion, flippers are trying their luck again….

It makes me all tingly inside to think about how much some of these flippers are going to lose. And this time, it will be their equity rather than funny-money from the bank.

Are you happy to see flippers active in our market again?

11 LAURELGLEN   Irvine, CA 92614  kitchen

Asking Price: $875,000

Income Requirement: $218,750

Downpayment Needed: $175,000

Purchase Price: $690,000

Purchase Date: 7/27/2009

Address: 11 LAURELGLEN Irvine, CA 92614

Beds: 4
Baths: 3
Sq. Ft.: 2,334
$/Sq. Ft.: $375
Lot Size: 6,500

Sq. Ft.

Property Type: Single Family Residence
Style: Traditional
Stories: 2
Year Built: 1985
Community: Woodbridge
County: Orange
MLS#: S586791
Source: SoCalMLS
Status: Active
On Redfin: 4 days

TurnkeyEquity Seller. This is not a REO or short sale. Corporate Owned.
Turn-key home. Bring your pre-approved buyers and close fast. Great
oppurtunity to get into Landing II, which is one of the most sought
after neighborhoods in Woodbridge. Woodbridge has been named The best
place in America to Raise a Family by Parent’s Magazine and the #1
Planned Community in the Country. Private Cul de Sac location, great
for families. Recent upgrades include casement windows, travetine
flooring,distressed Spanish Hickory hardwood flooring,entertainment
center in family room,custom built child’s bedroom with bunkbed and
cabinets (must see!),plantation shutters,above ground spa (sold in ‘as
is’ condition) recessed lighting,new carpet throughout, new interior
paint. Exterior will be painted prior to close of Escrow.

Corporate Owned? Yes, the corporation you formed to flip properties….


Take a good look at this sales price history. This is a mid-range property in one of the most desirable neighborhoods in Irvine that declined in value during a 6 year period.

Date Event Price
Aug 24, 2009 Listed $875,000
Jul 27, 2009 Sold $690,000
Jul 14, 2003 Sold $722,500

If this property sells for its current asking price, the flipper stands to make $132,500 after a 6% commission. Not a bad deal if you can get it.

BTW, I have a major analysis post on Shadow Inventory coming out tomorrow. Here is a teaser statistic for you: 175,000 Orange County homes will go through foreclosure between 2007 and 2013. That is 40% of the housing stock with a mortgage. I will show you all the calculations tomorrow…