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How we cashed in before the housing crash
Our friends said we were crazy. Relatives asked whether we were in financial trouble. But in April 2005, my wife and I bailed out of the American dream. We sold our two-bedroom Pasadena condominium and became renters again.
We got nearly three times what we had paid for the place nine years earlier. It seemed to us like a staggering profit -- and a sign that the market had been pumped up beyond reason.
That's why we decided to rent instead of buying another house right away. We wanted a place with a yard and a third bedroom, but we weren't willing to pay the sky-high price or take out an exotic mortgage to buy something our income did not justify.
So our plan was to take our profit and wait for prices to return to Earth. The madness had to end, we thought.
For a while, we wondered whether we would prove to be the crazy ones as home values in Southern California overall continued rising through last spring. But a closer inspection of real estate sales data shows that signs of trouble were already appearing when we sold.
Condo prices in the ZIP Code where we owned ours peaked a few months after we got out in 2005, at the median price of $480,000 (almost exactly what we got for our place).
But at the time, a lot of people thought we had sold too early. To stay on course, I adopted a personal anthem. It was a Public Enemy song that hit big in 1988 during the previous real estate run-up: "Don't Believe the Hype."
The song played in my head constantly. I heard it whenever friends warned me that I would be missing out on massive future gains. The music's volume went up as real estate agents said that if we stuck to our plan to sell and then rent, we could be priced out of the hot Southern California market for good.
The thumping chorus carried me through: "Don't believe the hype!"
Now that the bubble has burst, my friends think I am a master of market timing. Those who haven't had their financial legs taken out from under them by the real estate crash are asking when they should buy investment properties to ride the next big wave of rapid appreciation.
As always, there's more to the story.
Though I would like to claim special powers to read the future, I was really just resisting the market mania of the time.
The tech stock bubble was fresh in my mind, as was the early-1990s real estate boom. At the height of our most recent real estate run-up, there was constant talk of new reasons the market would not fall: immigrants, endless demand for scarce land in sunny Southern California and so on.
It all sounded to me like the Florida real estate boom chronicled by economist John Kenneth Galbraith: the boom of 1928.
The Florida run-up, Galbraith wrote, contained "the indispensable element of substance." He meant Florida's obvious appeal as a sunny destination, much like that of Southern California.
Yet on top of that substance, real estate prices in Florida accelerated to the point that people depended on those gains to support their spending.
A similar phenomenon happened here. I saw friends with otherwise good judgment buying houses they couldn't afford, confident that they could refinance when their home values went up by double-digit annual rates. Others used home equity to pay for fancy cars, meals, vacations and other things that would never return any value.
Of the 1920s Florida bubble, Galbraith wrote, "People want an excuse to believe" in the boom and can't be persuaded by evidence to the contrary. This is what I saw in Southern California in 2005.
The idea of an ever-rising real estate market was a favorite topic in much of the news media. A Los Angeles Times Sunday magazine cover in November 2003 carried this headline: "Will L.A.'s Real Estate Bubble Burst? No, Because There Isn't One. There's Just Too Much Demand, Not Enough Supply and No Room to Build. None of That Will Change."
Reading those words, I thought of Galbraith, and those people in 1928 wanting an excuse to believe.
Legend has it that smart money on Wall Street knew the stock market was headed for a crash in 1929 when shoeshine boys started giving stock tips. I sensed trouble when a homeless man told me he was studying for his real estate license.
When we held our one open house, the frenzied strangers who poured into our living room only deepened my sense that reason had given way to something like mania. But even if I had picked up some of their exuberance and doubted myself, there was no time to reconsider. The place sold in a week -- to a corporate economist -- while repairs were still underway, including one job that left a 3-foot-wide hole in a ceiling.
I wondered what it would have taken to deter those eager buyers. Asbestos? Rats?
By the time the excited throngs cleared at the end of the first day, I no longer doubted my belief that the bubble was about to burst.
Reading the signs
About the time I was getting out of the market, Mark Kiesel was thinking about unloading his Newport Beach house. An executive vice president of the Pimco investment firm, Kiesel's day job involved studying the housing market.
He didn't like what he saw. "Basically, prices were inflated by incredibly cheap financing," Kiesel said. He believed that credit would eventually tighten, which would lead to a rising inventory of houses for sale and fewer people able or willing to buy.
Kiesel had bought his house in 2004 with a 4.25% mortgage rate. "When people are giving you a free lunch, you should question it. I knew the person who loaned me money at that rate was crazy," he said. "That's why it had to stop."
So in the summer of 2006, Kiesel sold his house -- netting a 20% return on his investment -- and moved into a three-bedroom apartment with one-fifth the square footage of the house. He and his wife, a lawyer, invested their proceeds in energy, metals and mining stocks.
Kiesel said they roughly doubled their money with those investments.
They are still renting the apartment, putting up with less space and keeping many of their belongings in storage. Kiesel said he would not buy a house until 2009 or 2010, when he thinks the market will turn around.
I'm still renting too, but unlike Kiesel, I'm an amateur when it comes to investing money. Our proceeds have been in certificates of deposit while we wait to dive into homeownership again.
As a general rule, financial planners don't advise people to sell their house at a profit and invest in stocks or mutual funds.
"We tell people don't try to time the market," said Laura Tarbox, a financial consultant in Newport Beach. "When you factor in the transaction costs of the sale, plus the [mortgage] tax benefits, it's rarely worth it -- and you still have to have a place to live."
To determine whether we made a smart decision, I asked Tarbox and her staff to run the numbers through a couple of scenarios. Would we be better off now if we had simply kept the condo?
Alternatively, what if we had bought a house right away after selling?
Tarbox confirmed that we came out ahead by selling when we did because our condo dropped in value by about 5% in the two years after we sold. But our timing was extremely lucky, she said, and there are costs that eat into the windfall.
Indeed, though we made a healthy profit on the sale of our home, we've had to pay rent for the last two years and have not had a mortgage interest deduction. And when we buy a new home, we'll have lost the Proposition 13 property tax advantage -- meaning bigger tax bills.
We don't know how much bigger, however, because we don't know what we'll pay for our new house. But had we stayed in the condo, we would also have paid about $14,500 in property taxes and homeowner's fees over the last two years -- money we could have potentially invested.
So in the end, Tarbox said, we came out well ahead.
We also did well by not buying right away. Since we sold in 2005, the median home price in Southern California has fallen about 9%, according to DataQuick Information Systems.
That's a broad figure, but we have an example close to home that is even more on point. One Pasadena house we've had our eye on just happened to sell for $888,000 right after we closed our condo deal in 2005.
It was repossessed and sold again by the bank for $720,000 in September -- a 19% decline.
So had we bought that house, our investment would in theory have declined by 19%. Instead, we earned about 4% on our money in CDs.
Any profit, however, must also be weighed against the intangible cost of living in a less-than-ideal rental house, one without air conditioning or a dishwasher and located an additional 20 minutes from my office. I'm pleased with our decision but suspect that many would not want to pay that price.
Kiesel likewise doesn't recommend that others follow the move he and his wife made.
"I wouldn't advise it at all," he said. "We were willing to sacrifice our living standards to make some money; not everyone should do that."
That advice also makes sense if you put it this way: People shouldn't expect to make money without sacrifice.
I've always been wary of getting something for nothing, and that's what made me so dubious about our latest real estate bubble. Too many people expected to get a bigger, better house without first earning more money. They expected to be able to buy more things by borrowing against their home equity, not by working to boost their incomes or saving.
Many of the people who are struggling to make their house payments were duped by commission-chasing mortgage brokers who put them in loans they couldn't afford. But it's also true that many of the borrowers who are in trouble knew they couldn't make the payments and were counting on rising home values to make up for any shortfalls.
As I thought through my own experience, I realized how much of a role values played in my own real estate decisions. Memories ultimately mattered more than math.
When I was a child, my mother moonlighted at department stores in December to earn extra money for Christmas gifts, and I remember parents of many of my friends doing the same. It never occurred to them to put everything on credit cards and worry about the consequences later.
I remembered moving as a young child to our first house in the suburbs after living in a couple of drab city apartments. The dirt pile that would soon become our lawn was a thrilling sight. I recalled a friend at work telling me that his family put their spare change in a cigar box for years, saving together as a family for the house they would eventually buy.
I wanted my own daughter to feel that same appreciation for our first house.
We do plan to buy again someday, on honest terms with a loan we can afford. We didn't expect to rent this long; our girl is 8, and we'd like to get into a house soon that she will truly feel is hers.
We know the wait will make it that much more thrilling to her when we move. But I hope the real reward comes years from now. Maybe she will remember our experience and think twice when people are again promising something for nothing, as they inevitably will.
That lesson could be more durable than all the granite counter tops, copper pipes and oak floors in the dream houses peddled in the bubble.