Thursday, October 18, 2007

Bottom-Fishing Fallacies

As housing prices fall, a siren song of hope lures bottom-fishers to bid on foreclosed or distressed properties. Here are three reasons to be cautious.

1. Catching the falling knife is risky. In the stock market, buying a stock which is in a downtrend is called "catching the falling knife." The idea is rather graphic: the only safe way to catch a falling knife is to let it hit the floor and stop quivering. Trying to catch it as it falls (i.e. catching the bottom) usually results in painful financial wounds.

That isn't stopping folks from trying, of course: Big winners, losers at auction of new Manteca homes (San Jose Mercury News)

"Cantrell bought his home a year ago for $670,000, The winning bidder Saturday of an identical home five doors down the street paid $391,000 - 38 percent less than what he paid."

Ouch. But the unspoken question should be: who says a 38% decline is the bottom? There are plenty of people with a strong financial incentive to convince you "this is the bottom": realtors, of course, and underwater lenders hoping to find a sucker:Realtor specializes in selling foreclosed homes. (S.F. Chronicle)

With headlines like this in every bubble state's newspapers, can you really be confident "this is the bottom"? Using what crystal ball? MORTGAGE MELTDOWN: NEIGHBORHOODS CRUMBLE IN WAVE OF FORECLOSURES
LOCAL TROUBLE ZONES: Epidemic repossessions hit several ZIP codes (S.F. Chronicle)

State's housing market agony predicted to deepen next year
Sales and prices will plunge even further after worse-than-expected '07, Realtors say (S.F. Chronicle)

2. That "deal" might be a money pit. Take a look at these typical foreclosed or distressed houses up for sale to get an idea of the expense required to "clean them up for sale or rent:"

Or consider this REO ("real estate owned" by a bank or lender) special, on sale now for only $470,000 in a neighborhood where livable houses are already selling for under $500,000:

Please go to to see the photos.

Before you bid on a beauty like this, assuming you can "clean up the pool and yard for a few thousand bucks," I strongly recommend going over the property with a fine-tooth comb with an experienced contractor. A yard of dead weeds can be cleaned up, yes, but it won't be transformed into a lush attractive yard without major expense. Ditto an abandoned pool, etc.

How is the plumbing? Did an angry ex-owner bust a few things on the way out? Or flush a clog down the main line? Even repairing broken fixtures, appliances, screen doors, etc., plus "cosmetic" painting can cost tens of thousands. If you don't believe me, just ask any working remodeling contractor in your neck of the woods.

3. Your low bid just sank the value of the entire neighborhood--including the house you just bought. The bottom-fisher has just played a terribly expensive trick on themselves: they bought a house whose "bargain status" is based on the "old value" of a year ago. But oops, the "new price" is what the bottom-fisher just paid.

In other words, the house that sold for $600,000 last year which was just bought at auction for $450,000 is not worth $600,000 once it's returned to liveable status--it's worth $450,000, and putting $50,000 in repairs into it is going to raise the value to about $455,000. No matter how much money is dumped into the house, it's still only worth the last price paid for a liveable/rentable house in the neighborhood.

Net result: the bottom-fisher just accelerated the knife's fall. Now the "real bargain" house has to priced well under $450,000... until next year, when the "real bargain" will be under $350,000... and so on, until the knife hits the floor and stops quivering--which based on previous declines in housing values (1990-1996) will be about 2012.

Thank you, Eugenie D., ($25.00) for your very generous donation to this humble site. I am greatly honored by your support and readership. All contributors are listed below in acknowledgement of my gratitude.

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