Is 'default, then rent' the new American Dream - or sign of a bottom?
First, some historical backstory. On Aug. 13, 1979, BusinessWeek ran the now infamous headline "The Death of Equities," proclaiming that "The masses long ago switched from stocks to investments having higher yields and more protection from inflation. Now the pension funds -- the market's last hope -- have won permission to quit stocks and bonds for real estate, futures, gold, and even diamonds. The death of equities looks like an almost permanent condition -- reversible someday, but not soon."
That article marked, almost exactly, the bottom in the stock market -- and the beginning of a 20-year long bull run that would provide investors with the highest rate of return in U.S. history. In other words, the BusinessWeek piece couldn't have been more wrong, but actually offered some value as a contrarian indicator.
Now let's turn to the Wall Street Journal (subscription required) which proclaims -- with eerily similar melodrama -- that "Thanks to a rare confluence of factors -- mortgages that far exceed home values and bargain-basement rents -- a growing number of families are concluding that the new American dream home is a rental." The headline is even more startling: "American Dream 2: Default, Then Rent."
The piece profiles schoolteacher Jana Richey and fireman Jay Fernandez, who defaulted on their mortgage, moved into a cheaper rentals, and are now doing just fine: "Ms. Richey's family of five used some of the money to buy season tickets to Disneyland, and plans to take a Carnival cruise to Mexico in March. Mr. Fernandez takes his girlfriend out to dinner more frequently. Mr. Fernandez says he now has the wherewithal to do things he couldn't when he was stretching to pay the mortgage. He recently went to concerts by Rob Thomas and Mat Kearney. He also kept his black BMW 6 Series coupe, which has payments of about $700 a month."
If the American Dream has now been reduced to letting your house go into foreclosure so that you can drive a BMW with $700 per month payments, then the dream is more of a booze-induced hallucination. But skipping over the temptation to descend into an elegy for morality and work ethic, here's the bottom line: people who don't own real estate are very, very unlikely to accumulate wealth, and people who do own real estate have a much better chance. That's been true since feudal times, and a couple years of mortgage market excess and inflated property values doesn't change that.
Ms. Richey moved into a cheaper rental and bought an $1,800 dining set after sticking the bank with the home she was upside down on. "You take a risk for the American dream," she said. "I don't have to worry about paying property tax, homeowners' insurance, the landscaping, cleaning the pool or any repairs."
But where exactly does she think the money for property taxes, homeowners' insurance, and landscaping is coming from? Renting instead of buying to avoid property taxes and maintenance costs is like eating at restaurants instead of cooking at home so you don't have to worry about food costs.
Back in July, personal finance expert David Bach told me in an interview that the current real estate crisis is "very similar to what happened in the late '80s and early '90s, except this time it's even better. People who bought in 1987 -- in most cases their home wasn't back to what they paid until 1995. But by 2000, it had doubled and in some cases tripled.
I don't know where prices are headed, but all I can tell you is that the fundamentals of why you buy a home have not changed: You have to live somewhere. You can rent it or you can own it. The one thing I know about renting is that ultimately, rents always go up over the long-term. Rents have increased an average of 4% per year over the past 50 years. You own nothing, you have no equity, and the cost of living is increasing. For that reason alone -- protection against rising rents -- buying real estate with fixed-rate mortgages makes sense."
Here are a couple statistics that should help investors and consumers realize just how asinine the notion of renting as the new American dream really is: