Is There a House in Your Future?

The Coming Real Estate Crash, by John English and Gray Cardiff, New Rochelle, N.Y.: Arlington House, 1979, 192 pp., $12.95.

Beating Inflation with Real Estate, by Kenneth R. Harney, New York: Random House, 1979, 288 pp., $10.

The first question I ask when evaluating predictions of doom is, "What is the source?" Why? Because if a bond broker wrote a book on real estate, I'd expect him to praise bonds and knock real estate. Gray Cardiff and John English are bond brokers. They know nothing about real estate. They know very little about the bond market either—it turns out.

What do they have to say? Essentially, that during the frontier period of American history there were many boom towns that went bust. Many speculators in real estate lost their shirts. This is certainly true. But during the same period, astute real estate investors built up immense personal fortunes. The truth is that in any investment medium, amateurs and ill-informed persons who operate on the "greater fool" theory lose their shirts. Professionals who make deals with some degree of care and knowledge of the market will make a fortune. The "greater fool" theory, by the way, is simply that an investor says, "I don't know a thing about houses, empty lots, gold bullion, cocoa futures [or fill in the blank], but everyone is buying and thus some fool even more foolish than I am will certainly buy me out a higher price." Ben Franklin correctly stated that "a fool and his money are soon parted."

But Cardiff and English predict more than a few fools losing their money. They see a general and national real estate depression that will "not spare the homeowner." What is their remedy? Sell your houses, folks, and use borrowed money to buy long-term treasury bonds yielding 8¾ percent. Wow! The book was written in 1978 and widely distributed in the fall of 1979. By the time it hit the streets, if the authors had followed their own advice, they would have lost 100 percent of their savings. Long-term bond prices had their worst year in a decade, plummeting 30 percent as interest rates went up to all-time highs. Meanwhile, in 1979, house prices in northern California had their greatest single year's appreciation in history, rising about 30 percent.

The real estate speculator who did the opposite of what the authors advised and put 10 percent down on a property had a net appreciation of 300 percent. [Note: a 10 percent down payment on a property appreciating 30 percent gives the leveraged investor a 300 percent return on his money]. Thus the advice, when written, was just about as far from the mark as one could get. It was worse than bad advice; it was atrocious. A highly leveraged well-chosen single-family home or small rental property remains the best investment in times of double-digit inflation.

There is no hint of disaster in Beating Inflation with Real Estate, a 1979 release from Random House, by Kenneth R. Harney. Harney's book is not sensational. It contains no revelations. If it has any faults, they are the failings of the proverbial "good" man or woman—no sex appeal!

Beating Inflation is a good book—a basic primer on how to invest successfully in real property. Harney points out something that Cardiff and English ignore: most of the risk in real estate is assumed by lenders who provide up to 100 percent mortgages on which the astute investor is not personally liable. Uncle Sam, by giving huge tax deductions to real estate investors, helps out and provides investment capital in the form of tax refunds and subsidized loans.

But I get the impression the author acquired his knowledge by reading other books, not by first-hand experience. This is not to suggest that Harney plagiarized—he gives credit to his favorite real estate authors and practically admits that his book is an anthology of the ideas of others. He puts together many techniques used by intelligent real estate investors to make "no money down" deals and to reduce income taxes to zero. He emphasizes that from time to time certain areas are overbuilt. Also, inexperienced investors can be led like sheep to the slaughter by sellers of pie-in-the-sky real estate shelters or speculations. But he correctly indicates that real estate investments made sanely can be fun, can yield 200 percent per year returns, and can be engineered to be excellent tax shelters.

Harney tells us that controlling huge amounts of real property with virtually no investment and no risk—at the same time generating big "paper" losses for tax purposes—is the main appeal of real estate to investors. This point is entirely missed by Cardiff and English. They assume that 95 percent or better financing on many real estate deals today is like the financing of securities speculation just before the 1929 stock market crash. The difference between a 95 percent "margin loan" on stocks and a 95 percent loan on real estate is so obvious that it should require no explanation. But, since both books missed this basic point, you should get it here.

Stock market margin loans are always "call loans." If someone buys $100,000 worth of General Motors and manages to wangle a $95,000 margin loan (which is illegal today), and those stocks go down in value, the lender automatically issues a margin call. This means the investor must come up with immediate cash—or the lender will automatically sell the pledged stock. In the 1929 era, this meant that if hundreds of investors received margin calls on the same day, a wave of selling was automatically triggered until virtually all margined investors were wiped out.

Real estate loans are entirely different: If I borrow $99,000 to purchase a $100,000 duplex with a $1,000 cash down payment, the market value of real estate can go up or down, but it does not affect my loan. I will owe the lender about $1,000 per month (at 12 percent interest), and as long as I come up with my monthly payment, the loan can't be called. Generally, real estate loans are amortized over very long periods—like 25 or 30 years. As a result, in periods of tight credit, there are fewer real estate transactions but none of the violent price swings that happen regularly in the securities markets. For a stock to decline 90 percent in a day is not unusual. For real estate to decline in market value more than 20 percent in a year is almost unheard of—except in the face of unusual disasters like Three Mile Island or the collapse of the main industrial employer in a one company town.

Thus, while a credit crunch might cause a lull in the rising real estate prices we have been experiencing in the last decade, it will not create forced "panic selling" of single-family homes as predicted by Cardiff and English. This kind of selling sometimes happens in the stock market, but the vast majority of small property owners are what the stock brokers call "strong hands." Homeowners are unconcerned with "market prices" until they decide to move. The decision to sell a home is generally made as a result of a job transfer, birth, death, or divorce.

Securities are often bought by speculators who will dump the stock if the price doesn't rise in two weeks. Real estate owners work in a much longer time frame. They will hold investment properties around seven years in order to reap maximum tax benefits. Because of the tax laws, a sale in less than one year is seldom contemplated, and because of the 1031 exchange regulations, real estate investors or speculators seldom pull their funds out of real estate. Why should they, when they can invest the profits from one real estate deal into another without payment of taxes on the profits?

Harney recognizes all these facts and sees no evidence of a coming real estate crash. I agree with him.

Bill Greene is the author of Two Years for Freedom and Welcome to the Tax Revolt.