·
Most
homes in normal markets appreciate 4-5% per year
·
Robert Shiller showed that
inflation adjusted
·
A drop in mortgage interest rates reduces the cost of
borrowing and usually results in an increase in house prices; a rise in
interest rates usually slows the housing market
U.S. Real
Estate Bubble: 2001-2005
·
Between 1997 and 2006, American home prices increased by
124%, way above their long-term average.
o 2004-2005:
Arizona, California, Florida, Hawaii, and Nevada record price increases in
excess of 25% per year.
·
From 2001 to 2006, loans secured by real estate were up 76% to
$4.51 trillion, residential mortgages up 58% to $2.18 trillion, commercial real
estate loans rose 59% to $904 billion, and home equity loans were up 203% to
$559 billion.
·
Former Federal Reserve Chairman Alan Greenspan said in
mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing
market) … it's hard not to see that there are a lot of local bubbles."
Causes
·
Low interest rates and large capital inflows from outside
the U.S. result in easy credit
o During
the 2001–2002 recession, the Federal Reserve cut
short-term interest rates from 6.5% to 1%, where it remained until 2004.
o The
interest rate on 30-year fixed-rate mortgages fell from 7.5% to 5.5%. The
interest rate on one-year adjustable rate mortgages fell 3 from 7% to 4%.
·
Several economists have argued that the stock market
crash in 2000 resulted in many people taking their money out of the stock
market and purchasing real estate, which many believed to be a more reliable
investment
·
Subprime borrowing
was a major contributor to an increase in home ownership rates and the demand
for housing.
o
The U.S. home ownership rate increased from
64 percent in 1994 (about where it was since 1980) to a peak in 2004 with
an all time high of 69.2 percent
o
1977: Community Reinvestment Act passed to require banks and savings
and loan associations to offer credit lower income individuals and small
businesses
o
1995: U.S. President Bill Clinton strengthens Community
Reinvestment Act regulations to require banks to loan to, and Freddie Mac and
Fannie Mae to buy mortgages of, even less qualified borrowers
o
2005: President G.W. Bush administration changes Community
Reinvestment Act regulations effectively permitting smaller lenders to reduce
loans to less qualified borrowers
·
The use of adjustable rate mortgages, interest-only
mortgages, and "stated income" loans (also known as "liar
loans") to finance home purchases between 2001 and 2005 grew.
o One
million borrowers took out $466 billion in option ARMs in 2004 through the
second quarter of 2006
·
The demand for mortgages to be made into mortgage-backed
securities increased dramatically, as fees were passed from the investment
banks to the lenders to the mortgage brokers
o The
securitized share of subprime mortgages (i.e., those passed to third-party
investors) increased from 54% in 2001, to 75% in 2006
·
Homeowners used the increased property value to refinance
their homes with lower interest rates and take out second mortgages or Home
Equity Lines of Credits (HELOC) to fund for consumer spending, fueling the broader
economy.
·
Purchase of real estate for investment purposes grew
because of easy credit.
o
During 2006, 22% of homes purchased (1.65 million units)
were for investment purposes, with an additional 14% (1.07 million units)
purchased as vacation homes. During 2005, these figures were 28% and 12%,
respectively. In other words, nearly 40% of home purchases (record levels) were
not primary residences.
o
In late 2005 and into 2006, there were an abundance of
television programs and books promoting real estate investment and flipping.
o
One company estimated that as many as 85% of condominium
properties purchased in Miami were for investment purposes.
·
The Economist magazine said that "the
worldwide rise in house prices is the biggest bubble in history," so any
explanation must consider global causes as well as those specific to the United
States.
U.S. Housing Correction, 2006-
·
Based on markedly declining 2006 market data, including
lower sales, rising inventories, falling median prices, and increased
foreclosure rates, some economists have concluded that the correction in the
U.S. housing market began in 2006.
o Sales of
new homes dropped by 26.4% in 2007 versus the prior year.
o According
to the S&P/Case-Shiller price index, by May 2008 average
U.S. housing prices had fallen 18.4% from their Q2 2006 peak.
o By
January 2008, the inventory of unsold new homes stood at 9.8 months, the
highest level since 1981.
o A record of nearly four million unsold existing homes were for sale,
including nearly 2.9 million that were vacant.
o National foreclosure
filings were up 47% from 2006
·
Causes:
o Between
2004 and 2006, the Fed raised interest rates from 1% to 5.25%
§ As interest
rates rose, ARMs reset higher. Higher monthly payments lead to increasing
defaults, particularly among subprime borrowers.
o Overbuilding
during the boom period led to a surplus inventory of homes, causing home prices
to decline beginning in the summer of 2006.
o Once
housing prices started depreciating, refinancing became more difficult. Some
homeowners were unable to re-finance and began to default on loans as their
loans reset to higher interest rates and payment amounts
o Foreclosures further
depress house prices.
·
There are a lot of parallels between America’s housing boom and
Japan's. The national average home price in
·
Chief economist Mark Zandi of
Moody's predicted a "crash" of double-digit depreciation in some
·
Results in the 2008 Financial Crisis
Government Sponsored Entities (GSEs) –
Fannie Mae/Freddie Mac
·
1968
Government mortgage-related agencies Freddie Mac and Fannie Mae are converted
to private corporations
·
1977: Community
Reinvestment Act passed to require banks and savings and loan associations to
offer credit lower income individuals and small businesses
·
1995: U.S.
President Bill Clinton strengthens Community Reinvestment Act regulations to
require banks to loan to, and Freddie Mac and Fannie Mae to buy mortgages of,
even less qualified borrowers Fannie Mae and Freddie Mac began receiving
affordable housing credit for purchasing mortgage bank securities which
included loans to low income borrowers, including subprime securities.
·
As of November 2007 Fannie Mae a held a total of $55.9
billion of subprime securities and $324.7 billion of Alt-A securities in their
portfolios. As of the 2008Q2 Freddie Mac had $190 billion in Alt-A mortgages.
Together they have more than half of the $1 trillion of Alt-A mortgages.
·
Gerald P. O'Driscoll former
vice president at the Federal Reserve Bank of Dallas stated that Fannie Mae and
Freddie Mac had become classic examples of crony capitalism. Government backing
let Fannie and Freddie dominate the
mortgage-underwriting. "The politicians created the mortgage giants, which
then returned some of the profits to the pols -
sometimes directly, as campaign funds; sometimes as "contributions"
to favored constituents." [77]
·
In 2006, Freddie Mac was fined $3.8 million, by far the
largest amount ever assessed by the Federal Election Commission, as a result of
illegal campaign contributions. Much of the illegal fund raising
benefited members of the House Committee on Financial Services.
·
Some lawmakers received favorable treatment from
financial institutions involved in the subprime industry. (See Countrywide financial political loan scandal). In
June 2008 Conde Nast
Portfolio reported that numerous Washington, DC politicians over
recent years had received mortgage financing at noncompetitive rates at Countrywide
Financial because the corporation considered for the officeholders
under a program called "FOA's"--"Friends of Angelo". Angelo
being Countrywide's Chief Executive Angelo Mozilo. [79] On 18
June 2008, a Congressional ethics panel started examining allegations that
chairman of the Senate
Banking Committee, Christopher Dodd (D-CT),
and the chairman of the Senate
Budget Committee, Kent Conrad (D-ND) received preferential loans by troubled mortgage
lender Countrywide
Financial Corp. [80] Two
former CEO of Fannie Mae Franklin Raines and James A.
Johnson also received preferential loans from the troubled
mortgage lender. Fannie Mae was the biggest buyer of Countrywide's mortgages
Real
Estate Taxes
·
Principle Residence: First $250,000 (or $500,000 for joint
owners) of profit on sale of a property is tax free if it has been your
principle residence for at least 2 of the last 5 years
·
Mortgage
interest deduction
o $250K for individual, $500K for married
o Law changed in the late 1990s –
started housing boom
·
Price
appreciation can be accessed in a number of ways: (1) Sell the property and
take out the gains. Disadvantages are: Pay tax on the gains (and lose cash flow
if it’s a rental). (2) 1031 exchange
Advantage: Defer the current taxes. Disadvantage: ultimately have reduced
depreciation as the depreciable basis of the first property rolls into the
second. (3) Keep the first property and borrow out the equity through either a
new loan or a second mortgage. Advantages: Keep the property. The cash is
tax-free.
·
Depreciation: A residence is depreciated over 27.5
years and a commercial building over 39 years. No depreciation is allowed for
land.
o
A
good rule of thumb is that you will be able to take a deduction for 4 percent
of the full value of the real estate if you maximize depreciation. That
depreciation first offsets against the income of the property.
o
The
accelerated depreciation method means that you front-end-load your deprecation.
After about five years, the amount of depreciation will be reduced. You need to
buy more real estate at least every five years to replenish your depreciation
basis.
·
Billions
of dollars were lost on real estate after the 1986 Tax Reform Act when the government stopped allowing tax breaks
for passive real estate losses. In other words, the government would subsidize
the difference between rental income and rental expenses, which were higher.
After the tax law change, the stock market crashed, savings and loans went
broke, and a huge transfer of wealth occurred between 1987 and 1995. That
single tax law change forced millions of people out of investing in real estate
and into the stock market.
·
Any
time that you are actively working on a property - fixing it up, managing it,
maintaining the property, etc., the income is taxed the same way as a salary
would be. That makes operating through an LLC unsuitable, as all active income
in an LLC is subject to a 15.3% self-employment tax in addition to regular
income tax. You'd get a better tax deal operating through an S Corporation, or
having your LLC taxed as an S Corporation, so you could split your income and
avoid the self-employment tax hit on at least half of your profits.
·
For
rental income to be considered passive under IRS regulations, it must be
generated without the property owner making much effort or incurring
significant expenses to create that income. (i.e. when
you don't do anything beyond receiving a check from the tenants). If you
operated a rental property through an S Corporation, or an LLC taxed like an S
Corporation though, you would now lose out on some tax benefits. That's because
the S Corporation requires you to take a salary (with resulting payroll taxes)
on at least part of your income. Where passive income is concerned an LLC is a
great choice, because passive income isn't subject to self-employment tax at
all.
·
The
1031 exchange (or Starker
exchange) is a real estate like-kind exchange that avoids taxes.
o
The
real estate must have been held for business or investment, not your personal
residence.
o
The
second piece of property merely has to be another piece of investment real
estate property – it does not need to be exactly the same kind of property.
o
You
must declare three possible choices for the exchange within 45 days and you
must close on the replacement property within 180 days. You need to invest all
of the cash from the sale into the next property, and the next property must be
purchased for at least as much as the sale price of the first property.
o
An
exchange accommodator is someone who only handles property exchanges – not your accountant or lawyer
o
While you can’t exchange an investment
property for an interest in a partnership even if the partnership owns real
estate, you can exchange an investment property for a group ownership property
if the property is held as tenants-in-common.
o
Disadvantage:
reduced depreciation as the depreciable basis of the first property rolls into
the second.
Purchasing Real Estate
·
Home
insurance:
actual-cost vs replacement-cost; HO-1 through 7
·
Interest only loans maximize tax benefits. Interest is
fully deductible, while an amortizing loan payment, with principal and interest
both, is only partially deductible. They increase risk, however.
·
Timeshares: Most recommend buying timeshares on
the secondary market – not the original offer from the developer. Most of the
value of a timeshare is lost immediately after the purchase.
Selling Real Estate
·
Several
websites give free estimates of a home’s value: Zillow
(www.zillow.com), RealEstate.com,
RealEstateABC.com and Reply.com
o The Wall Street Journal found the
median difference between the Zillow estimate and the
actual price was 7.8%. One-third were within 5%, but less than 1% were off by
50%
Real Estate Law
Title
·
Allodial title is a
where real property is owned free and clear of any encumbrances and is
inalienable, in that it cannot be taken by any operation of law for any reason
whatsoever.
o
True allodial title is rare,
with most property ownership in the common law world —primarily, the
o
Allodial title is
used to distinguish absolute ownership of land by individuals from feudal
ownership, where property ownership is dependent on relationship to a lord or
the sovereign
o
Land is said to be "held of the Crown" in
o
In the
o
Before 1774, all land in the American colonies could also
be traced to royal grants, usually one grant creating each colony. The original
grantee then sold or granted parcels of land within their grant to private citizens.
The Treaty of Paris (1783) ended any residual rights held by the original
grantees or the Crown. Some states created a form of allodial
title while others retained the tenurial system with
the state as the new ultimate landholder.
o
Apart from land that was formally owned at the time of
the Revolutionary War, most American landholders can trace their title back to
grants by the federal or state governments of land obtained by purchase
(Louisiana Purchase, Florida, Alaska), treaty (the Ohio Valley, New Mexico,
Arizona, and California), or annexation (Texas, Hawaii).
o
Previous grants prior to those territories becoming
o
The government can compel the sale of privately owned
real property for public benefit by eminent domain laws
o
The right to tax real estate is preserved in the
Constitution though it is a right reserved for the states.
o
Schemes to obtain allodial
title usually advise property owners to file a deed of allodial
title with the local registry office, or to publish a notice of allodial title in a local newspaper. However, neither method is recognized by
o
Two states,
o
Other institutional property ownership can also be called
allodial, in that property granted for certain uses
is held absolutely and cannot be alienated. For example, universities and
colleges that hold property for educational purposes can be described as having
allodial title. In most states, property held by
churches for the purpose of worship also has status similar to allodial title. American Indian reservations also share
some similarity with allodial title. However, in all
these cases, it is also clear that if the title ceases to be used for the
purposes for which it was granted, it reverts to the state or the federal
government.
o
Although allodial title cannot
be lost in most circumstances, that also means that it cannot be transferred or
encumbered without losing its allodial status. As
such, when a property owner dies and leaves ownership to more than one heir,
the allodial status of the property is lost. Allodial title cannot be mortgaged. Moreover, as liens
can't attach to allodial title, it is difficult to
finance improvements to a property held in allodial
title
·
Equitable
Title: As late as the Tudor period, in order to avoid estate
taxes, a legal loophole was exploited where land was willed to a trustee for
the use of the beneficiary. However, trustees often abused this privilege, and
heirs found that the courts of common law would refuse to recognize the
"use" clause, and would instead grant title in law to the trustee.
However, the courts of equity, which were developed by the sovereign to deal
with obvious injustices in the common law courts, ruled that the heirs were
entitled to the use of the property, and gave them title in equity. As rulings of
equity courts ranked above those of common law courts, this gave heirs the use
of the land, but not title to it in the common law. However, this distinction
between common law and equity title helped develop forms of security based on
the distinction, now known as the mortgage. Enjoyment of the property during
the period where the mortgage was in good standing could be assured through the
equity courts, while the right to foreclose on the property to merge the common
law and equity title were guaranteed in the common law courts
·
Until the 18th century, almost all common law property
ownership depended on proving a link of possession from a royal grant of title
to the property owner. Although the feudal system was rapidly disappearing from
o
Proving ownership in absence of the documents was an impossibility, and forgeries of crown grants were common
and difficult to detect. Moreover, it was nearly impossible to determine if
land was subject to common law encumbrances (i.e. mortgages). This led to the
establishment in the 18th century of land registry systems, where a central
office in each county was responsible for the filing of land deed, mortgages,
liens and other evidence of ownership, transfer or encumbrance. Under land
registry, deeds and charges were not recognized unless they were filed, and
persons who filed were given priority over previous transactions that had not
been filed. Moreover, under statutes of limitation, only documents that had
been filed in the past 40 years had to be consulted to determine the chain of
ownership.
·
Fee simple refers to the interest
that a person can have in a parcel of land. The holder of a fee simple has
ownership with powers of disposition during the owner's life, and upon death
the property descends to the owner's designated heirs
Land-Use Control
·
Land-use
is mostly controlled at state and local level.
Federal direct control is only on federal land, but indirect control is
through stipulations on disbursement of federal funds to local governments and
though environmental laws such as wetland protection.
·
States’
powers are derived from police powers
and eminent domain
·
Police
power: states enact
laws to promote health, safety, and welfare
o Few states control land use at the
state level, e.g.
o Local governments receive enabling legislation from the states to
enact general plans, zoning laws, subdivision regulations, and
growth-management ordinances
o Zoning
laws consist of a
zoning map and zoning ordinances, which include:
§ Use restrictions: commercial,
residential, industrial, agricultural. Also residential density, heavy or light
activity
§ Structural restrictions (bulk
regulations): floor-size, lot-size, setbacks, height, architectural review,
historic areas
§ Zoning variances: to be granted in general, it