FREE RENT? MODEST GAINS? HUGE PROFITS!

IT IS EASY TO FEEL WEATHY IF YOU ARE BEING PAID TO LIVE IN YOUR HOUSE!

A recent article talked about 4 year housing gains pushing 7.5%. The article said that homeowners feel wealthy because of the gains in value of their homes. The big gaping hole in the article was its failure to mention the leverage factor.

In recent years, boomer after boomer has traded up to the "big house". This was made possible by the historically low interest rates. In 1965 my parents had a large 4 bedroom 4 bath house built on 20 acres of land. My parents were born right in the middle of the Bob Hope generation baby boom. Dad was 45 years old in 1965, almost the exact peak age for trading up. The youngest of the baby boomers bore after WWII will turn 46 this year--the peak year for trading up. The reason Mom and Dad were able to trade up in 1965 was because interest rates were low. The mortgage on their home was locked-in at 5%.

The boomers that traded up 4 years ago have done well.

Down Payment; $100,000
Mortgage; $400,000
Total Initial House Value; $500,000
Interest rate on mortgage; 5%
Annual interest cost; $20,000 (less than the annual rent on a $500,000 house).
Average annual appreciation in value; 7.5%
Average annual gain in value; $37,500 (actually more because of compounding and timing)
Gain in 4 years; $150,000
Return on Equity over four years: 150%!

Yep, folks have been "paid" $150,000 on a $100,000 investment while enjoying owning the "big house". Many of those who did not trade-up are jealous--can you blame them.

Here are the numbers for the family that stayed in the "little house".

Little house value 4 years ago; $180,000.
Mortgage balance; $80,000
Monthly payment $1,500 (only a few hundred less than the big house payment)
Average annual gain in value; $13,500
Gain in 4 years $54,000
Return on Equity over four years 54%.

Is there any wonder that folks are moving up! The fellow who moved up four years ago has made $96,000 more than the fellow who stayed put.

The rest of the story is that many of the older baby boomers bought a second home and experienced an average annual appreciation of 13.5%.

On a $500,000 second home, the gain in four years has been in the range of $270,000 or a return on equity of 270%. These kinds of gains do create excitement. There are millions of other baby boomers who have not bought a second home. Many more will.

Sooner or later, supply will catch up with demand. This does not mean there will be drop in the price of houses. The annual depreciation will surely flatten. In the mean time, don't get too excited about the bubble bursting.

Ken Fisher has been my favorite "market guru" for decades. He says the housing bubble cannot be a bubble as long as all the pundits are talking about it. He is right. The talk has slowed the rate of increase and dampened the speculative buying. However, the talk has not quenched the demand. Boomers have made money in their real estate and are ready to buy more. After a slow summer, I expect resort properties to be hot again this fall and next spring. If you are planning to buy a second home, you should do so as soon as possible. The leverage involved can help produce extraordinary returns on equity. Don't buy unless you are prepared to make the mortgage payment in good times and bad for the next 10 years or unless you are speculating on being able to sell at a nice profit in just a year or two.

BUY THE BULL! THE BIG BOOM BUBBLE IS BEING DRIVEN BY THE PEAK SPENDING YEARS OF THE BABY BOOMERS.