Patrick Killelea: What Every Homebuyer (and Homeowner) Should Know Now

For many, the collapse of the housing bubble was the trigger that began the era of economic slowdown Americans find themselves mired in.

But recently there have been growing reports in the media of a housing "recovery." So we've invited Patrick Killelea, founder of the popular housing site and author of The Housing Trap: How Buyers Are Captured and Abused and How to Defend Yourself, to clarify the situation.

The short answer is this: While there are some markets where home prices are back in line with both fundamental and historic norms, buyers still need to exert caution when making a purchase.

First, to the reports of "recovery":

Prices at the low end are definitely rising. All measures are showing that. But I don’t like to use the word “recovery,” because it implies there’s something good about rising prices. Rising prices are a kind of inflation. I’d be delighted if reporters would use the correct term and say "housing inflation return." But back to the point, prices are rising at the low end. But it’s not really an organic growth.

What’s happening is that a lot of investors realize two important things. One is that the price of a house in the biggest bubble areas like Phoenix fell well below the price implied by the rental evaluation. So these guys want to make a profit and they realize, if we buy up these houses and rent them out, we’re going to get a better return on our money than we can get anywhere else, especially with interest rates being as low as they are. The return on a rental property, often referred to, as “capitalization rate” can easily be 10% in these areas. And that’s huge. So that drew the attention of not only little investors, but also actually even big hedge funds. Although recently a lot of those have announced that they’re getting out of the game. They seem to have picked over a lot of these places, and there aren’t the deals that there were even a year or two ago.

At the other end of the spectrum are really expensive places like New York City. The crash was very muted, and it was hardly a crash at all. It was a downward trend in pricing. But what that means is, it’s still difficult, or maybe even impossible, to buy property in New York City and rent it out for a profit. You can’t do it. You’ll lose money. So if you were buying there, you’d be betting truly on appreciation that’s not justified by the underlying fundamentals. 

I said that investors realized two things. The other thing investors realized is that they have cash. Ordinary buyers, families, don’t generally have enough cash to buy outright. So that gives the investors a huge advantage, especially since lending is still pretty tight. Even with the low interest rates, it’s still considerably harder to get a mortgage now than it was in the big bubble years, 2004 and 2005.

So I’d say it’s an investor-driven recovery. And that recovery is really only in the places where they had a huge bubble and a huge crash. I’d say that it’s safe to buy in those areas, especially in places where the house is lower than the rental equivalent cost.

Patrick goes on to share the key elements to keep in mind when buying a house, including price-to-rent ratios, leverage limits, construction quality, and diversity of the local economy.

Beyond that, he shares his concerns about how the playing field when buying a home is slanted against the buyer's interests. He warns of numerous tactics the industry employs, most notably information asymmetry, that consumers need to be aware of, including:

There are all kinds of tricks that agents play. I list a lot of them in my book, but it would probably take several more books to cover it all. There is a lot of psychological manipulation of buyers. Agents are used-house salesmen. That sounds harsh, but it’s true. They are kind of like used-car salesmen: they’re not there to provide value; they’re there to get a commission. That’s their goal. And if you don’t buy, they don’t get paid.

A typical trick of theirs would be first taking you around and showing you extremely ugly and overpriced houses. And then they show you the one that they think you’ll buy. Maybe it’s overpriced as well, but not as bad. So you’ve got an anchoring effect, and it makes you a little more susceptible.

There are all kinds of other and evil games that are played. And because the whole housing market is very non-transparent, it’s very hard to pin them down. You don’t have any way of knowing if there are any other offers at all, because you’re not allowed to look at the other offers. You don’t know that they exist. So agents can lie with impunity and say, oh, there are twenty offers, and people just believe it. They think why would the agent lie?

Clearly, they’re not thinking hard enough. The agent has a motive to lie. And if you can’t prove that they’re not lying, the agent has the means, motive, and the opportunity to deceive you for profit. That would be enough to convict them if they were in court. But it’s normal business practice in real estate, so nobody seems to think twice about it. 

And agents and house inspectors often have a cozy relationship. Maybe a little too cozy, where the agent recommends an inspector, and the inspector sort of passively agrees he’s not going to find anything. He gets business from the realtor, and the realtor gets the recommendation that you should buy it. You should really separate those things. Don’t take the realtor's recommendation for an inspector. Find your own inspector, preferably one who has nothing to do with that realtor. 

Patrick also shares insights from his analysis of years of national home purchases. These include: don't sell too often (the transaction costs will kill your returns), don't upgrade too frequently (it's more costly than you think), and it's worth it to transact without an agent if you're able to do so.

Click the play button below to listen to Chris' interview with Patrick Killelea (39m:55s):

This is a companion discussion topic for the original entry at

A rural view of Prop 13.
Prior to Prop 13, farmers in California were being squeezed by high property taxes.  In our area (1.5 hours west of Bay Area), the income a farm generated wasn't enough to cover property taxes.  Without prop 13, many farms would have simply gone out of business. 

The 40 acres west of us have been in 1 family for 3 generation.  The 20 acres south and 20 acres east of us have both been in 1 family for 2 generations.  My wife and I (and our neighbors to the north) both moved in in 1987.  By locking in low property taxes for generations, you reduce turnover and generate community.  Real community.

And the elderly?  They would have been forced to sell their home and move to another state if Prop 13 wasn't enacted.

The Bay Area is very wealthy by rural California standards.  If Prop 13 bothers anyone in this state, you have the option to pay additional property taxes if you choose.



Real Estate = Royal Estate.
You never own it. You rent it from the State. Too much counter-party risk for me. Keep your options open. 

I've got to get back to work on my boat.

CM said: "sounds like business to me", and this is so true.
My opinion: It is preferable to rent than buy in this economy because of the freedom to move at any time. This is a huge chain attached to your life, especially if the economy goes wacko again. I would still wait until the dust really settles. The only asset with regards to a mortgage for me is one where a good piece of land is attached so that you may plant/produce a cash crop to feed yourself. Now is as good a time as any especially if you see yourself living there a long time.

You must not be emotional, do the math, and take advantage of the laws, the system, to benefit you.

There is NO moral hazard to your thinking at all are my thoughts. Remember, you owned a home pre-2008 that is now worth 30 to 40% less and your interest rates are probably in the 5 to 6% range or higher on your original mortgage. That is an injustice that must be dealt with so however you deal with this is a personal matter. Besides, we get back into Recession and property will really find its bottom but will stay there a lot longer than most Folks think because if the trend is part time workers then what bank is going to lend you any cash?

Additionally, I am convinced that there are so many homes held off the market because banks are trying to prop up the prices, and there are so many Folks who will still bankrupt their debt.That this beast has a ways to go before prices truly clear. No question in my mind about this. I believe and can find where I read that 1.2 Trillion dollars have been removed from the liability side of the homeowners budget doing just this. I say, GOOD FOR THEM. That makes me believe that this is just the first wave of this story.

I personally know many GOOD FOLKS who have one member of the family making a very sound wage but one who has lost his/her job or is now hired back part time so that Business can take advantage of controlling its Business costs. They also got slammed by the economy and carry substantial credit card debt that's interest payments have risen very substantially to 12. 14 and even 20% ( or more) because the credit card companies are allowed to charge these rates. These are the same cards that these Good Folks have faithfully paid on time for many years at 3, 4 or 5% interest. Banks or anyone charging these new, higher rates was loan sharking back in the day and people went to jail for this. Not anymore. If you are a bank and have given Good People a credit card then laws don't apply to you.

Even though you still have one stable wage earner in your household if the math says you can bankrupt, you can bankrupt. Lastly, many Folks are paying their debt by cashing in their retirement funds, and they are not aware that bankruptcy protects all retirement accounts and NO ONE can go after your retirement monies so why would anyone do this? Just BUSINESS!

Think of this legal option as transitory. 

Anyways, many of these Folks that I know here in Michigan have bankrupted, eliminating all credit card debt and all the loan shark interest rates. They have bankrupted their property but still live in the home, can live in the home FOREVER if they choose but have gone back to their mortgage company and have negotiated a new interest rate of 3%, have taken a 12 to 15 month rent free savings as they await mitigation with the banks, and have negotiated longer terms which only reduce the costs to their mortgage payments.

Additionally, they have just stopped paying their second mortgage (usually a lien to the 1st mortgage) which then gets charged off so that eliminates their second mortgage costs.

Bottom line, what does this save?

Well, take $25 thousand bucks for credit cards (and most Folks will max the cards out because they are bankrupting) @ 10% interest (average now) and do the math. Then take an average $50 thousand buck second mortgage that is usually higher interests than the 1st mortgage so 7%, and a reduced savings from a 6% interest barring account on a 1st mortgage and reduce that to 3% plus add 10 years to the mortgage because after all you are a renter now. This is like $25,000 a year for the rest of your life! You are debt free Folks and it's just business, and legal. 

You will NEVER get back what you initially signed up for when you mistakenly thought your home was an investment when in fact it is just debt, a money pit.

The next generation of home buyers will make less wage, be part time workers, will have tremendous student loan debt, and will NOT be as secure with their jobs going forward. This beast hasn't found its bottom at all are my thoughts. If anything the risks to banks is greater. The banks only need to park their funds at the Fed earning a gauranteed spread, and the system is now set in quick sand not bedrock.

Folks, you are talking about a serious supplemental wage savings here, and a couple thousand a month that you can walk away from at anytime in the future that will still be protected by bankruptcy court.

The negative is you will probably not be able to buy a home in the next 5 years (so what), you would have eliminated all debt (good deal) and live within your means now (great idea), and you become good consumers again because you have a few extra bucks in your pocket (Fed will love that) and all stress have been removed. PLUS, the system favored you this time, you played the game and legally righted your families ship (Yippee). Everyone is happy. Good deal are my thoughts.

Just one hang up: Recourse-Non-recourse States. Yikes!

Read this and notice who the new hires are and why.

Then read this and understand just what is going on in the Bankruptcy and Mortgage end.

I know for a FACT this is happening and a brief excerpt from the article.

"This couldn't be further from the truth, and to put baseless rumors of this nature to rest once and for all, below we have compiled a simple chart using the NY Fed's own data, showing the total change in mortgage debt, and what portion of it is due to discharges (aka defaults) of 1st and 2nd lien debt. In a nutshell: based on NYFed calculations, there has been $800 billion in mortgage debt deleveraging since the end of 2007. This has been due to $1.2 trillion in discharges (the amount is greater than the total first lien mortgages, due to the increasing use of HELOCs and 2nd lien mortgages before the housing bubble popped)."

…and for balance, and please note how many times the word MIGHT was used:

Respectfully Given



No Sir, now is not a good time to buy are still my thoughts.
We now have the world entering in a contraction, a Recession and probably a pretty serious one. Europe is a mess, China, Japan, Australia, Canada, etc…This will come home to roost on our shores. That in mind, then a pretty severe down turn seems inevitable as everyone begins to seriously protect their own turf.

Recession-Depression, still feel the same. We have had no real economy now since the Fed started pumping and propping, and until we do then a set back is inevitable are my thoughts.

Part time workers in place of full time workers is a situation where it isn't hard to imagine people just getting by. Like sharing a full peanut butter and jelly sandwich among four people. They all live but no one is really full.  Play this out in the real economy and I only imagine a zombie like existence. Better for sure than having half the people starve, and half just a little better feed.

Business must get and stay lean. So if the economy turns then business do not want to lose their best people but still need to trim some muscle now. So they technically will remove hours, and explain to the workers that "I love you Brothers, and we all have to sacrifice here a bit to keep everyone together". That means Business can still get accomplished what they need too but their expenses drop with relations to benefits, unemployment insurance and a whole host of persistent costs that they no longer are required to pay. Wherever business can save a buck they will, and labor is the most expensive costs usually.

Walmart is a great precursor to what labor can expect to face if things get worse.

I just don't see where this will benefit the worker, the consumer. I can see how this would benefit business as more people will still be able to afford the very basics and nothing more. So big ticket items just don't seem to be a long range priority. Most Folks will  just want to make sure they get at least a corner of their sandwich.

Hell, we could get so many people off the government rolls and too work doing jobs that pay the same as food stamps and associated unemployment costs to our government. As I think of this that sounds like a great idea and we should do this. However, what are the unintended consequences of this? That will be another thoughtful muse for later. Socialism?! YUK!

The problem then becomes stagnant to falling wages as hiring and firing is made easier for business so the sheeple plays by the rules.

The problem going to a bank for a mortgage, new car, big ticket item as a part time worker is negative right from the get. Credit will just die on the vine. We are a debt based consumer driven economy, right?

For so many Folks discretionary funds will just not be spent if discretionary funds will even be there for these people. In the Great Depression and the after effects, the consumer was forever changed, and this Great Recession may just have the same effect.

I understand I have really simplified this but I just don't think that the consumer will be all that anxious to spend if given ANOTHER Recession, I just don't. This beast crashed in 2007 and really crashed in 2008. That's 4 years with a possible Recession up next that involves the whole world and we just might end up with a lost generation of consumers. Plus we have a cheap energy problem. The problem, it ain't cheap. 

Good Grief are my conclusions today. I say today because Lord knows Good Grief can really be Holly Cow tomorrow or Whoaaaa Nelly the next day, and at the end of the week, Kaboom!!!

Preparations and resiliency really is a good idea, and should always be our focus and get our undivided attention, EVERY DAY! Like a bonsai tree, a snip here, there…


Bob, you are so correct when you say,

It is preferable to rent than buy in this economy because of the freedom to move at any time. This is a huge chain attached to your life, especially if the economy goes wacko again. I would still wait until the dust really settles. The only asset with regards to a mortgage for me is one where a good piece of land is attached so that you may plant/produce a cash crop to feed yourself. Now is as good a time as any especially if you see yourself living there a long time.
I agree that the deleveraging has a long way to go. And house or apartment is a just place to live. The people, not whether it's rented or bought,  make it a "home."  Budgeting for shelter requires a cool, detached look. Renting makes sense if you want to have flexibility. The only reason I am no longer renting is that I married a man who has a paid-off house (with enough of a yard for a nice kitchen garden.) Oh, and by the way, we are both debt free. My friend Erin (regional manager for our small, community bank) tells me that those in debt are hurting badly while those who have no debt are doing well.

One thing I told Erin was that some banks are donating empty, foreclosed home to the communitiesfor a tax write-off equal to what the mortgage/original value was. Then the community fixes it up and sells it for what it is now worth. Everybody wins.