Addiction to Prediction?

Helpful if unsettling January 3, 2012 blog post on the Process Maximus  blog site by Robert Speck that reflected what we can predict with high probability: more predictions about the future, many of which are wrong and soon forgotten and forgiven  as we move onto the next .

While I recommend the full article you may find the conclusion a most helpful summary:

Question Authority

Prediction should be all about risk, uncertainty, and likelihood, but what you’ll hear this week and throughout the year is a chorus of experts telling you with great certainty what the future will bring. Don’t believe them. If you’re jonesing for advice, try listening to those who are providing detail on probability, risk and trends. But know that the future is never about certainty and always about probability. When prognosticators get it right, they were just plain lucky. They may have played the odds. They may have had some truly intuitive insight that others did not. But there is never a sure thing.

Deflating the Home Price Bubble: Where Might We Be?

A fairly simple way to assess the value of the housing market is to look at the price-to-rent ratio. This metric equates the median home price to what an equivalent property would yield in rent (known as owners’ equivalent rent). As is evident from calculations based on national and regional median prices and rents, this metric appears returned to levels last seen in the early 2000s, which means that in some markets buying is again looking like a reasonable option. A corollary to this, rental properties in select markets may have become attractive investment opportunities for some individuals with the capacity and means to invest and borrow inexpensively.

The run-up to the 2005/2006 peak certainly showed signs of a bubble in the making, as property values significantly outpaced rental prices during that period. In many markets prices were well higher than 20 times annual rent, a benchmark that many seem to see as an indication of overpricing.

Example: a home selling for $800,000 should have been renting for ~$3,500/month. This would have been a ratio of:

                           $800,000/$42,000 = 19

($3,500 x 12 months/year = $42,000 in annual rent)

We should also consider that the current wisdom finds 20 to 1 as the tipping point for the Buy vs. Rent decision.  While select factors can push this ratio they cannot do so for long, at least not forever. These may include:

·         Property tax rates

·         Interest rates

The higher they go (and this we must imagine is inevitable at some point) the more expensive will be buying and, as rents tend to lag, renting will enjoy a margin of advantage until either home prices come down, or rents catch up.

So, what can we expect for the long term return in housing stock investments?

When considering a home as an investment please consider: home prices, on average, track to inflation, as do rents. They do not grow any faster in the broad market.

“Wrong!” you say?

How can they grow faster I reply, when all we have at our disposal with which to buy these homes is our wages, which have, on average, struggled mightily to keep up with inflation.

This is to suggest that a portfolio of fully owned (not leveraged) average residential real estate will on average not grow wealth (increased purchasing power) over an extended period. History is littered with one off examples where this has not been the case. This is particularly true in many in the “hot” markets of California and others. And yet - maybe not.

As I said above, changes in Interest Rates are a lever that can throw off the equilibrium – but only for a while. A forty year period in which interest rates drop from ~14% to ~4% for home mortgages allows for a 150% market price increase for the same mortgage payment. This attributes 3% of the annual average real estate price growth. Add this to the ~4.3% average inflation from 1070 to today and we should have gotten a compounded ~7.3% price increase just to stay even with inflation

So…

That home one bought in 1981 for $25,000 with no upgrades made (only basic maintenance – find me that house!?!) could have appreciated to ~$530,000 today and yet only kept up with inflation and the interest rate decline “bonus”.

Well then… How were people making money investing in homes?

Appreciation of a leveraged asset.

Ok then… How might it work well going forward?

Charging more for rent than you pay in financing, lost opportunity cost, and tax, which may be do-able as the cost of financing is temporarily so low.

This is not a new normal – except for so many who do not study or remember history – this is the old normal all over again.
Keep in mind also what an increase in mortgage rates from 4% to 7% (near to the long term national average rate) may mean for the price of such a home? All else held static, it would require a ~30% price correction to sustain the current monthly payment. This would drop the $530,000 house to ~$370,000.

So how might we approach purchasing a home or a rental now?

1.      Consider the article “Why U.S. Housing Prices Won’t Recover” by Jack Hough on Marketwatch, and

2.      Consider the below interesting (dare I say, useful) linked interactive graph as relates to your specific case analysis. Click on the below image to jump to the New York Times web site tool:

Is it Really Getting Worse?

Despite the pleadings of mass media these days economist Jeff Thredgold reminds us, in his semi-annual Happy Talk blog posting, that the general direction of the world is up, not down, and there are plenty of reasons for optimism. Here are a few of Jeff’s points that jumped out at me:

·      Even as U.S. economic output (GDP) has climbed by more than 210% since 1970, aggregate emission of six principal air pollutants has plunged by 60%

·      The divorce rate dropped by one-third between 1981 and 2008, and is at its lowest level since 1970

·      Productivity of U.S. workers rose an average of 2.4% annually during the past 10 years, some of the strongest gains in 40 years

·      When comparing economic size and population, the average U.S. worker is 10-12 times more productive than the average worker in China.

·      Roughly 80% of companies that suspended or reduced their 401(k) matches during the past 2-3 years have reinstated them

·      America produces more steel today than 30 years ago, despite the shuttered plants and slimmed-down work force

·      During the early 1960s, the five-year survival rate from cancer for Americans was one in three. Today it is two in three…continuing to climb…and the highest in the world

·      Donations to charity rose 3.8% in 2010, with $291 billion donated by individuals, foundations, and corporations. As a percentage of GDP, Americans gave twice as much as the next most charitable nation…England.

·      Men’s time spent on child care [with their children] has tripled over the past 40 years.

·      A recent poll of more than 12,000 global business figures conducted by the World Economic Forum ranked the U.S. as the world’s most competitive economy

To see Mr. Thredgold’s full list as posted on his blog click here.

The New IRS Audit: Snake In Your Mailbox?

The IRS has taken to technology. Back when a few billion dollars used to impress even the most wealthy among us the IRS budgeted a few more to upgrade their computer systems. The aim, in part, was to be able to actually track us in a manner more consistently with what so many of us imagined they were already doing. Truth be told, while so many of us imagined that our financial life was an open book to the IRS, the agency has been anything but omniscient with regards our finances.

No Judy, they are not doing this because they know better and just want to annoy and inconvenience you.

So, they set out to be able to match up all of your W-2s, 1099s, 1098s, 5498s, and the like with what you reported on your 1040 return (along with your Schedules A, B, C, D, etc.). You probably thought that they could do this all along. Not so, unless they actually manually pulled your file and did so “manually”. Now, the IRS is doing this digitally. This is one of the reasons that the IRS insists that CPAs file all of their clients returns electronically. This enables the service to more easily do data matching with the employer and brokerage houses W-2s and 1099s.

“So”, you say “What does this mean to me?”

More “Mail Audits”. This is the “new” IRS audit. This is when you get a 10-20 page document in a #10 window envelope from the IRS. Inside you find that the IRS has determined you understated taxable income on your return and they are billing you for the missing tax. They are able to make very specific (if however inaccurate) claims in this  manner because their computer data base can now match up all incoming records and reports with your SSN on them.

Consequently, your chances of an audit by mail (“correspondence audit”) has roughly doubled, as these are the audits that have dramatically increased. What to do when this occurs:

1.      Assume that the IRS is mistaken and you will not owe much if anything. This, I have found is most often the case, but our immediate reaction is panic.

2.      Open the envelope, see the amount they claim you owe and say “they are mistaken” aloud. This will calm you a bit and set you in the right direction to proceed (rather than ripping the arm off a dining room chair and beating your trusty lap top with it).

3.      Contact your CPA/EA immediately and forward to him/her all of the documents sent to you by the IRS (leaving anything out is perilous).

4.      Set the reply date (typically no more than 30 days from the date of the IRS letter) on your calendar and be sure to reply in some way prior to this date – even if to request more clarification or time to gather information. You, not your CPA is the responsible party if no reply is received.

5.      Once you have submitted your full reply to the letter forget it. There is no practical means of tracking it and expecting a timely reply is a fools delusion. Eventually you should receive a reply. If it is close to what you expected pay and move on. If not (and if unfavorable) see step #2 above and proceed from that point.

So there we are. The new snake in your mail box. If you haven’t gotten one don’t be too proud, they just haven’t gotten to your data yet. If they have and you “beat” the claim well good work but you didn’t really do anything too special.

This is the New IRS, the new face of government, the faceless and voiceless government (at almost all levels). It is the government we created, our systems. Like self-check-out at the grocery this is not too likely to go away – ever.

So, if you do get great service from anyone in a government agency, consider they are bucking the current in so many ways the least we can do is assure them how meaningful their effort is to us.

Neither Commonwealth Financial Network® nor Mark Phillips & Associates provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.