Real Wealth Society

Tuesday, February 21, 2006

What Is A Market? How Does One Define A Market By Wayne N. Krautkramer

A recent article, POP GOES THE REAL ESTATE WEASEL! PART 2, generated a number of comments, questions, and complaints from my readers.

Before we go further, let me state that we are going to be talking about real estate as an investment vehicle, not just the once in a lifetime purchase of a home to live in, raise a family, and then to retire in a condo of choice on the beach in the Costa del Sol, Spain, or Puerto Vallarta, Mexico .This is a lifestyle choice, not a scheme to get rich flipping condo’s and houses during a bull market.
The main issue was the definition of a market! I stated that Real Estate is not a real market, because you are unable to buy and sell at the market. When you sell at the market in real markets, you will usually be filled (the transaction is completed) in a matter of minutes. I am referring to the Stock, Commodity, and Bond markets.

I further said that when you sell in Real Estate, the question is to who? Certainly not to the appraisers, or the brokers. When you put Real Estate "on the market", all you are doing is letting the salespeople know that you interested in selling! When, to whom, and at what price is unknown, and may be unknown for a long period of time.

The first and biggest problem you encounter in Real Estate is price. What is X property actually. worth? Both the potential buyer and seller are working in the dark. So proper valuation becomes paramount in the analysis. Rarely does the occasional home buyer have the experience to judge the truth of what they are being told.

The Real Estate brokers will always try to sell a "live one", always claiming that this is the time to buy, and that the prices always go up! "They aren’t making any more land" is their big mantra. Using this argument as a basis, properties in Rome and Greece should be selling in the billions, as they haven’t made any more Greece, or Rome, in the last few millenniums.

The other sales claim is that this property is unique. Another very dubious argument in a world of tract housing, and mini malls. I personally love to hear them use this argument in Phoenix and Las Vegas, where even the land is just one huge desert.

And Real Estate agents do work on a sales commissions, which is based on the selling price. Yes, the more you pay, the more they make! There are fixed commission brokers, but too few to mention here! So reliance on brokers for the accuracy of prices is a dubious premise.

Real Estate appraisers have now become notorious for overapprasials But then they do work for the Real Estate Agents, and the Mortgage Bankers, not you. When you listen to an appraiser’s report, just ask "Is That An Offer? Watch the story shift!

Real markets don’t have this problem. You want to know the price of corn, wheat , unleaded gas, crude oil, IBM, Google, Microsoft, General Motors bonds, or US bonds, just look at the large number of quote services available. In many cases, you can even see 10-25 years of price history, complete with a price chart that is based on actual exchange prices.

So you know with absolute certainty what people are paying for that stock, commodity, or bond.

Quotes are not subjective appraisals.

Of course these prices change over time. But you do know the real price right now. In real estate, you are speculating on both now and the future. That’s too many variables for me. No equation can be solved unless there is a least one known (fact) in the equation.

We don’t need to get this sophisticated to refute real estate as a market.
Let talk about supermarkets. Imagine a supermarket where there are sales clerks and clericals waiting for your visit to get a list a what you want, and then calling their friends to see they have any items that they want to sell. Then they get back to you, and tell you what’s available, and how much they want for it. Of course, none of this is guaranteed by this supermarket.

I don’t know about you, but I go to markets where they have an inventory of food for sale, and all I have to do is agree, or disagree with their price. They are a making a market in food. We would all starve to death if we were waiting for some hookup contact to get back to us.

Real people, in a real building, having an inventory of real products, that they purchased with real money, with returns and refunds available for dissatisfied customers is my idea of a market. This is an idea whose time has come.
This real estate market concept would be funny if they didn’t charge so much in hookup fees. According to my sources, the national average as of this month for real estate commissions is 5.1 percent of selling price. That’s some $12,750 USD for a hookup fee on a $250,000 house! This is funny. It does explain why every 3rd person I meet is "in real estate". This has to be the most expensive bulletin board service in the known galaxy.

Let’s address that $12,75O USD commission. It is the admission price to buy a $250,000 USD house.

But what would it pay for in a real market?

At the average commission rate ($15.00/contract) in the commodities business, that would be the commission to buy 850 futures contracts
In the case of Gold, assuming a closing price of $550/oz, that $12,750 USD would pay the commission for $46,750,000 USD of Gold.
Another way of looking at this is say that the commissions for $250,000 Gold would be 4.6 contracts of Gold for a commission cost of some $68.20 total
Do you feel like you’ve been had yet.? But wait! We have more "you’ve been had" for you!

In the case of Crude Oil, that commission would cover 850,000 barrels of Crude Oil worth some $51,850,000 at today’s prices

The commission cost to by $250,000 worth of Crude Oil in the futures markets is $60.00 at today’s crude oil prices.

In the case of Google, that commission is the admission price to buy some 1,275,000 shares through Ameritrade. Google had a verified closing price of $369.00 USD on 2/17/2006. The market value of that many shares of Google is some $470,000,000.

The commission cost to buy $250,000 worth of Google stock is approx. $10.99 through Ameritrade.

And in real estate, this only gets you a measly $250,000 house in a market that has no liquidity, no accurate quotes, and no exchange guarantees to force the performance of the broker. And let’s not forget all those other costs, such as closing costs, insurance, and the biggest selling point, the negative dividend! You call this maintenance, and property taxes. Sure, you get a tax deduction! Otherwise, no one in his right mind would ever buy residential real estate.
I must have a vision problem, because I just don’t see what you get for this ridiculous hookup price in real estate!

From an economic point of view, it’s a disaster. The transaction costs are too high to "trade" real estate. And the other problem is, what if your wrong on your forecast? You can’t just turn around and say sell me out "At the Market" to your local real estate hookup network. There is no market for real estate. If there is a real estate exchange that makes a market in houses and condo’s, please e-mail me immediately. Inquiring minds want to know!

This is the part of this article where we can have some fun exploring alternative scenarios for your hard earned money.

Alternative Scenario # 1
You take the $12,750 commission that you were just about to pay to the Real Estate Hookup Network. Take the money and place with a commodity broker. Buy, or sell, 37 contracts of corn, as that is how much margin you have in your account. Sell out your position when you have a 15 cent profit. Take your profit of $27,750 and go on vacation! Then take the original $12,750 and give it to the Salvation Army. This way you won’t feel guilty about all those former Real Estate Hookup Network employees who are now living on the streets. The soup kitchen will always feed them, and they will receive an uplifting sermon about the evils of chasing money while they are eating.

Alternative Scenario #2
You take the $12,750 commission that you were about to throw away, give it to you commodity broker, Sell a few Bond contracts short, and watch all you friends lose their houses as their VAR mortgages begin to increase as the interest rates rise. After this has happened, take your profits, and buy their foreclosed houses with the profits. Then have them over for a barbecue in their prior residences to show them your appreciation for giving their houses to you.

Alternative Scenario #3
You take the $12,750, put the money into a good discount stock broker, sell short the 2-4 biggest capitalization housing stocks, and wait. Then take the humongous profits that you have made, and buy a failing Real Estate Brokerage operation. This way you have all remaining suckers paying you the Real Estate Network Hookup fees. Then you hire a really hard ass high performance manager for the business, and then move to the Costa Del Sol, Spain, or Puerto Vallarta, Mexico. As Oprah would say "It’s all good".

We could go on forever with this scenario generator, but it’s time to close the article

We hope you had as much fun reading the article as we had in writing it. We’ll put the Real Estate Hookup Network to rest with that famous California Valley Girl exit line, "See Ya, Wouldn’t Want To be Ya!"

Wayne N. Krautkramer

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