I’ve been getting multiple e-mail requests about doing an analysis about renting versus buying especially in high priced areas. Since in my mind’s eye, the answer is rather clear for the moment since any equation will tell you outright that buying does not make sense with current prices and trends. There was no point in using mortgage calculators or figuring out tax breaks since the numbers were enormously tilted for people to rent or lease out their living quarters in banana republic metro areas. Yet it is important to understand that there will be a time, as has been the case in history, when purchasing a home will make economical sense even in bubblista areas. We can argue the merits of the pride of homeownership and the joy you get from having the unrestrained power to paint your living room hot pink, but it is hard to place a momentary value on that. And in the world of real estate investing, economics means everything as those in the subprime arena are learning the hard way. So we will simply focus on measurable numbers since it is pointless in using housing pundit rhetoric since many recent new homebuyers are learning that the only loyalty home builders have is to the bottom-line. First we will examine the fascinating fact that in many healthy metro areas, rental prices will increase while home price trend lower. Then, we will look at housing price declines and why spending $1 for two shiny quarters isn’t a smart way to invest. And finally we will delve into the tighter credit markets and the implications this will have on purchasing a home in the future.

Rental Prices will go up in the Short-term

First, let us take a look at rental prices in Los Angeles County via the Census Bureau:

Median Rent:

2005: $918

2004: $873

2003: $821

2002: $768

Keep in mind this is aggregate data for a county with the population of 9,758,886 people. But the trend is unmistakable, rental prices are going up across the board. From 2002 to 2003 rent prices went up 6.9%, from 03-04 they went up 6.3%, and from 04-05 they went up 5.1%. This trend is also appearing in more recent data even in the face of the mounting housing downturn. This data is useful because the majority of people in Los Angeles County rent. Yes, we hear the famous line of 70 percent of US households own their home but this is the Republic of Southern California and 51 percent of households rent. Clearly this trend will continue since many people will be losing their homes. And don’t believe the rhetoric from the housing lenders that they are trying to help these folks from losing their homes; they are using Orwellian propaganda trying to make is seem that they have their best minds trying to rework mortgage structures with at risk owners. What they call support is a piecemeal budget analysis with someone telling you, “maybe you can take on another renter or maybe you can cut back on your discretionary spending” but nothing in terms of true help. The true help would come in the form of restructuring the debt with a monetary cost to the company for putting people into these diabolic loans. Meaning, they would need to subsidize their mistake of putting people in mortgage products that had no possibility of being repaid and essentially converted the lender, Wall Street, and the buyer as a speculative racket that might as well be doubling down in Vegas. Again, we are hearing all this talk about help but nothing is happening. These folks are all hoping Uncle Sam will be there as the lender of last resort but somehow we are deeper in mortgage sewage than the government realizes. Then we have bizarre things happening in the current market and apparently everyone is now part of the housing complex.

Back to the renting issues. How are prices still going up in the face of what is happening? It is rather simple if you think about it. Many of these current subprime buyers will lose their home. They should have never been put into these mortgage products to begin with. So they will become part of the rental demand market. In addition, you have prospective buyers sitting even more steadily on the fence since there is little doubt housing is imploding. Even the most avid housing pundits are tempering their speech realizing that they’ll be seen as an enormous anti-Nostradamus by making chump predictions. So the demand being placed on the rental market will accelerate in the next year. Southern California is already a healthy rental market and with the accelerating mortgage problems, we will see rental rates remain healthy and possibly, increase at a stronger pace. In addition, you will see some sellers who are unable to sell that will become “unsuspecting” landlords. To recoup some of their losses they will need to charge higher rental rates but only to the extent that the market will bear. As you can see from our data, rental rates should trend upward by 5 to 7 percent which ironically, should increase the CPI owner’s equivalent of rent.

Spending $1 for a Kick-Back of Two-Quarters

But what about the tax benefits of owning? Aren’t all renters simply flushing their money down the porcelain toilet of perpetual loserville? First, there is a mistake in believing renting provides no economic benefit. Everyone needs shelter unless you are going the way of the nomad and living under the San Gabriel river. Renting provides the same economic substitute as owning a home aside from tax benefits, equity buildup, and the ability to take a sledge hammer into your kitchen wall should your heart desire. The only problem in hyper bubble markets like Southern California, renting an equivalent place will cost you 2 times less than owning. So for example, you may be able to rent a home for $2,200 that would cost you $4,000 if you were to buy it. And that $1,800 is being invested ideally at a rate outpacing inflation. The way housing is currently going, you’d be better off playing Keno at your local Indian casinos. So let us run some hypothetical numbers:

Home Price: $500,000

Rental Equivalent Price: $2,200 per month

Down Payment: $25,000

Assumed Rate of Return on Investments: 7%

House Payment: $4,057

Tax Savings: $806 (25 percent tax rate)

Principle payment: $424

Net House Payment: $3,252

With these assumption we will also use wonderland inflation data from the ministry of truth otherwise known as the BLS. We will assume inflation is running at 3 percent. In addition, we can safely assume that appreciation will be non-existent for a few years but we are being generous and factoring a 2 percent appreciation for this home. The inflation rate is important because this impacts our overall rate of growth in rental payments. Like I previously stated, we expect rental rates to go up in the short-term, but they will start trending down as the market starts seeing employment losses which lag. So assuming all of the above, purchasing this home will not break even until get this, 17 years! And why is that? Because we are investing the saved difference into an investment that is yielding only 7 percent. Here’s the break down after 17 years:

Value of Investment: $324,517

Value of Home Equity: $320,859

So it isn’t clear that you should own since the above factors in the tax savings as well. In the short-term scenario the numbers become even more obvious. If we are to look at the 5^th year of owning this home, this is what we find:

Value of Investment: $106,843

Value of Home Equity: $56,379

And again we are factoring in a 2 percent growth rate for housing. Many bears are predicting nominal losses in the double-digits. So we are talking about a six-figure losing proposition for at least the next few years. Plus, what can you get for $500,000 in Los Angeles County right?

Tighter Credit Markets

The credit markets were self correcting until the Fed decide to jump in and give the implication that they were the lender of last resort. Now the implication is that we will have a bailout and the market is rejoicing. Yet looking at the mortgage reset charts and mortgage equity withdrawals, it is clear we are only entering the first stage of a multiyear housing bear market bailout or no bailout. And when we look at Real Homes of Genius, we understand that fraud and outright speculation will come crashing down. You must ask yourself that a large proportion of our population was involved to some extent in producing products that provided no socio-economic benefit to our society. 2/28 loans? Option ARMS? Need we dig into more data of people making $9 hour being put into loans with the assumption they are making $157,000? The only people benefiting from these loans were Wall Street and the lenders. No one else. Initially the claim was these people now have the pride of homeownership but what a crock that was. Lenders will continue to tighten since risk is now perceived in the market. This will make it more difficult for people to refinance, purchase discretionary items, and in general will put a pause on the consumer spending which greases the wheels of the American economy. We talked about debt being seen as the new form of money. But all this is changing. And Americans with a negative savings rate will have a hard time doing a paradigm shift in which lenders will require a down payment. Even a miniscule down payment like 5 percent will bring the market to a screeching halt. Everything is borrowed.

No one has a crystal ball into the future. Even Alan Greenspan didn’t see the subprime mess coming (or at least he would like us to believe that). Big Ben even in May of this year talked about the subprime market being contained in a “silo.” And of course we have the heads of housing lenders and builders making fools of themselves by making outlandish predictions that are now being verified in the arena of reality as false. Save up, run the numbers, and the time will come to buy. But right now, against the propaganda machine of the housing industry, this is not the time to buy a home.

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Filed under: After the bell, Good news, Indices, Market matters, Economic data, Headline news, Federal Reserve

The Minutes of the September 18 Federal Open Market Committee (FOMC) meeting were released today at 2 PM ET. Because of the 50 basis point reduction in the Federal Funds rate that many on Wall Street (myself included) did not expect at the time, there was more anxiety than usual surrounding the release of this report.

Yesterday, the market ended the day for most indexes on the downside, although only mildly so and on low volume because of the Monday holiday. The markets were also off slightly, prior to the release of the minutes. A rally began shortly after the release of the report. The big question is why?

On one side of the equation, the Fed gave no indication that this was only the first in a series of rate cuts. It actually appeared that the cut was more a form of insurance to “forestall” the potential effects of the housing crisis on the broader economy. This indicates that there may not be any additional rate cuts in the near future.

Continue reading The Federal Open Market Committee minutes: A glass half full!

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Filed under: Bad news, Consumer experience, Starbucks (SBUX), China

The latest from the China-linked recall department: The federal Consumer Product Safety Commission on Tuesday announced that Starbucks (NASDAQ: SBUX) has voluntarily recalled 250,000 children’s mugs, which it sold from last May until this August. Apparently the colorful plastic faces of Dot the ladybug and Dash the turtle can break off, posing an inviting and pointy choking hazard for your youngest. The latte empire has so far gotten just seven reports of the cups breaking. No injuries have been reported, thankfully.

Were you even aware that Starbucks was marketing to children?

No one will be surprised to learn that the mugs were of course manufactured in China, adding to the long list of Chinese-made toys, scooters, and knickknacks that have been recalled for choking hazards, high lead levels, electrical shock risks, likelihood of catching fire and so forth.

Dating back just to Thursday, 14 of the CPSC’s last 15 recall announcements concern products manufactured in China (the P3 IonizAir air purifier was made in Taiwan). And, your favorite domestic companies are surely striking new contracts for Chinese outsourcing right now, so start your boycotts or brace for more recalls going forward.

(This is not terribly related, but it’s worth wondering whether recalls of products that might find their way into higher-class homes get more press than the cheap knickknacks such as these fun but excessively leaden keyrings, which sold for a buck at the KKR-held Dollar General.)

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Filed under: Google (GOOG)

Twitter has seen lots of traction lately. But, there is competition, such as from Finland’s Jaiku. The company says that it’s “an activity stream and presence sharing service that works from the Web and mobile phones.”

And, now Google Inc. (Nasdaq: GOOG) has just bought the company. In fact, Jaiku is a spring chicken, having been founded in February 2006 (the product launched in July 2006).

No doubt, mobile is key for Google. And, like other areas - such as videos - it’s been tough for the company to develop things organically. So, why not buy its way into the space?

Unfortunately, you can’t check out the Jaiku service (it’s closed to new users right now). And as seen with other Google deals - such as for Jot - it’s unclear when we might see it re-emerge (or appear in other Google services).

But, if I were Twitter, I would be quivering.

Also, if you want to check out other M&A deals, click here.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements.

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Filed under: Newspapers, Housing

Here’s a fascinating story from The Wall Street Journal: “Despite the downturn of the mortgage market, a type of home loan has remained surprisingly sturdy: one extended to illegal immigrants….For loans more than 90 days in arrears, ITIN mortgages have a delinquency rate of about 0.5%, according to independent estimates. That compares with 1% for prime mortgages and 9.3% for subprime mortgages extended to those with spotty credit histories.”

The Journal talks about the possibility of a weakening in this lost stronghold but there’s another interesting story here: If these immigrants can pay their mortgages, why can’t other people? Part of the reason could be that these mortgages are evaluated using different, more stringent metrics.

But I also wonder if too many Americans have just lost the sense of pride and commitment to keep their homes. If illegal immigrants can keep their homes, while they send money to families abroad and face tough job conditions, why can’t Americans?

If immigrants can keep up with their mortgages, does it really make sense for Congress to push for bailouts for homeowners who are falling behind?

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Filed under: XM Satellite Radio (XMSR), Alcoa Inc (AA), Goldman Sachs Group (GS), Yum Brands (YUM), Options, Akamai Technologies (AKAM), SLM Corp (SLM)

The markets drifted though much of the session until the Fed notes were released and then the markets made some solid gains. When the Fed cut interest rates last month there was a change of policy, but also a change of heart, and this was the first chance to assess that by reading the official Fed minutes.

The NYSE had volume of 2.9 billion shares with 2,282 shares advancing while 996 declined for a gain of 93.88 points to close at 10,280.31. On the NASDAQ, 1.9 billion shares traded, 1,726 advanced and 1,252 declined for a gain of 16.54 to 2,803.91.

XM Satellite Radio Holdings, Inc. (NASDAQ: XMSR) rose $0.98 (7%) to $15.24. Goldman Sachs Group, Inc. (NYSE: GS) rose $12.24 (5%) to $239.20. Yum! Brands, Inc. (NYSE: YUM) rose $1.82 (5%) to $38.11 after reporting Q3 profits of 0.50 per share. Akamai Technologies, Inc. (NASDAQ: AKAM) rose $1.70 (5%) to $35.62.

Frontline Ltd. (USA) (NYSE: FRO) had heavy volume on the October 45 calls (FROJI) with over 138,300 options trading. There was similar heavy volume on November 45 calls (FROKI) with over 82,600 options trading. FRO is about to issue a 3.25 dividend, so this activity is likely dividend arbitrage. Accenture Ltd. (NYSE: ACN) saw heavy volume on the October 35 calls (ACNJG) with over 30,500 options trading. Alcoa, Inc. (NYSE: AA) saw heavy volume on the October 40 calls (AAJH) with over 25,500 options trading. SLM Corporation (NYSE: SLM) saw heavy volume on the November 50 calls (SLMKJ) with over 25,800 options trading after a filing suit over the failed takeover. In options there were 4.6 million puts and 6.8 million calls traded for a put/call open interest ratio of 0.68.

Kevin Kersten is an Options Analyst with InvestorsObserver.com. Disclosure note: Mr. Kersten owns and or controls a diversified portfolio of long and short positions that may include holdings in companies he writes about.

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Filed under: Launches, Money and Finance Today, Serious Money

If you wonder whether anything useful is accomplished inside the ivy-covered walls of academia, I present the following as evidence that the answer is a resounding yes! According to our sister blog Engadget, researchers at the UK’s National Space Centre and University of Leicester have developed a universal currency,

The Quasi Universal Intergalactic Denomination (QUID), makes obsolete our earthly dollars, euros and yuan. Now that this huge hurdle has been overcome, the small matters such as the physical impossibility of faster-than-light travel can be attended to.

The team solved two dilemmas posed by the problem of establishing planet-to- planet pocket change; the design of the money, and the rate of exchange. For design, they concluded that the new money should not have magnetically-dependent features, and no sharp edges- we’d hate to anger thin-skinned aliens with weapons who might suffer paper cuts from our folding money. Therefore, the galactic greenbacks they designed are teflon discs of incremental size, stackable and chemically inert. (The Register notes the surprising similarity of these discs to those used in The Adventure Game.)

The wampum comes in six denominations, and like much of our planet’s currency, is not backed by specific assets, but is indexed against the British pound at £6.25 to one QUID. I suspect they consulted The Force to set the exchange rate.

Word on the street is that cabbies can get you a better deal, though.

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Filed under: Deals, Management, Newspapers

It must have been hard for cautious executives to sit back and watch during the buyout boom, but it’s looking pretty smart now: With the credit markets dried up, heavily-leveraged firms are finding themselves in a precarious position. Private equity firms are struggling to close deals they agreed to, watching some fall through, and wondering how a lot of the other ones will pan out.

But CEOs of publicly-traded companies who didn’t get into the easy money game — avoided excessive buybacks and stupid acquisitions — are in a great place now: They have plenty of cash to scoop up bargains, and don’t have to compete with any army of private equity firms like they would have had to a few months ago.

As Benjamin Graham and later Warren Buffett have often said, being fearful when others are greedy and greedy when others are fearful is the key to success in business.

Now that the private equity firms are getting fearful, it might be time for more strategic buyers to get greedy.

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Filed under: Rumors, Launches, Competitive strategy, Google (GOOG)

Expanding on a TechCrunch post last month, BusinessWeek has joined speculation that Google is planning an open-source debutante ball for its 67 million-user Orkut social networking site. Wait, what?

Yes indeed — Google (NASDAQ: GOOG) runs its own Friendster/MySpace/Facebook. Orkut has been around since early 2004, though you’d have trouble finding any users among your own friends. However, the site does a mean, market-leading business in Asia and Latin America, particularly Brazil (Orkut’s forums are nearly dominated by Portuguese). If you believe the chatter, Google will make Orkut’s source code available to outside programmers, duplicating the third-party-widget blueprint largely fueling the ascension of privately-held Facebook.

Does this do anything to explain Google’s recent run-up on the Nasdaq? GOOG crossed $600 yesterday, joining five other shares trading higher than $600 (which just equals six shares aching for splits) and climbed further today, trading in uncharted territory for the search giant.

Call me a party-pooper, or maybe just unimaginative, but GOOG’s current climb seems uncalled for, particularly now when Facebook seems poised to change all the online rules, just as it apparently has changed Google’s plans. I mean, Google is a dynamite search engine, but don’t give it undue credit. Its history is one of acquisitions, tinkering and positioning, and lately it’s playing a lot of catch-up, what with Orkut’s speculated run at Facebook and all the hubbub about a Gphone platform.

Am I the only one baffled by Google’s recent rise?

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Filed under: Newspapers, Competitive strategy, General Motors (GM), Next big thing

According to an AP story, beginning in 2009, police chasing new General Motors‘ (NYSE: GM) cars equipped with the OnStar system will be able to remotely take control over the car’s accelerator, slowing it to a safe stop, perhaps while broadcasting a warning to the perp over the car radio.

The technology is already established. You’ve probably seen the Tiger Woods ad for General Motors, where he’s locked out of his car only to discover that, through GM’s OnStar service, the company can remotely unlock his car for him. The service also offers hands-free calling, GPS directions, vehicle diagnostics, and feedback on your makeup and hair.

The OnStar service is already used to track equipped stolen cars, leading to the recovery of hundreds each month. The fly in the ointment here, though, is that owners of these cars will have to buy into the $200-a-year OnStar package after the initial free first year, and the company has only a 60% conversion rate to date. I wouldn’t be surprised, however, to see insurance companies lowering rates for OnStar-equipped cars, which would help offset the cost.

Given this capability, I wonder how receptive parents would be to installing such control devices on their teenager’s cars. I can imagine them sitting at home, remotely putting their foot on the brake whenever the child appears to be speeding, all the while passing along “helpful” hints via the car radio. For businesses, perhaps company cars could be controlled to deny the driver the ability to stop near golf courses or girlie bars.

The continued development of this technology seems to keep us on the path toward turning over control of our vehicles to a wireless network. Is that a good or bad thing?

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