Tuesday, May 29, 2007

Florida's New Eminent Domain Law

First, I'm not a lawyer (hurrah!). Fortunately, it appears the City of Key West has a good one.

Eminent domain is defined by wikipedia as:

Eminent domain in common law legal systems is the inherent power of the state to seize a citizen's private property, expropriate private property, or rights in private property, without the owner's consent. The property is taken either for government use or by delegation to third parties who will devote it to "public use." The most common uses of property taken by eminent domain are public
utilities, highways, and railroads. Some states require that the government body
offer to purchase the property before resorting to the use of eminent domain.

Eminent domain is a constitutionally protected power given to municipalities. The rule of eminent domain is the governmental power to take private property for public use. The Fifth Amendment of the U.S. Constitution states, "... nor shall private property be taken for public use without just compensation." The framers of the Constitution included this clause as a safeguard to property owners in recognition that the government would at times have a public need for private property, but at the same time assuring property owners that they would be paid for its’ taking.

Property owners have long realized and accepted that the government has this power. Most property owners although distressed are not surprised that the government can force a sale of their property if the property lies in the path of a proposed public highway or public building.

In response to a US Supreme Court ruling a few years ago, States began enacting laws to further define and limit the abuse of eminent domain. Florida was the first state in the US to pass such legislation.

Let's look at Florida's eminent domain law - which became effective this year. I highly encourage you to read the law - especially any of you barristers out there. Please feel free to comment to this post.

In short, the law:

"Prohibits the transfer of private property acquired through eminent domain to another private entity with certain exceptions, including for use by common
carriers, public transportation, public utilities, or where the private use is incidental to a public project. Prohibits the use of eminent domain to eliminate blight conditions or to generate additional tax revenue. Authorizes the use of eminent domain under the Community Redevelopment Act if it is necessary to remove a threat to the public health or safety"

So, the law says you can't take private property and give it to someone else unless there are certain exceptions. Mainly, the law restricts taking property for private endeavors. But this is a street that will remain a street (not turn into a commercial project). I couldn't find anything in the law that said the street could not lead to a commercial businesses. After reading much of the law, my understanding is that a street would be allowed for eminent domain. Actually, the law seems to me to clearly allow this to happen. The city of Key West would have to compensate Truman Annex for the taking, but with my plan of gating and fencing along Southard Street, Truman Annex would still be a gated community (so far, the bulk of their damage claims comes from losing a "gated" status). Plus, the law provides for eminent domain for community redevelopment, which may or may not apply here.

Some commenters to this blog have attacked me and anyone who believes that eminent domain is a viable legal option.

For example, a commenter signed as Harvey J. Keck wrote

The issue is that the city does not have the necessary rational to succeed in this endeavor. 1. Bad faith in negotiations with a signed and enforcible agreement (with the issue of police powers removed). It looks very bad when the city unanimously signs an agreement (which they freely did) to obtain land and
then once it gets the land abrogates that agreement. What will the courts say
about that, I wonder? 2. Already existing public roads which allow access to the
property and are presently used for traffic both private and commercial.3. Recent Florida laws restricting eminent domain to further commercial development especially when there are alternatives already in place.4. The requirement for the city to pay for both sides of this legal dispute. (Where's the money for
this going to come from especially after the Duck Tours gets their payments).There are other arguments but these need to be addressed with legal arguments and not just fantasy rationalizations.

In response,

  1. forget the agreement. that has nothing to do with eminent domain. if it makes you feel better, you can believe you won the case and got the contract enforced. NOW THE CITY FILES EMINENT DOMAIN. THINGS CHANGE. If a municipality needs a street for the common good - the law says they can do it. and since it is already a street, they could simply seek an EASEMENT - and Truman Annex would still own the street and the public could use it as the City sees fit
  2. yes, we know about the streets. but it is up to the municipality to decide what is the best plan. and with a growing waterfront usage, Southard Street makes sense.
  3. You keep saying this is a commercial endeavor. But that doesn't sound right to me. The eminent domaining of Southard Street would KEEP IT A STREET. And it would be leading to a property that is 75% park. It would not be difficult for the City of Key West to prove that this project is for the public good.
  4. Yes, Harvey. We know. You're going to make the City pay. And pay big. Are you looking forward to making the citizens (AND YOURSELF) pay? I'm not so sure it will be as expensive as you warn - especially given my idea. Heck - What does an easement cost? And what if the Navy declares a need for an easement? Anyway, I don't think you know what any of this will cost. Bringing up the Duck Tours as a final salvo is lame. Your FEAR is not working on me.
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Saturday, May 26, 2007

Rose Colored Eyeballs

With two big bottles of contact lens "juice" on my shelf I hear the news that AMO Complete Moisture Plus contact lens solution is being recalled. Not just some manufacturer lots. No, the entire product line. China has already banned the product - a notable move given the US's scrutiny of Chinese product safety (dog food, toothpaste). Amusing world.
If you have some of the product, the company has set up a "hotline" (not so hot) to receive a return package - allowing you to get your money back. Call 888-899-9183.
It is recommended that you don't use any more of the product, AND throw out any lenses that have come in contact with the solution.
Thought you should know.

Here is the story from the AP wire:

ATLANTA -- Government officials are warning people to throw away a contact lens solution after an investigation linked it to a rare eye infection.
The warning concerns AMO Complete Moisture Plus Multi-Purpose Solution, used for cleaning and storing soft contact lenses, said a spokeswoman for the U.S. Centers for Disease Control and Prevention.
The solution seems to be a factor cases of Acanthamoeba keratitis, a painful eye infection that can lead to permanent vision loss or blindness.
The CDC and the U.S. Food and Drug Administration are investigating 138 confirmed cases.
The solution is made by Advanced Medical Optics Inc., a publicly traded company based in Santa Ana, Calif. The company issued a statement Friday night saying it was "immediately and voluntarily recalling" the solution.
"There is no evidence to suggest that today's voluntary recall is related to a product contamination issue and this does not impact any of AMO's other contact lens care products," the statement said.
The confirmed infections have been reported since January 2005, the company said.
CDC officials said people should discard the solution, throw out their current contact lenses and toss the lens storage case. All of them may harbor the infecting amoeba, said Michael Beach, team leader in the CDC's division of parasitic diseases.
An estimated 85 percent of U.S. cases of Acanthamoeba keratitis occur in contact lens users, but it's extremely unusual - the estimated prevalence is one to two cases per 1 million contact lens wearers. Contact lens wearers who practice proper lens care and people who don't wear contact lenses can still develop the infection.
It's hard to diagnose and treat - and some of the drugs used to fight the infection are available only overseas or from compounding pharmacies.
Doctors first suspected a problem in 2004, when a University of Illinois-Chicago ophthalmologist, Dr. Elmer Tu, noticed more than a dozen cases of the infection. Normally, he might see only one or two in a year, Tu said.
UIC doctors saw 35 patients with the condition from May 2003 through September 2006. About 55 percent used the Advanced Medical Optics product exclusively, Tu said.
UIC investigators think the infection is not originating in the manufacturing process, but that the cleaning solution is not protecting people from the infection, which they get in their eyes through showering or swimming, Tu said.
The amoeba that causes the infection is naturally present in soil and water. Wearing contact lenses while swimming or in the hot tub appears to increase the risk of infection.
The cases were reported to the Illinois state health department, which notified the CDC. A CDC investigation in about 35 states led to Friday's announcement.
The solution is not marketed to protect against the amoeba. But "it's supposed to be free of any type of microorganisms. It's not supposed to result in anyone getting an infection," said Julie Zawisza, an FDA spokeswoman.
The FDA will take information from the CDC investigation and try to discern what about the solution - or how people were using it - could be responsible for the infection cases, she added.
Health officials have interviewed 46 patients so far. Of those, 36 wore contact lenses and used some form of solution, and 21 used the Advanced Medical Optics solution within a month of onset of symptoms, Beach said. It was a strong enough association to cause health officials to issue Friday's warning, Beach said.
Dozens of cases of this rare condition can be significant, eye experts said.
"It's a large number if it's happening to you. It's a large number if there is a little pocket of it. It's not a large number if you consider there are 35 million contact lens wearers in the United States," said Dr. William Ehlers, a University of Connecticut Health Center ophthalmologist.
The company said in its statement that consumers who believe they have the recalled solution should call (888) 899-9183. It is contacting retailers, customers and distributors on return and replacement instructions, it said.
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Wednesday, May 23, 2007

Solution to Southard Street?

Depending on the outcome of the TAMPOA vs City of Key West (and the United States too), eminent domain may become necessary for the City for control of Southard Street.

TAMPOA has claimed that losing Southard Street would cause that community to lose a large amount of value. The reason, according to TAMPOA, is that Truman Annex would no longer be a gated community, and gated communities, according to TAMPOA, are worth more than non-gated communities.

But what about a smart solution?

Here is what I suggest.

Erect fences and gates along Southard Street - thereby keeping Truman Annex gated. The street and sidewalks/greenspace are wide enough that fences would fit. (I've include an artists rendition of what this might look like. Also, since the guardbooth would no longer be necessary, I thought it nice to show what Southard Street might look like without it).

If the City incorporates an idea like this into their eminent domain proceedings then they could show the judge that there are not significant damages to Truman Annex. Remember, unlike many eminent domain proceedings in the United States, no one is losing a house here. Its a street and it will remain a street.
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Saturday, May 19, 2007

TAMPOA President Leaving Truman Annex?

Tom Tukey, president of the Truman Annex Master Property Assn. (TAMPOA), has his and his wife's Truman Annex house up for sale.

List price is $5.3 million. The house is described in the MLS as:

"Stately, showcase home. Grandly placed at the heart of the finest street in the most elegant enclave on the Island yet within walking distance to dining, shopping and entertainment. Built with an eye to historic aesthetics but with the most demanding modern construction; far above current code. 10' ceilings, crown and base moulding, mahogany floors throughout. Six bedrooms; all with walk in closets, full baths, French doors and porches. Seventh full bath near living area and office/library. Enormous great room. Solar heated pool. Double carport. Large Captain's walk with spectacular water views. Over 1000 SF of decks plus over 1000 SF of storage in addition to the 4572 SF of living space. Simply the pinnacle of Key West living."

The offering price equates to $1,159.23 per square foot.

Included in the listing are photos of the interior, exterior, and water views. The water view photo (included in this post, above) is interesting: according to the photo the Tukeys had a view of the water, the Navy's outer mole, and the Truman Waterfront property. This view would certainly change when the City begins to redevelop the Truman Waterfront.

You can view the listing at http://keywestmls.com/search/ under listing #104548.

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Thursday, May 17, 2007

Truman Waterfront Plans Taking Shape

Yesterday's "Naval Properties Local Redevelopment Authority Workshop" unveiled a preliminary master plan for the Truman Waterfront property, conveyed to the City of Key West with stipulations.

I've included images of the plan which were presented to the commission and public (click the images to see larger versions)

The plan appears to balance the communities desire for greenspace with the obvious value to the City of this important piece of waterfront. In my mind, it looks very good and will be a vibrant, enjoyable, and interesting new addition to the City of Key West.

The plan creates a large park out of most of the land 75%-80% greenspace. Also included in the plan is a "Bahama Village Square", marina, harbor walk, public pier, flexible greenspace that accommodates a soccer field (also for events, concerts, etc), public gardens, an interactive children's' fountain, maybe a restaurant, and an assisted care living facility. Planners were quick to point out that none of these particulars have been decided, and will require public input and voter referendums. The plan is an outline of what general uses each area might be designated.

Many ideas were mentioned for the various spaces - many for community organizations with very worthwhile causes. Some good ideas included a culinary institute for our hospitality industry, spaces for Bahama Village residents to have cottage businesses, art spaces, and trade instruction.

Also included in the plan is 86 residential affordable housing units, retailing directed to those affordable housing units, nearly 200 parking spaces, butterfly/bird attracting plantings, bocci courts, and plenty of shaded areas.

Ed Swift spoke at the public input and believes that Cuba is likely to open sooner rather than later (though he conceded that he's been saying that for 30 years). Swift pointed out that high-speed, ocean going ferries will want to operate out of Key West to travel to Cuba. He implored the City officials to consider this future need while designing the property and design with Cuba in mind.

Norma Jean Sawyer, executive director of the Bahama Conch Community Land Trust, was inspiring - and an excellent leader for her community. She reminded the commission that the conveyance of the land by the Navy was for the purpose of "economic development". Her plans for the Bahama Village Square, approximately 6.6 acres, will greatly benefit her community. Removal of the fences bordering Bahama Village and the waterfront will immediately benefit Bahama Village, and she (along with other speakers) requested that the City move quickly on taking down the fences.

Commissioners seemed all over the place in their comments.

Rossi thinks there is already too much vacant commercial space in town, and does not we need anymore. And, he said that without the traffic issue worked out (thanks to TAMPOA), and the Admiral's Cut issue, there is probably little that is worth planning for now.

Menendez spoke passionately about the needs of children.

Verge moaned that this project would cost a fortune - stating that the cost projection made 5 years ago of $20 million was now probably more likely $100 million. I can't imagine how the numbers could change anywhere near that.

In the end, the Commission directed City staff to look into removing the fences, placing some sod, and starting the very long process of planning with special meetings.

This plan, no matter what it is, is likely to take a very long time. After all, as Norma Jean Sawyer mentioned, this whole thing began over 10 years ago.

TAMPOA is likely to have a fit over this - and I won't be surprised if they fight the City over every minute point, making the residents of Key West wait and wait for their new park and amenities.

It should be clear to TAMPOA that Southard Street is part of the City plan. Fight in court all you want - the City will need the street, and eminent domain is fair if the City does not prevail in the current litigation. TAMPOA claims that they'll lose value - but the City may be able to make the claim that the improvement to the neighboring property will benefit them - offsetting their "loss".

Either way - TAMPOA, you may think you live in an investment - but in reality, you live in a community. Threatening to make the City pay tens of millions of dollars because you lose your "gated" status is sad. We are islanders - in this together. I'm sure you could enormously repair your image in the City if you simply ended your claim to the street. All islanders may even rejoice, and head down to Truman Annex and thank your for helping to make our island a better place.
Your comments are encouraged. What do you think?
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Tuesday, May 15, 2007

How Much is Your Key West Home Worth?

With the national residential real estate underway, many in Key West are wondering how much their house is worth.Forget appraisal numbers. Many properties are selling below those estimates.

A better indication of current home values - and the temperature of the real estate market - is recent sales data.

Following are the residential real estate transactions for Key West during the month of March, according to the Key West MLS. I have excluded the "sales" of the Santa Maria Condominiums (Sally O'Boyle wrote an excellent post about the Santa Maria numbers). I've calculated price per interior square foot for a better sense of where buyers are meeting sellers:

Listing Date: 12/4/2006 Selling Date: 3/20/2007 Original Price: $690,000 Listing Price $625,000 Selling Price: $565,000 Address: 803 Virginia St Interior Sq Ft. 1,000 Price per Sq Ft.: $565

Listing Date: 1/10/2007 Selling Date: 3/19/2007 Original Price: $515,000 Listing Price $515,000 Selling Price: $475,000 Address: 3685 Seaside Dr 206 Interior Sq Ft. 798 Price per Sq Ft.: $595

Listing Date: 3/3/2006 Selling Date: 3/16/2007 Original Price: $355,000 Listing Price $315,000 Selling Price: $319,725 Address: 419 William St 5 Interior Sq Ft. 369Price per Sq Ft.: $866

Listing Date: 10/20/2006 Selling Date: 3/16/2007 Original Price: $899,500 Listing Price $899,500 Selling Price: $797,000 Address: 1105 Washington St Interior Sq Ft. 1,374 Price per Sq Ft.: $580

Listing Date: 1/12/2007 Selling Date: 3/16/2007 Original Price: $425,000 Listing Price $424,900 Selling Price: $400,000 Address: 900 White St 1 Interior Sq Ft. 650 Price per Sq Ft.: $615

Listing Date: 2/2/2007 Selling Date: 3/16/2007 Original Price: $525,000 Listing Price $525,000 Selling Price: $456,000 Address: 3727 Flagler Ave Interior Sq Ft. 1,392 Price per Sq Ft.: $327

Listing Date: 3/7/2007 Selling Date: 3/16/2007 Original Price: $1,895,000 Listing Price $1,895,000 Selling Price: $1,750,000 Address: 635 William St Interior Sq Ft. 1,670 Price per Sq Ft.: $1048

Listing Date: 1/12/2007 Selling Date: 3/15/2007 Original Price: $519,000 Listing Price $519,000 Selling Price: $519,000 Address: 1126 Stump Ln Interior Sq Ft. 610 Price per Sq Ft.: $851

Listing Date: 1/31/2007 Selling Date: 3/15/2007 Original Price: $719,000 Listing Price $719,000 Selling Price: $699,000 Address: 3713 Pearlman Ter Interior Sq Ft. 2,122 Price per Sq Ft.: $329

Listing Date: 11/17/2005 Selling Date: 3/14/2007 Original Price: $550,000 Listing Price $350,000 Selling Price: $315,000 Address: 2601 Roosevelt Blvd 508 A Interior Sq Ft. 750 Price per Sq Ft.: $420

Listing Date: 9/5/2006 Selling Date: 3/14/2007 Original Price: $595,000 Listing Price $569,000 Selling Price: $555,000 Address: 1106 Elgin Ln Interior Sq Ft. 1,490 Price per Sq Ft.: $375

Listing Date: 8/14/2006 Selling Date: 3/9/2007 Original Price: $649,000 Listing Price $569,000 Selling Price: $510,000 Address: 1714 Seminary St Interior Sq Ft. 1,512 Price per Sq Ft.: $337

Listing Date: 9/25/2006 Selling Date: 3/9/2007 Original Price: $549,000 Listing Price $399,000 Selling Price: $350,000 Address: 808 Virginia St 2 Interior Sq Ft. 1,031 Price per Sq Ft.: $339

Listing Date: 2/2/2007 Selling Date: 3/7/2007 Original Price: $1,100,000 Listing Price $1,100,000 Selling Price: $1,000,000 Address: 314 Margaret St Interior Sq Ft. 1,156 Price per Sq Ft.: $865

Listing Date: 1/28/2006 Selling Date: 3/6/2007 Original Price: $825,000 Listing Price $695,000 Selling Price: $637,500 Address: 1301 Newton St Interior Sq Ft. 1,368 Price per Sq Ft.: $466

Listing Date: 10/11/2005 Selling Date: 3/5/2007 Original Price: $1,495,000 Listing Price $1,095,000 Selling Price: $950,000 Address: 1329 Duncan St Interior Sq Ft. 1,884Price per Sq Ft.: $504

Listing Date: 1/9/2007 Selling Date: 3/2/2007 Original Price: $649,000 Listing Price $649,000 Selling Price: $569,000 Address: 1700 Seminary St Interior Sq Ft. 2,682 Price per Sq Ft.: $212

Listing Date: 12/27/2005 Selling Date: 3/1/2007 Original Price: $1,525,000 Listing Price $1,495,000 Selling Price: $1,325,000 Address: 908 Packer St Interior Sq Ft. 2,086 Price per Sq Ft.: $635

Listing Date: 11/17/2006 Selling Date: 3/1/2007 Original Price: $475,000 Listing Price $399,000 Selling Price: $385,000 Address: 1901 Roosevelt Blvd N-107 Interior Sq Ft. 938 Price per Sq Ft.: $410
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Monday, May 14, 2007

Has Cay Clubs Bit Off More Than It Can Chew?

Reports in the local press last week revealed that Cay Clubs is laying off employees companywide.
Here in the Keys, it was reported that 80 employees have been let go.

The vice president of operations, Frank Rego, made the layoffs sound like they were more closely tied to their upcoming merger with Keys Hospitality Acquisition Corp. ( a "blank-check" company formed to acquire assets). Rego was quoted as saying: "We are reorganizing to get structured as we need to operate as a public company," he said. "There are certain ways a company has to act as a public entity. We need to get things in a way that will be accepted by shareholders."

But later in the same report, Rego seemed to be pointing to bigger problems in the real estate developer arena. He was quoted as saying, "It is a down market. Several developers across the country are going out of business," Rego said. "We need to make sure we can prosper through a down market so we're one of the companies that stay in business."

No doubt that the real estate market has become treacherous for developers. Widespread reports of overbuilding of condos and condo prices crashing in South Florida have scared and bankrupt some developers. Projects that failed to get pre-construction buyers have been cancelled or abandoned on the mainland. And here in Key West, the change is evident as well. Major condo-conversion projects, like the Atlantic Shores, Hampton Inn, and others have found that they will be better off as hotels - and have, as I have heard, cancelled plans to go "condotel".

Cay Clubs is now among the largest developers in the Florida Keys. The question that we should be asking: "Have they bitten off more than they can chew?. And what effects will it have on the Keys should Cay Clubs and it's new parent company become financially unstable?"

Cay Clubs, only recently formed in the past decade, is betting that people will continue to buy expensive second homes, boat slips, and condominiums. Plus, they recently acquired the Turtle Kraals, Half Shell, and A&B Lobster House restaurants.

Remember, during the go-go-go real estate craze of the past few years, hotels in Key West were being bought up, closed, and turned from transient rentals to condominiums. Now that buyers are nearly non-existent, what will happen to the hundreds of hotel rooms stuck in limbo? What if the whole enchilada goes belly up....will we be left holding the bag?

With most of the Cay Clubs holdings in Florida, aren't they particularly sensitive to market shocks? Since Florida is suffering the biggest declines in real estate, should we worry about one of the largest developers here in our backyard? Think about this: in only the past 2.5 years, Cay Clubs has acquired at least 8 Florida Keys locations.
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Thursday, May 10, 2007

Documenting the Crash

The news is getting worse and worse for the US housing market.

If you are not convinced scan the headlines and peruse the stories at the housing crash blog located at patrick.net. That site aggregates news stories from a wide range of reputable sources.

Here are a few of the headlines that struck me as noteworthy:
  • April Foreclosure Filings More Thank Double Over 2006

  • Subprime Problems Trickle Up Food Chain

  • Prices Fall in Rich New York Suburbs Once Immune to Slump

  • Rental housing glut seen

  • Realtors ignore 1989, pretend "first" national price decline

  • Tip of the Iceberg on subprime loan debacle

  • Perfect storm of debt in Florida

  • Foreclosures through the roof in FL

  • Owners who can't sell are driving down rents
So how has the national real estate meltdown effected Key West?

According to Zillow.com, ("Zillow.com is an online real estate service dedicated to helping you get an edge in real estate by providing you with valuable tools and information") the market, based upon sale amounts, is dropping quicker in Key West than the rest of the US.

(click the above chart to see a larger view)

Zillow's numbers are probably not completely accurate - since they are dealing with a somewhat limited data set. For historical reference, the following chart shows how Zillow records value trends for the 33040 zip code, the city of Key West, Monroe County, the state of Florida, and the United States. If this chart is accurate, Key West appreciated far ahead of the United States and Florida, and is now falling quicker than them.

(click the above chart to see larger view)

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Saturday, May 05, 2007

What Your Realtor Doesn't Want You to Know: Part III

Still think it is better, no matter what, to buy then rent?

Apparently some anonymous commenters to the Key West Chronicle blog believe buying is better, having said:

"I would also disagree with you that renting is advantageous to buying. That has never been the case before so why should that be the case now. "


"You are also forgetting other benefits that homeowners have ie: income tax deductions at the end of the year, and the pride of home ownership. There is also some worth in not having the hassle of dealing with landlords, many of whom do not take care of their rental properties. "
Sally O'Boyle and Rock Trueblood have done excellent jobs of refuting these ideas with sound reasons and numbers to back their comments on this blog and posts on their blogs.
Realtors in Key West (and the rest of the world) beat the sales drum announcing that is a great time to buy and admonish renters for foolishly throwing away money. But when it comes to markets, timing is paramount. This could be one of the worst times to purchase real estate. Currently, on a national level, 1 in 8 subprime borrowers are in foreclosure. Plus, over the next 6 months over $300,000,000,000 (that's three hundred billion dollars) in "teaser rate" loans will reset to higher interests rates.

For those not yet convinced, check out the Buy vs. Rent calculator that the New York Times created (I've included an image showing how a $1400 per month renter fared versus a buyer of an average priced home in Key West with a 5% annual price appreciation - a number far above long-range historical averages)

Also, here is an excellent article on the subject of renting by Jack Hough of Smartmoney.com, published May 2, 2007:

A contrarian's view: Houses don't appreciate any faster than the level of inflation over the long term, so forget about buying a home and put your savings into stocks.
By SmartMoney
I have something un-American to confess: I rent an apartment despite having enough money to buy a house. I plan to keep renting for as long as I can. I'm not just holding out for better prices. Renting will make me richer.
I normally write about stocks for SmartMoney.com, but the boss asked me to explain to readers my reason for renting. Here goes: Businesses are great investments while houses are poor ones, so I'd rather rent the latter and own the former.

Stocks versus houses: Returns

Shares of businesses return 7% a year over long periods. I'm subtracting for inflation, gradual price increases for everything from a can of beer to an ear exam. (After-inflation, or "real," returns are the only ones that matter. The point of increasing wealth is to increase buying power, not numbers on an account statement.)
Shares have been remarkably consistent over the past two centuries in their 7% real returns. In Jeremy Siegel's book "Stocks for the Long Run," he finds that real returns averaged 7% over nearly seven decades ending in 1870, then 6.6% through 1925 and then 6.9% through 2004.
The average real return for houses over long periods might surprise you: It's virtually zero.
Shares return 7% a year after inflation because that's how fast companies tend to increase their profits. Houses have their own version of profits: rents. Tenant-occupied houses generate actual rents, while owner-occupied houses generate ones that are implied but no less real: the rents their owners don't have to pay each year.
House prices and rents have been closely linked throughout history, with both increasing at the rate of inflation, or about 3% a year since 1900. A house, after all, is an ordinary good. It can't think up ways to drive profits like a company's managers can. Absent artificial boosts to demand, house prices will increase over long periods
at the rate of inflation, for a real return of zero.
Robert Shiller, a Yale economist and the author of "Irrational
," which predicted the stock-price collapse in 2000, has recently turned his eye to house prices. Between 1890 and 2004, he says, real house returns would've been zero if not for two brief periods: one immediately after World War II and another since about 2000. (More on them in a moment.) Even if we include these periods, houses returned just 0.4% a year, he says.
The average pundit, planner, lender or broker making the case for ownership doesn't look at returns since 1890. Sometimes they reduce the matter to maxims about "building equity" and "paying yourself" instead of "throwing money down the
drain." If they do look at returns, they focus on recent ones. Those tell a different story.
Between World War II and 2000, house prices beat inflation by about 2 percentage points a year. (Stocks during that time beat inflation by their usual 7 percentage points a year.) Since 2000, houses have outpaced inflation by 6 percentage points a year. (Stocks have merely matched inflation.)

Stocks versus houses: Valuations

But though stock returns have come from increased earnings, house returns have come from ballooning valuations, not increased rents. The ratio of share prices to company earnings (the price-earnings ratio) has remained relatively steady. It's about 16 today, close to both its 1940 value of 17 and to its 130-year average of about 15. Not so the ratio of house prices to rents. In 1940, the median single-family house price was $2,938, according to the U.S. Census Bureau, while the median rent was $27 a month, including utilities.
That means the ratio of prices to annual rents was 9. By 2000, the ratio had swelled to 17. In 2005, it hit 20. We can adjust for the size of dwellings, but it doesn't make much difference. The ratio of single-family house prices to three-bedroom apartments is 19. In SmartMoney's hometown of Manhattan, where more detailed data is available, the ratio of condo prices per square foot to apartment rents per square foot is 22.
Video: Should you rent or buy?

Two main events have caused house valuations to inflate since World War II. First, the government subsidized housing by relaxing borrowing standards. Before the creation of the Federal Housing Authority (FHA) in 1934, homebuyers who borrowed typically put up 40% of the purchase price in cash for a five- to 15-year loan.
By insuring mortgages, the FHA permitted terms of up to 20 years and down payments of just 20%. It later expanded the repayment periods to 30 years and reduced down payments to 5%. Today, down payments for FHA loans are as low as 3%. Aggressive lenders offer loans with no down payments or even negative ones so that homebuyers can borrow the full purchase price plus closing costs. Some require little documentation of income, assets or ability to pay.
That means more Americans can win loans for homes, and they can win them for far more expensive homes than their incomes had previously allowed. Two-thirds of American households own homes today, up from 44% in 1940, even though the percentage of Americans living alone has tripled during that time. The ratio of house values to incomes has risen 260% in just under four decades.
A second event helped boost house demand in recent years. Share prices plunged in 2000. The Federal Reserve, fearing that the decline in stock wealth would cause consumers to stop spending, reduced the federal-funds rate, the core interest rate that determines the cost of everything from credit cards to mortgages, to 1% by summer 2003 from 6.5% at the start of 2001. Since most of the cost of financing a house over 30 years is interest, monthly house payments shrank and demand for houses soared. In some markets a string of big yearly increases in house prices led to panic buying.

Stocks versus houses: Conclusion

For house returns over the next 20 years to match those over the past 20, the government and private lenders would have to "up the ante" by relaxing borrowing standards further. Given the recent attention paid to swelling foreclosures, that seems unlikely. I suspect real returns will turn negative over most of the next two decades, but that house prices won't necessarily dip. Since 1963, they've done so in only two years versus 18 for stocks.
That's because homeowners mostly just stick it out rather than sell during soft markets. But if house prices remain flat, they produce negative real returns due to the creep of inflation. According to calculations made by The Economist in summer 2005, house prices would have to stay flat for 12 years with annual inflation at 2.5% for the ratio of prices to rents to fall from its 2005 perch to merely its 1975-to-2000 average.
So to sum up why I rent: Shares right now cost 16 times earnings and over long periods return 7% a year after inflation. Houses right now cost 19 times their "earnings" and over long periods return zero after inflation. And they look likely to return less than that for a while.

Questions and objections

In what follows I've tried to anticipate and address questions and objections:
"You can't live in your stocks" or "Renters throw money down the drain."
Rent is the cost of owning shares with money you would otherwise spend on a house. Houses have ownership costs, too: taxes, insurance and maintenance. Rent costs about 5% of house prices each year if we apply the price-rent ratio of 19. House incidentals often cost around 2%.
If you have $300,000 and a choice between spending it on a house or shares, you'll pay $6,000 a year in incidentals if you buy the house or about $15,000 a year ($1,250 a month) in rent if you buy the shares. But the shares will return $21,000 a year after inflation while the house will return zero. (My numbers work out even better than these. I pay a smidgen less than $1,250 a month for rent, while house prices in my neighborhood are far higher than $300,000.)
Note that houses and shares have transaction costs, too. Homebuyers pay around 1% in closing costs when they buy and 6% in broker commissions when they sell. Share buyers pay $10 trading commissions, which are negligible for buy-and-hold investors.

"Homebuyers get tax breaks."

So do share buyers, but both are a bad deal. The interest on loans for houses
(mortgages) and shares (margin balances) is tax-deductible. But the rates are almost always too high. A big house loan presently costs 6.1% interest, while a big stock loan costs about 9%. For the returns, we can forget about inflation because it helps debtors while hurting investors, making it a wash for those who borrow to invest. Still, nominal returns of 3% for houses and 10% for stocks aren't high enough to justify those rates. The tax breaks aren't really breaks at all. Moreover, a majority of homeowners don't claim them. Their incomes are low enough to make the standard deduction a better deal.

"What about the pride of homeownership?"

It's not for me. I define ownership as no longer having to pay for something and being able to do as I please with it. I own my coffee maker. Homeowners must pay taxes each year even when their mortgage payments are done. In certain markets they can't even make changes to the houses they've paid for without seeking the approval of others. Personally, I feel the pride of ownership for shares of businesses, and I'm proud to occupy a nice place while leaving the burden and poor returns and maintenance to someone else.

"You seem to knock government housing subsidies, but they've helped many Americans afford homes."

My inner socialist agrees. My other inner socialist worries that the government has effectively raised prices to the point where the middle class can't afford houses or buries itself in debt to own them. My inner capitalist is too busy watching shares to care about house prices. My inner conspiracy theorist notes that while politicians tout the social benefits of homeownership, none mentions its tax benefits to the government. I pay no taxes on the overall value of my stock portfolio, just on my cashed-in gains and collected dividends. But Americans pay taxes on the full $11 trillion worth of housing they own plus the $10 trillion worth of it they're still paying
Video: Should you rent or buy?

"Houses are bigger than apartments."

True, and both can be rented. A third of renters live in single-family houses. I prefer an apartment for now. I like not having to fill it with stuff. I like using a fifth of the energy of the average American. I like being 20 minutes from work and not having owned a car in 10 years. I like not stressing over whether to get the marble countertops or the imported tiles or the 52-inch flat screen. I'm not especially frugal; I spend a teacher's salary each year on restaurants and travel. But I guess I'm too busy or lazy right now to bother with a big house and its innards.

"Are you saying I should sell my big house and rent an apartment instead?"

No, unless you have more space than you need and moving wouldn't be disruptive to your family, and you want to cash in on recent housing gains, make more money over the next couple of decades, use less energy while simplifying your life, and you don't mind seeming odd to friends. In which case, yes. But really, I'm not trying to win anyone over. Strong demand for houses keeps my rent cheap.

"Renting is for poor people."

True. But it's for rich people, too. The average renter makes about $34,000 a year, but while the percentage of renters declines after incomes exceed $20,000 and rents exceed $600 a month, it jumps again once incomes top $150,000 and rents top $1,200 a month. In other words, poor people rent modest apartments for lack of choice. Middle-income people buy houses. High-income people, presumably with a dose of financial savvy, often rent nice apartments instead of buying.

"You say houses return zero. But I've made a fortune on my house in recent years."

I'm referring to inflation-adjusted returns over long periods, absent external boosts to demand. You're referring to gross returns over a short time period that combined lax borrowing standards and ultra-low interest rates. Over the next 20 years I believe houses will return zero or slightly less after inflation, and that stocks will return 7%.

"So you're never going to buy a house? What about raising a family?"

I might buy one eventually, but the longer I can put it off the more I'll get out of the shares I'll have to sell to afford it. I'm 34 now with a fiancée and a fish. I'm going to try to rent for at least 10 more years. If I have kids I'll probably move into a big apartment or a house once they reach running-around age. I'll rent, most likely.

-This article was reported and written by Jack Hough for SmartMoney.

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Tuesday, May 01, 2007

What Your Realtor Doesn't Want You to Know - Part II

Since most of the real estate advice you hear comes from realtors, I thought it would be of use to point out how wrong their advice is.

Local realtors have been running an ad in the papers boldly declaring: "It is a great time to buy a home". Certainly it would benefit the realtors.

But is the advertisement true?

Actually, the ad is misleading.

Here is where the ad is wrong:

First, the ad claims that the large inventory of Key West properties won't last. The ad has been running for months, and in reality the number of properties for sale has increased. And, the official numbers actually understate the number of properties available. Not included in the MLS numbers are the large number of homes/properties still in development, properties in foreclosure, and the many for-sale-by-owner properties.

Second, the ad claims that median national housing prices will post gains in 2007. But according to the National Association of Realtors, their official forecast predicts a drop in median home prices for 2007 (a first since they have been keeping track...which only goes back 40 years). Here is a chart from the National Assn. of Realtors website showing their official forecasts (click on the chart to see a larger version):

Third, the ad claims that Former Fed chief Alan Greenspan recently said that housing prospects are looking up. Mr. Greenspan said that 6 months ago. More recently, his tone has become more ominous. He most recently said there was a risk that rising defaults in subprime mortgage markets could spill over into other economic sectors. On March 15, 2007 Greenspan said: "You can't take 10 percent out of mortgage originations without some impact." "Subprime woes were "not a small issue," said the 81-year-old policy kingpin emeritus. Greenspan has put the chance of a US recession by the end of 2007 at 1 in 3.

Finally, the ad claims that "real estate is a great investment", and cited an 88% increase in national median home prices over the past 10 years. But don't mortgages last more than 10 years? Yes, they are usually 30 years. So lets look at other decades instead of cherry picking the very best period in the history of the real estate market. Going back to 1890 and removing the effect of inflation, only three out of ten decades saw an increase in median home values. Most times, real estate underperformed most other asset classes. (click on the following chart to see a larger version)

Also, I've also included a chart in response to the ad's declaration that since interest rates are near 40 year lows homebuyers have a once-in-a-lifetime opportunity. Click on the chart to see how the economy responded to rates rising off of low levels.

Maybe it is time for the realtors to stop misleading the public, update the ad, or pull it from publications.
Either way, it's NOT a great time to buy a home.
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