Monday, April 27, 2009

My Experience with a House Auction in Birmingham

Today, I participated in a house auction in Vestavia, Alabama. We discovered the auction three days ago. We had the house inspected yesterday. From the time we viewed the house, we began due diligence for the auction.

We found a green ranch style house built in 1960 with good bones, but necessary repairs. It sat on a half-acre lot in an excellent neighborhood. Prior to auction, the house was listed for $139,000—cheap enough to assume financing, and payment. First, we decided whether we wanted the house. My wife had an emphatic “YES!” Actually, she designed the color patterns, and chose appliances from Craigslist. I was more apprehensive.

Next, we began due diligence, which consisted of three steps: an inspection, speaking with the mortgage underwriter, and financial analysis. The inspector told us to plan for a new air conditioning and heating service ($2,000 - $5,000) immediately, and a new roof ($5,000) within a year. The mortgage guy helped us minimize our initial capital outlay. Interestingly, a 5.75% interest rate was more desirable than a 4.75% requiring a MIPS payment of $3,000, an origination fee of $1,500, and a monthly PMI of $100. With the 5.75% mortgage and required payments at closing, and immediate repairs, we found a maximum on the house to be $112,000.

The house had a 5% “service fee” tacked onto the maximum mid. Therefore, our maximum bid was $107,000 (actually $106,667).

With our inspection, mortgage information, and financial analysis, I headed to the auction. I told our real estate agent to kick me if I bid above my maximum price. Five houses were auctioned off, and ours was last. Experience of seeing four auctions prior to “game time” soothed my nerves.

Once ours was announced, I listened keenly. The disclaimer was the same as the four previous, and bidding began similar to the others. Bids quickly ramped up from $10,000 to $40,000, $60,000, $80,000, $90,000. Then silence. Someone was holding the highest bid at $90,000, and the auctioneer asked for $95,000; he got it. Quickly someone else bid $100,000. Pace slowed, and everyone looked around for the next bidder. When he asked for $105,000, I flashed my card. $106,000; someone else. $107,000; I was quicker to bid this time. The pace slowed again. From $10,000 to $107,000, only 45 seconds passed. I remember my analysis—I was at my maximum.

Next a lady raised the bid to $108,000. I waited to give her thinking time. I waited to give me thinking time. I remember my analysis--$108,000 to $109,000 was marginal. The difference between the two was slim. I flashed my card. I had the high bid: $109,000.

Do I want this house? Are there costs associated with the house I don’t know about? Will this wipe-out my savings? Pausing, she bid $110,000. I don’t know how long I had the high bid—4 seconds, maybe. It felt like a minute, and everything became clear.

At $110,000, she and I were the last bidders. My decision prior to the auction determined it was too high for me. I feared buyer’s regret. At $107,000 I was certain. At $110,000, I feared a bidding war that left me standing, and owning uncertainty.

Pressure came, and everyone was looking at me. Auctioneer asked if I would go $111,000? How about $110,500? I shook my head, and the event was over. She won the house for $110,000 (plus a 5% “service fee,” or 115,500).

As I walked away, I tried to answer the question, “Would I have paid $110,000?” All I could think was, “absolutely.”

Saturday, April 25, 2009

Relationship of Past to Future and Thought Models

Future events are more predictable than the past. Taleb stated this in Black Swan and provided good support. Essentially, this point in time could be created by infinite possible historical events. Some historical possibilities are quixotic: the world was created yesterday, and everything is the way it is. Others more rational: over 4.6 billion years the earth created life from a melting pot (which is the debate between creationists and everyone else). Even the recent past, i.e. yesterday, creates infinite nodes on a decision tree, and multiple nodes lead to the current point. Anyone could have done infinite events yesterday, not restricted by resources, time, other people, or environment, and be where they are now.

However, resources, time, other people, and environment bind the future. A person can only get so far today based on resources (i.e. money), time (only 24 hours better get going), other people (“liquidity for one, insolvency for all”), and environment (200 years ago you had a small possibility spectrum). Side note: I’m an optimist, and I believe in stringing together victories for change—not fell swoop, lottery changes to the future.

Past future decisions had more possibilities than current future decisions. Creation of predictive models attempts to tame the future based on collective handling of the future in the past. Past future decisions were based on resources, time, other people, and environment at that point in history.

Failures of models attempt to define collective output of all decisions with a limited number of inputs. Deviation from the future and predictive models occurs due to a change in inputs. Models disregard the current binding input in favor of past correlative inputs.

Bubbles happen when most inputs are found from past data, and perpetual future assumptions are made on this limited set of inputs. Crises happen when a new binding input is collectively found.

In 2007, what was the binding input: confidence, incoming or outgoing money? Economists are largely okay with cramming 2007 into current models, calling it largely accurate, and going forward. Economist’s antithesis wants them hung for not predicting the future.

Economists have shown they are excellent builders of models that match the events. However, they are lousy at determining the actual inputs.

Everyone poorly defines current restrictions on the future. For example, ask someone “What do you want to do?” Then ask them “Why aren’t you doing it?” That person will give a list of artificial restrictions.

Sunday, April 12, 2009

Buy or Rent: an NPV of the Birmingham Housing Market

My wife and I sold our house in May 2008. With our equity, we could afford to set the price aggressively to sell. It was better to sell our house for less, than it was to hold on for a mythical price.

After we sold our house, we moved into an apartment. When selling, the buyer’s agent asked, “Why are you selling?” And my reply was, “I don’t want to be in a house right now.” I can’t say that I foresaw the economic meltdown last fall; my projections were 10% interest rates as the supply money for mortgages decreased. Either way, it was a good move.

Trade-Offs: Apartment v. House

Apartments are cramped, and most “features” of a house are indirect to the features of an apartment. For instance, in an apartment you don’t have yard work, in a house you have to do yard work; the trade-off is a yard where you can play. Other trade-offs include maintenance, cost of utilities, trash, taxes, etc. The costs of a house are explicit, but most benefits are implicit.

Like most personal finance decisions, we have decided we want to live in a house for non-financial reasons. We made the decision based on non-financial metrics, but financial metrics determine our price range and feasibility of living in a house.

Assumptions & Data

As, we are not speculators; therefore, we are not betting on aggressive increases housing price. Remember this when I am talking about owning a house, and appreciation.

We will start with our known information and assumptions:

Principal on House$120,000.00
Interest Rate4.85%
Mortgage Months360
Tax Rate12.00%
PMI Rate1.00%
Pay PMI Until20%
Variable Utilities (House / Rent)50.00%
Property Taxes1.00%
Repairs (Mortgage Payment)50.00%
Rent Increase2.15%
Corporate Bond Yield6%
Growth of House Value1%
Closing Costs3%

Currently, our rent is $830, marginal tax rate is 12%, monthly variable utilities average $215, and fixed utilities average $100. I’m using the corporate bond yield of 6% to discount the costs. Marginal tax rate is included because of the beneficial treatment of mortgage interest by the IRS. I'm using 6% discount rate because I can receive that on a relatively safe bond.

One bit of contention is the 2% growth of house value; it is the long-term growth of housing values—-I read that recently somewhere. Include anticipated repairs and upfront repairs that must be made prior to move-in. Monthly repairs of "50%" assumes costs are half the mortgage payment, which is a best guess. Owning would significantly outweigh renting if no repairs were needed.


First, buying a house with a 30-year mortgage is not a positive NPV project.

Given the assumptions above, the following NPV’s exists for renting and owning after the following durations:

1 years($19,315.04)($13,381.76)
5 years($73,679.56)($61,384.46)
10 years($126,077.78)($110,696.20)
20 years($191,423.27)($182,415.45)
30 years($231,285.04)($229,245.59)

Throughout the duration of the project, renting always has a higher NPV than buying. From year 1 through year 20, renting actually has gains on buying. Only from year 20 through year 30 when principal has been reduced, does buying gain on renting.

I've heard people claim, "At least with owning a house, you receive a check when you leave." If he rented and saved the rest, he would have more money than the closing check. Seeing that most people are moving houses less than every 10 years, most are making poor financial decisions.


In order to maintain our current economic position on housing, we cannot buy a $120,000 house. Also, the value of housing is a function of time, and the indeterminate market value of the house. As people have recently found, the owner receives the benefit/detriment of changes in house prices.

We continue to look for houses, but I don't expect to make any money in the process.

Thursday, April 09, 2009

Got a Team

When my uncle played ball as an eleven year old, my grandfather took the role of coaching. He didn’t participate in the original draft; due to each team having too many players, the league created a team, and he was given players from other teams. Since he didn’t choose the players, he received the worst players from every team. Each of them could have easily played right field for any other team—in little league, right field was the position for people who were rotated in to play the minimum number of innings.

To make it fair, the other coaches had given him first pick on equipment. “To choose a wooden bat, you don’t just go up and grab it. You hold the fat end of the bat, and tap the handle on the ground.” When he told this story, it was always the occasion we had a wooden bat, or an object equitable to a bat—a stairway baluster. He would demonstrate with the bat how to tap lightly, “you should that ‘ping.’ That’s when you know a bat has pop.” He could always find a solid piece of material to have that right high-pitched sound.

After they chose the equipment, he would begin with the story of crafting a team. “They were ragtags. Half of them hadn’t played baseball before. The first thing I'd do is make them hit baseballs out of the bushes.” He showed me how to hit in bushes—ruined some good azaleas. “I would put a baseball on a limb, and they would hit it. We did that for house a day.”

When I was twelve, we had a Cinderella season, and ended up in the championship series. He took me to the azaleas out front, and I hit baseballs the week before the series. I had a hit every at bat that series, except one: it was a liner to the second baseman.

“Why didn’t you hit off tees?”

“There was an endless supply of bushes—we’d tear up too many tees. When someone struck out, I’d send them to hit off the bushes. We’d practice from three o’clock in the afternoon to dark every day. Next, I needed a pitcher. There was one kid with two left feet—he had two left feet. He could hum that ball.” He’d make a pitching motion with his arm—you’d see his longer finger nails wrapped around the imaginary ball.

Tuesday, April 07, 2009

Preaching Circuit

Mitchell’s head was hard as steel.  Legend has it; he killed the mountain goat in his office by ramming it. An asset that rivaled his will was his ability to place events in chronological, cause-effect relationships.  As an ardent dissident of every official of the United Methodist Church (UMC), everyone who would listen heard him call it a “Preacher’s Union.”  UMC brought changes to the local church, and he decided long ago those changes were lacking.

“You know why we have a fifth Sunday night singing?”  Standing outside the church after we’d sung hymns from the red book, Mitchell asked a rhetorical question and didn’t expect anyone to answer.

“Before this church was United Methodist, we had a preacher that would travel on a circuit of four churches.  We couldn’t afford a full time pastor, so we split one.  On Sunday morning he would have services from nine in the morning to one in the afternoon.  Sunday nights, he would rotate between churches.  First Sunday night he would be at Iron City; second Sunday night he would be over the mountain; third Sunday night he’d be here.  When the fifth Sunday night rolled around he would be off, and the churches would join together to sing.” 

Monday, April 06, 2009

The Swimming Hole

I’d grown up going to my great-grandmothers house; the same one where my papa grew up. We called the area “Rawhide,” but we were the only ones I’d heard call it “rawhide.” My papa told me stories about living over there, and I’d just imagined the woods. My mind transposed him into some woods I’d been in.

One day, we were heading up to my uncle’s on a winding road. Rawhide sat on top of one major hill and two minor hills which abutted each other. The three peaks of the hills were arranged in a triangle, and the winding road weaved through the bottom center of the triangle, and back up to the top of the hills. As we reached the low spot, my grandfather pulled over.

“Come on.”

“Where are we going?”

“Gonna show you were we played. It’s right down here.” He pointed as we walked off the road, through a thicket. Thirty five yards off the road, it opens up.

“This is where we’d swim.” Didn’t look much like a swimming hole, just wet leaves.

“It was 10 feet deep, and about 15 yards long. Leave’s must have filled it in.” He pushed some leaves out of the water, and clear water sprang up to replace the leaves. A spring gushed in the middle of the hills.

Old 78

“When we were younger, we lived on 78.” Ned pointed the direction of the highway, going left out the church doors a quarter mile down the road. “We owned a convenience store.  78 was gravel then, and people would travel between Birmingham and Atlanta.  I remember when Bama played Georgia Tech, good number of folks traveled to see them.”

Going away from Birmingham on 78, you’d run up a hill just past Anniston.  “As far as we were from the hill, people were getting on it going toward Birmingham.”

I’d seen a stone building on 78 near the location he’d pointed earlier.  I’m not sure if that building was the store, but I assumed it was.  The buildings sandstone fa├žade looked old enough.

“One day, young man came down the hill; he was hauling.  78 was gravel, and he lost control.  We were playing outside when he ran off the road.  Across from the store, there were some low-lands that held water.  He ran off into the water; we ran down to him.  I held his head out of the water.  He was bleeding, and we drug him up to the road.”

“You know he just laid there and died.  We tried to make it comfortable for him.”

Sunday, April 05, 2009

The Bridge

“We were getting close to a mine,” being a kid, I had no idea what that meant. “The ship rolled on waves whose peaks put the mine at deck level. “

“What’s a mine?”

He pressed his thumb to his forefinger, measuring off three and a half inches as he did when we were fishing, “It was a ball of steel with spikes sticking out. When those spikes hit something it blew up. It was too close on us for big guns, and everyone was getting tense.”

“Winslett! Get your gun and get up on the bridge! I ran up there, as the mine slid closer to the hull. I aimed at the spikes,” he held his finger up again. His long nails gave his finger an extra inch.

“I got my 30-06; ran up to the top. Aimed down at the mine with my iron sights. The target was bouncing on the ocean. I missed it the first shot, reloaded and WHOOOM! Ocean water shot all over the deck.”