A recently published article in The Wall Street Journal indicated that nearly 15% of “homeowners” with outstanding mortgage balances of $4M or more were at least 90 days overdue in their payments. That is nearly twice the rate for all home loans. In America today there is growing number people of the “big house, no cattle” variety who are facing bankruptcy.
Hyperconsumption is an economic disease that is prevalent in all socioeconomic strata. Of these three major economic factors (income, net worth and market value of home) which is the best predictor of consumption? The market value of one’s home. Income ranks second; net worth, although significant, ranks third. The Wall Street Journal article also contained two interesting case studies. One former Wall Street executive, Mr. RF, recently declared personal bankruptcy. Just prior to that his house was in foreclosure proceedings. He attempted to sell his home for $13.9M but had no offers. This 18,000 square foot home had 11 bathrooms. From my own research I have discovered that only 6% of decamillionaires live in homes that have 8 or more bathrooms. The median number is in the 4 range. Also, in Stop Acting Rich (p. 242), I mention that the median square feet of the primary home owned by a CEO of a Standard and Poor’s 500 firm was 5,600 or less than one-third of Mr. RF’s home.
The other case study profiles a Hollywood actor whose $35M home went into foreclosure and reverted to the lender. Why is it that so many so-called Hollywood “stars” insist on living in such expensive homes? Do they think that they are wealthy because they have high incomes, live in mansions and believe their own press clippings? Again, income is not wealth and wealth is not a big mortgage. Many in Hollywood are only acting rich.
What if you “own” a $35M home? If you do, then you are actually in the real estate business. And, in this case, the owner of the business (the actor) is out of business!
Contrast this actor with those millionaires in America who list their primary vocation as “owner of a real estate investment company.” What percentage of their wealth [70% of which is in investment grade real estate] do these people typically generate in terms of annual realized income? According to my research, the answer is somewhere in the 3% category. In fact, their objective is to minimize their realized (taxable) income and maximize their unrealized income, i.e. build wealth without a cash flow. At this rate, how much wealth would they have to have to realize enough income to pay for a $35M home, plus mortgage interest and property taxes? Even if they had a net worth of over $100M this purchase would require the equivalent of 20 years or more of all their realized pretax income! This scenario may give you some idea why most professional real estate investors do not live in $35M homes.