The theft of sweat equity

Finland has been going through a housing boom the last years with new areas and housing popping up all over the suburban areas, especially apartments with pokey rooms and no storage space. I have been wondering how and why some of my friends and colleagues have been buying the homes they have, since pretty much all of them have bought new, newish, or newly renovated homes. In Finland, nothing is cheap, especially housing and personally, I wouldn't want to pay for someone else's design choices, nor their sentiment. Today I found out why people buy this way.

They have little choice.

There are two reasons for this:

banks and the government.

There is apparently a law that says a bank can lend a maximum of 85% of the purchase price of a property with the remaining 15% needed to be fronted by the buyer. That means that for example, a house that is 200,000€ can have a maximum bank loan of 170k on it with 30k fronted. Seems fair?

The devil's in the details. You see, there are essentially no houses that are that cheap which do not require renovation and as the law states, "85% of the purchase price of the property", which means that if it requires work, all of the renovation cost has to come from the buyers.

For example, we were looking at one property that we would have likely got for about 150k, but it would have needed about 130-150k work done to it. The most the bank would be able to provide in a loan would be 125k or so with us fronting 25 for the loan, and the other 170k we would have to have on hand as cash. Ummm.

Do you see the issue yet?

If we bought and renovated the house for say 300k all up, the actual value of the fresh property would be pushing toward 400k, meaning that we would have sweat equity in the home. Not many people have 170k cash on hand for renovations.

What this means is that they are forced to buy something that is move-in-ready and requires very little work, something new or freshly renovated. If buying new, there is essentially nothing that can be done to the property to increase its value other than the normal housing market trends, if buying newly renovated, you are paying for someone else's work and likely not getting what you want anyway.

What this means is that new home buyers and especially the young are essentially forced into buying something out of their price range in order to get something suitable, because they can get a loan for it.

I will explain just in case it isn't clear.

Say my wife and I have 45,000€ cash.

1 - If we buy a 200,000€ house that needs repair, we will have to use 30,000 to secure the loan which will be a max of 170,000, and only have 15,000 to do all renovation work.

2 - For the same 45,000€ cash, we could take a loan of 255,000€ and buy a 300,000€ home that while ready, will not appreciate much in value.

However, in the first house we would able to spend 80,000 on renovation minus the 45k deposit and have a loan of 235,000. But, we would also have a house that is worth closer to 350,000. We sell the first home and we make ~70,000 profit due to the sweat equity put in, we sell the second and we break even.

However, we are in a housing bubble, which means overpriced houses... well the new ones. Because of this loan restriction that doesn't allow for renovation costs, while beautiful old homes sit on the market unsold, brand new homes are getting bought up by those who have no other option as they do not have the cash for the repairs of a fixer-upper home.

This is insane!

Once that bubble pops, there are going to be a lot of people siting in loans that are at their outer limit in homes that are going to significantly lose value as the house of cards falls over due to the foreclosures. However, the renovated homes which will also depreciate will fall much closer to the purchase price plus the renovation costs and only lose the sweat equity component. This means that if an owner has to sell, they can cover their debt.

But, this is definitely a money begets money system as those with the means are able to purchase rundown homes, cover the renovation costs themselves and then flip it to someone who can't afford the renovations themselves so have to take a higher loan. So, someone that can't afford to do the work themselves is forced into taking a higher loan?

This is what I am now dubbing, the theft of sweat equity. Once upon a time (and our current apartment) a person with low funds could buy a cheap place that needed work, take a little extra on the bank loan to cover the cost of renovations, and put their sweat into adding value to the apartment. I did this for my first apartment in Finland which led to a profit 5 years later that allowed my wife and I to do it again in our current place, which we will sell and add more than 50% on the capital that we put in 5 years ago to get the loan.

Rinse and repeat. But, no. We can't do it again because the banks are essentially forcing us to take a larger loan on a place that requires no work, and unless we can come up with a great deal more cash, there is very little we can do... Well. Fuck that.

I am not going to have my ability to add value with my hands be taken away from me and we are going to do everything in our power to make sure that we do not have a large loan and still buy a place that we can appreciate in value through our work. While we were stretched before, this is going to likely take it to a new level, but if we can manage it, we should be sitting relatively well - it just might take longer as the renovations will be done piece by piece - which is not what we wanted.

This law is ludicrous, but now that I know it exists, it is obvious why there is a housing bubble, and obvious why when the recession hits, so many people are going to lose their homes. There is a surplus of housing and as older people with larger homes start to search for serviced apartments (aging population and these are now in shortage), their homes are unpurchasable as no one has the money to renovate them and they can't get a loan for the upgrades.

But, eventually the law will change again as people are pushed out of the new homes they can't afford and into older homes that are falling apart, and the housing market will swing again. Currently, I believe that the best value homes in Finland are the old ones that need work, but the catch is that you need to have the cash and skills to cover the cost of the renovations as the bank by law can't lend it to you.

For my wife and I, we are now contemplating how much risk exposure we are willing to take as in the old houses, there will nearly always be surprises of some kind and we will not have a renovation loan to fix them straight up. But, if we manage to make it through with fingers crossed, we could not only be in a better financial position when the next recession arrives, but we will also have built a home that we love with our own hands.

This is going to take a lot of work and financial discipline. We have a trip already booked for April, which will be our first in 4 years, and likely our last for a while too. But then, it is like any investment, there is an opportunity cost to every action.

However one looks at it though, this law is a pretty brilliant way to ensure sure those without, will never be with, as the law imposes an economic barrier on the ability to use one's own skills.

Clever pricks.

Taraz
[ a Steem original ]