Author Topic: Get Rich With: A Mortgage!  (Read 11187 times)

elysianfields

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Get Rich With: A Mortgage!
« on: April 27, 2012, 05:49:51 AM »
OK, I know it's bold of me to question received wisdom, and with my first post no less.  But before you all wig out on me, read on, perhaps there's a method to my madness.

First of all, I'm still working in the US Foreign Service; my family and I are posted to a US Embassy in South Asia.  Because I'm assigned overseas, my employer provides us rent-free housing, a significant benefit to our family of four.

Meanwhile, we're renting out our SFH in Northern Virginia which we bought in 1998 (we should have bought 15 comparable houses back then).  In the interim, real estate prices in our area tripled, then plateaued during the Great Recession.  Rents, however, are heading up.  Ours is at the point now that, were we reassigned to Washington, we would have to give up a significant income stream to move back into our house.  We made an excellent decision buying this property, but admittedly we were also very lucky.

We most recently financed a month ago, taking out - wait for it - a 30-year mortgage at 3.5%.  We also went whole-hog, borrowing the maximum ($417,000) for a conforming loan.  We also have a home equity line at Prime Rate minus 0.5%, or 2.75% right now.  We use the HELOC as our "springy debt" source of emergency cash (cf. http://www.mrmoneymustache.com/2011/04/22/springy-debt-instead-of-a-cash-cushion/).

So why did we bother with such a big, long mortgage?

First of all, this is likely the cheapest you can find anywhere.  Since we're in the 25% Federal and 5.75% Virginia tax brackets, the after-tax rate is a measly 2.42375% after taxes.

Long-term, we believe that tax rates are headed up, so we appreciate being able to protect a good amount of our income from taxes.

Furthermore, we save like fiends and fervently believe that we can make more than 2.42375% in the stock market over the next 30 years - heck, there are plenty of quality stocks with dividend yields higher than that right now.

Also, by getting our home equity out of the house, we're actually increasing our liquidity and flexibility.  We also have some cash to cover any unforeseen home expenses or to purchase the next house if/when we serve in Washington.

Finally, whether we continue to work or not, we only need to make the next month's payment; keeping that cash / equity out of the house puts us in the driver's seat with regard to investment choices.

In short, we think this mortgage will help us create more wealth more quickly than we otherwise would.  A best-selling financial planner thinks the same thing (cf. http://www.ricedelman.com/cs/education/article?articleId=232) and the Journal of Financial Planning and other academic analysts opine the same.

Heck, even MMM admits that "when it comes to mortgage debt, [he's] a man of contradictions (cf. http://www.mrmoneymustache.com/2012/04/25/unlocking-your-home-equity-for-profitable-investments/).

I look forward to your critiques / comments.  Cheers!

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #1 on: April 27, 2012, 09:02:11 AM »
Heck yes!  I completely agree with you.

The anti-debt crowd won't like it, but the money is so cheap right now.  If you are careful not to over-leverage, it's such a powerful tool.

And when interest rates rise and you can put money in a CD at 6%+, who the heck's gonna pay off a mortgage at 3.75% instead?  One will be wishing they had an extra few hundred thousand at those cheap rates.

Leverage is a powerful tool if you have the discipline and intelligence to use it wisely.
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Sparafusile

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Re: Get Rich With: A Mortgage!
« Reply #2 on: April 27, 2012, 11:36:37 AM »
Can you broadly define "over-leverage"?

velocistar237

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Re: Get Rich With: A Mortgage!
« Reply #3 on: April 27, 2012, 01:07:11 PM »
I refinanced to a 15-year loan last year. Rates have dropped even more, and I've learned a lot about personal finance since then. I'm tempted to refinance again... back to a 30-year loan.

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #4 on: April 27, 2012, 03:50:42 PM »
Can you broadly define "over-leverage"?

That's a good question and one that will depend on each individual (specifically their risk tolerance and ability to handle problems).

I do think leverage is more dangerous at certain times than others.  Volatility especially makes leverage dangerous.

I know that's not very helpful, so I will try to make up some parameters that may fit a broad definition for you, but don't hold me to it.  Here goes...

In real estate, I would be comfortable using 100% financing (i.e. nothing down) for a single property or two.  After that, having some equity put in is likely a good thing.  I personally put down 25% on my rentals.   I feel like a 75% LTV (loan to value) is fairly comfortable/safe.  That does depend on the environment, of course.  Anyone who put 25% down in 06 got wiped out.  I feel in today's market it's unlikely to drop another 25%+.  In addition, I'd only be comfortable doing that in a property that cash flows quite a bit.  If my properties go down in value, but they're making me a nice income stream, what do I care what the paper value is?  That makes me more comfortable using leverage.

If I was flipping in a volatile market, I'd pay cash.  To prove it: I have two rehabs going right now.  I purchased both with cash.  I have multiple rentals.  They are financed.

If you can't afford to pay cash on a flip, and you use leverage, and the value of the property declines so suddenly you're selling for a loss, you can't cover the difference (because you used leverage), and you're in a bad spot, possibly having to hold a property you needed to sell with money that you needed tied up in it, etc.

A buy and hold that cash flows which you're planning on holding for at least 10 years?  That makes me much more comfortable using leverage, because if the values decline, you don't have to sell, and indeed, aren't planning on it.

All that said, and I've only barely touched on leverage for two tiny aspects of real estate (buy and hold and flipping).  Haven't got to many other aspects, or leveraging stock, or FOREX or anything like that...

Thus why I say what over leveraging is depends on your circumstances, environment, risk tolerance, etc.  I know it when I see it.  ;)   And I can answer more specific questions.  But a broad "what is overleveraging" is indeed tough to define, one should look at each individual situation.

Does that help, or is it about as clear as mud?
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arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #5 on: April 27, 2012, 03:55:24 PM »
I refinanced to a 15-year loan last year. Rates have dropped even more, and I've learned a lot about personal finance since then. I'm tempted to refinance again... back to a 30-year loan.

Here's a plan:   Refi to 30 year.  Keep paying the 15 year payment.

If you want, you can always pay it off in that same 15 years.  If at some point you decide it's better to not, you can drop down your payment to the lower 30 year amount.  That will help in case of job loss, but also with the situation I described above (with CD rates).

For example, let's say you refi to 30 years, start paying down your mortgage (at, say, 3.75%) on a 15 year schedule.  Then in 3 years, interest rates rise due to action (or inaction) from the Fed.  Now CDs are paying 6-8%.  You can drop your payments towards that low interest debt down and send that extra money to CDs to earn you more than you're getting paying off the loan!

It's a more advanced move I would recommend to people who can control their spending.  Most people would take the extra money from only paying the 30 year amount instead of 15 and spend it.  If you have the discipline to save it, then it's a much better to choice to get the 30 year, because you always have the option to pay it off like a 15!  But it gives you more flexibility and security and options.
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Sparafusile

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Re: Get Rich With: A Mortgage!
« Reply #6 on: April 27, 2012, 04:52:00 PM »
Does that help, or is it about as clear as mud?

Yup :)

The only leverage I know about is on the commodities market. There it's pretty well defined. I appreciate the insight into real estate.

AJ

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Re: Get Rich With: A Mortgage!
« Reply #7 on: April 27, 2012, 05:55:54 PM »
Here's a plan:   Refi to 30 year.  Keep paying the 15 year payment.

I'm not advocating this, but:

If you subscribe to this logic why not get a 40 year loan? Rates are still very reasonable (4.25% vs 3.75% for the 30), and you buy yourself 10 extra years of "cheap money" for a measly half a percent.

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #8 on: April 27, 2012, 08:44:16 PM »
Here's a plan:   Refi to 30 year.  Keep paying the 15 year payment.

I'm not advocating this, but:

If you subscribe to this logic why not get a 40 year loan? Rates are still very reasonable (4.25% vs 3.75% for the 30), and you buy yourself 10 extra years of "cheap money" for a measly half a percent.

Sure, I think that could be a great idea.  For me, it likely won't matter, because I'm planning on refinanacing every so often (even at *gasp* higher future rates) in order to tap equity.  With home prices growing to (roughly) equal inflation, your 100k home, at 3% inflation per year, will be worth roughly 326,000 in 40 years.  That's money sitting I'd rather have access to.

Though your strategy might be good for if you are just having your one (primary) residence.

Refinancing works especially well with rentals.  Refinancing gets you money out TAX FREE. 

Here's an amazing strategy.  Say you have 24 rentals worth 100k each.  Rule of 72, 3% inflation means they double in value every 24 years.  You do a mortgage ladder where one is 30 years from paying off, the other 29, the next 28, etc. and so on down.  Each year, you refi the one that is closest to paying off to max out the term.  You gain all the untapped equity.  The next year, you refinance the next one, and so on, each year, until you get back to the first one.  24 years later.  By that time, it's approximately doubled in price.  You refi to take out 100k (in 2011 dollars) tax free.  The next year, house #2, which has doubled since you last refi'd it, you tap 100k in today's dollars.

Every single year your refinance gets you what the house is worth, in today's dollars, completely tax free.

As long as the rent covers the mortgage (and since rents rise with inflation, if you bought it right and kept it up, it should), you are gaining the value of one of the houses every year into your pocket tax free.  Aside from any cash flow the house itself provides.

I'd take 100k/year, inflation adjusted, just for filling out refinancing paperwork once/year.

...but that's a separate side tactic.
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Tyler

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Re: Get Rich With: A Mortgage!
« Reply #9 on: April 27, 2012, 10:05:44 PM »
Can you broadly define "over-leverage"?

IMHO - putting yourself in a situation where your potential financial liability is greater than your own cash investment.

AdrianM

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Re: Get Rich With: A Mortgage!
« Reply #10 on: April 28, 2012, 05:24:20 AM »
This is a great idea but not for the reasons you would think.

The beauty of arebelspy plan is that it uses inflation to pay back the money he borrowed with inflated dollars, but he gets to spend it now while it still has purchasing power.

This is all covered in the book secret mortgage power. I highly recommend this book for its out of the box thinking.
http://mortgagesecretpower.com/authorinfo.htm

I only wish that in Australia we too had 30 year fixed interest loans. Sadly the best we have is 10 year fixed for a 30 year mortgage.

Best of luck arebelspy

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #11 on: April 28, 2012, 07:54:12 AM »
Thanks for the recommendation Adrian, I'll check it out.
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elysianfields

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Re: Get Rich With: A Mortgage!
« Reply #12 on: April 30, 2012, 12:06:50 AM »
Thanks, Arebelspy and AdrianM, this was the kind of discussion I was hoping to have, and it's much more valuable than remonstrations of how debt is evil.  Debt is like a power saw: using it carries inherent risks, it should only be employed by a properly-trained user, and in competent hands the rewards can be tremendous.

I hadn't thought about a mortgage / refinance ladder, that's brilliant.  I must say that I'm not expecting significant inflation in the short or medium term, not with the economy in neutral and the Fed stuck at the 0% lower bound.  Also political realities - big banks are the largest creditors and of course heavy lobbyists - mean that the Fed will raise rates at the first whiff on inflation.

Since we're already talking about leverage, let's push the envelope: how do you feel about using margins on stock?

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #13 on: April 30, 2012, 03:07:36 AM »
Since we're already talking about leverage, let's push the envelope: how do you feel about using margins on stock?

This I have a less strong opinion on than real estate leverage (mortgage).  But here's my opinion, and maybe some others will chime in with theirs and we'll get some good ideas/discussion going.

In theory, I have no problem with the idea of stock leverage (margin).  In practice, I have a hard time thinking of a situation where using it isn't trying to time the market, which I don't believe one can successfully (other than getting lucky occasionally).

With real estate, if I were doing something short term (such as a flip), I'd use cash (and currently am) because of volatility in the market, short term leverage represents more risk.  I have no problem (and indeed encourage) doing a 30-year mortgage on a long term buy and hold.  Real estate does always go up long term (rising with inflation), so using leverage like that which gets paid off is prudent.

The market, which is even more volatile short term, has even more risk.  I believe it also is going to go up over time, but not necessarily in the short term.  The same reason I wouldn't leverage a short term real estate deal (or at least not much, I'd be able to cover it if necessary and using private money soas not to get "stuck.") is because I will HAVE to sell in the short term, and if the market is down, I'd be in a very bad spot.  With a 30-year, long term mortgage, the bank can't call your loan unless you're in default (aside from a few caveats, like the due on sale clause).

With stocks, a similar issue occurs in that a margin call can hit you at a bad time, and you're stuck and out a lot of money.  If there were a good way to leverage stocks over a long term and have no risk of margin call (literally they are not allowed to call it, not that the risk is just low, but does not exist), I'd be good with that. 

But trying to use leverage the way it exists now - where a margin call means you suddenly have to put in money no matter what, or risk losing your investment - is timing the market too much for me.  You're hoping the market doesn't go down in the short term.  I can't tell if it will or not.  Can you?  That's what you're saying you can do if you buy on margin.

Too much risk and volatility there for buying on margin to be tempting to me.

(And when I say "the market" that could be whatever you're invested in, be it futures, a single stock, whatever.)

Thoughts?
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gooki

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Re: Get Rich With: A Mortgage!
« Reply #14 on: April 30, 2012, 03:46:32 AM »
But trying to use leverage the way it exists now - where a margin call means you suddenly have to put in money no matter what, or risk losing your investment - is timing the market too much for me.  You're hoping the market doesn't go down in the short term.  I can't tell if it will or not.  Can you?  That's what you're saying you can do if you buy on margin.

Just to chime in here from someone who is a big advocate of paying down debt. I agree 100% with the above.

I assume you have a fairly large net worth, so low cost debt is low risk for you. You're obviously not going to fritter it away on consumer goods. But I would recommend sticking to low risk investments. Or at the very least if you are buying stocks DIVERSIFY, and be in for the long term.

High risk investing is for money you can afford to lose.

Medium risk investing is for money you can tie up long term.

Low risk is for money that isn't yours (a roof over your head, smart rental property, term deposits (my bank is offering 5.5% for 5 years, but exchange rate fluctuations would make this risky for anyone outside my country)).

I will sum up - when it's not your money you're investing, don't get greedy. Be happy with just 2% growth above the interest rate you're paying.

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #15 on: April 30, 2012, 07:46:00 AM »
I agree gooki. 

To give another example to your point: When I do 0% balance transfers, I stick the money in a no-risk (insured) low interest rate account.  Doesn't earn a whole lot, but it'll be there when I need to repay the balance when the promotional interest rate runs out.

I could try to earn more by putting it in stocks or something like that... but again, that's timing the market and hoping it doesn't go down in the short term, which I'm not a fan of.
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elysianfields

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Re: Get Rich With: A Mortgage!
« Reply #16 on: May 02, 2012, 11:56:01 PM »
Thanks for the input, folks.

I admit that, while I never use the full 50% margin available on most stocks, I do use a wee bit from time to time as a method of "pre-saving" and in lieu of making regular purchases.

If I've identified a stock that I think is particularly cheap right now and I have insufficient funds in my account to cover the size of the position I want to open, I'll buy it on margin.  I won't do this with more than one stock, and I'll use only up to the amount I think I can pay down in a year.

If you think about it, purchasing stocks on a monthly basis through most brokerages is either impossible or expensive.  My strategy allows me to purchase a stock I've identified, at a price I like, and then pay back into my brokerage account on a monthly basis, as if I were making monthly purchases.  Like a 30-year vs. a 15-year mortgage, or a HELOC, it increases my cash available for other things and gives me flexibility with regard to time.  Moreover, the rate is dirt cheap - I'm currently only paying 1.66% on margin balances at Interactive Brokers.

Again, I'm glad to see a fruitful discussion of the possibilities, rather than the usual "debt=bad" or "margin=very evil" I see elsewhere.  In fact, it's difficult to find strategies which utilize margin in a judicious way; most web postings about margin assume you're going to go for 100% leverage and thereby lay waste to your portfolio.

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #17 on: May 03, 2012, 07:29:56 AM »
An individual stock?  Yikes.

The leveraged permanent portfolio experiment on the ERE forum intrigues me.  Your idea scares me.

:)
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ShavinItForLater

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Re: Get Rich With: A Mortgage!
« Reply #18 on: June 14, 2012, 04:15:41 PM »
What would happen if the market crashed again, and then you lost your job?

arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #19 on: June 14, 2012, 07:06:58 PM »
What would happen if the market crashed again, and then you lost your job?

I assume this is addressed to elysian?

Not sure if you're referring to the main topic (mortgages) and talking about if the housing market crashed and one lost their job, or if you're talking about the brief discussion at the end about leveraging stocks.  So I'll just address both.  ;)

In the first case, if you're cash flow positive, you don't care about a market crash or losing your job.  In fact, it would help with the latter, as it'd be bringing you in some cash.  One may counter "well what if real estate crashes, you lose your job, AND your houses are empty."  Okay, a few things. 1) You should have cash reserves when having rental houses. 2) You should be able to support a below market rent and be cash flow positive, so you can get them rented immediately.  So this idea of them being empty shouldn't be a huge problem.

In the second case (stocks), you're correct that a market crash could lead to bad times (ala margin call).   Thus my own opinion on the idea:
Quote
But trying to use leverage the way it exists now - where a margin call means you suddenly have to put in money no matter what, or risk losing your investment - is timing the market too much for me.  You're hoping the market doesn't go down in the short term.  I can't tell if it will or not.  Can you?  That's what you're saying you can do if you buy on margin.

One doing this strategy would dismiss your concern because they think they can time the market, and wouldn't worry about it crashing.

Naturally the idea of "market crashing timed with job loss" is a risk with either one.  It may be riskier for some than others (union jobs, those who run their own business, or have other high forms of job security, may not have to worry about losing their jobs), and risker for stocks than real estate (where you have to put in money in case of a margin call, versus still being cash flow positive).

But I think it's a risk anyone doing this would have considered, and dismissed.  Either because they know the risks, and act in spite of them (because they deemed the potential upside is worth it), or because they're plain old gambling, so they dismiss all risk.
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smedleyb

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Re: Get Rich With: A Mortgage!
« Reply #20 on: June 14, 2012, 08:02:49 PM »
I think buying real estate today is like buying stocks in 2009.  In think buying stocks in 2012 is like buying real estate in 2005.


arebelspy

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Re: Get Rich With: A Mortgage!
« Reply #21 on: June 14, 2012, 08:12:10 PM »
I think buying real estate today is like buying stocks in 2009.  In think buying stocks in 2012 is like buying real estate in 2005.

I agree with the first.  The second I think you're WAY overblown, huge amount of hyperbole.

RE in 2005 cut in half from that peak.  You think we'll see a 50+% haircut on stocks in the near future?  I.e. going from DOW 12652 (today's close, rounded) to 6326 in the (semi)near future?

That would be lower than the lowest point in 09 (when it hit 6547.05 on March 9, 2009).  Even if you think it's headed lower, or even for another crash, do you truly believe it will be worse than 2008, and equities will cut in half or worse?

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Mr Mark

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Re: Get Rich With: A Mortgage!
« Reply #22 on: June 14, 2012, 09:40:16 PM »
Buying the market with leverage seems analogous to having a negative bond ratio in terms of asset allocation. So more volatility for lower long term returns.

smedleyb

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Re: Get Rich With: A Mortgage!
« Reply #23 on: June 15, 2012, 12:31:47 PM »
I think buying real estate today is like buying stocks in 2009.  In think buying stocks in 2012 is like buying real estate in 2005.

I agree with the first.  The second I think you're WAY overblown, huge amount of hyperbole.

RE in 2005 cut in half from that peak.  You think we'll see a 50+% haircut on stocks in the near future?  I.e. going from DOW 12652 (today's close, rounded) to 6326 in the (semi)near future?

That would be lower than the lowest point in 09 (when it hit 6547.05 on March 9, 2009).  Even if you think it's headed lower, or even for another crash, do you truly believe it will be worse than 2008, and equities will cut in half or worse?

The RE market did not peak in 2005, but rather a year later, and another 10-15% higher, before prices collapsed.  I think stocks today are on a similar trajectory.  It's not a perfect analogy, but the point remains:  anyone who thinks their money is "safe" in the market at these levels over the next 5 years is in for a major disappointment. 

Another reason the analogy is imperfect: stocks exploded higher in 2009; I suspect RE has hit a bottom but I do not expect prices to snap back like stocks did. 

MrSaturday

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Re: Get Rich With: A Mortgage!
« Reply #24 on: June 15, 2012, 01:02:19 PM »
It's not a perfect analogy, but the point remains:  anyone who thinks their money is "safe" in the market at these levels over the next 5 years is in for a major disappointment. 

The market has never been "safe" for people investing with a 5-year time horizon.

All my holdings from 2007 are still doing just fine, despite the huge crash in 2008.  I'd imagine they'll probably be fine in 2022 even if there's another crash in 2017.

Praxis

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Re: Get Rich With: A Mortgage!
« Reply #25 on: June 18, 2012, 12:13:51 PM »
I think buying real estate today is like buying stocks in 2009.  In think buying stocks in 2012 is like buying real estate in 2005.

I agree with the first.  The second I think you're WAY overblown, huge amount of hyperbole.

RE in 2005 cut in half from that peak.  You think we'll see a 50+% haircut on stocks in the near future?  I.e. going from DOW 12652 (today's close, rounded) to 6326 in the (semi)near future?

That would be lower than the lowest point in 09 (when it hit 6547.05 on March 9, 2009).  Even if you think it's headed lower, or even for another crash, do you truly believe it will be worse than 2008, and equities will cut in half or worse?

The RE market did not peak in 2005, but rather a year later, and another 10-15% higher, before prices collapsed.  I think stocks today are on a similar trajectory.  It's not a perfect analogy, but the point remains:  anyone who thinks their money is "safe" in the market at these levels over the next 5 years is in for a major disappointment. 

Another reason the analogy is imperfect: stocks exploded higher in 2009; I suspect RE has hit a bottom but I do not expect prices to snap back like stocks did.

Housing being at a bottom is only a side benefit to me; the borrowing rates are the big key!  They're subsidized and way less than borrowed money should ever go for.  Snagging as many properties with mortgages as possible while no one can buy seems like the best move at the moment.  Plus, taxes.