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Personal Finances

If not now, when?

I don’t want those that read this blog to think I’m against buying real estate… I’m all for it, I just don’t think it’s a good idea to buy now.

If I had not been looking to buy last summer, I would have never dived into the numbers and ultimately started this blog. Up until then I pretty much accepted the idioms that real estate only goes up, and after seeing prices go so high, watching them come back down suddenly made them seem affordable.

Then you roll back the time frame a few years and, holy shit, you realize we’re ridiculously out of line with historical means… and then you start thinking there must be something more to the story… and for those who have been reading this blog for any length of time, you will have noticed I’ve been trying to tell it.

So, for those of you who were like me, my advice is this… wait.

Don’t try to time the bottom. It can’t be done without exposing yourself to extra risk and requiring a great deal of luck. The bottom will not be apparent until six months to a year later, maybe even more depending on how volatile the economy remains.

As they say in the investment world, don’t try to catch a falling knife. These prices are falling for a reason, there is not going to be another big run up immediately after bottoming out. The potential downside of prices continuing to drop is far greater then the small upside that would be realized from hitting the bottom perfectly.

This is just my take, but as a first-time buyer I’d rather pay a little bit more and know I’m buying an appreciating asset, then risk prices dropping another 50K, losing my down-payment and being trapped in the purgatory of negative equity for a decade.

Those that bought in 2007 are already there, I have several friends that took the plunge and they’re definitely taking a bath. It’s not a situation you want to find yourself in.

Speaking to those other potential first-time buyers out there, it is all about price and buying into an appreciating market.

The price you enter the market at will be felt throughout the rest of your life. No matter how successful those that entered during the bubble will be in future endeavours, their finances will never be as good as they could have been. That’s why bubbles are so dangerous, as much wealth as they may create, people tend to over-do it during the up-tick, and by time things have came back down to Earth more wealth is destroyed then was ever created.

The reason price at entry is so important is that all your future moves on the property ladder will be relative, you’ll be trading up based on the equity built up over time. That’s why being in negative equity is such a sticky situation, cause when you owe the bank more then what your house would sell for, even if prices of bigger places come down to a point you’d qualify to buy them, you’re not going anywhere.

You’ll probably buy bigger homes, probably carry bigger mortgages, but you’ll never made a more important decision then when to enter the market. And generally it’s pretty safe, for 20 years before 2005 it was probably fairly safe to buy-in at any time in there… but then we entered the bubble, and as people have been finding out, it’s now a very dangerous game.

Beyond that, most first-timers are not buying places they intend to stay in for every long. Often it smaller condo’s and town-homes and as they progress through life those are not enough to accommodate significant others and kids. These developments are coming hard and fast at those in their late 20′s – early 30′s, so often they only hold that initial property for only 2-5 years before trading up.

If you’re taking a 25 year mortgage on the place, you’re not making up much equity. After three years you’ll be lucky to have made up enough to cover your agent commissions and closing costs. After five years, you’ll have maybe that +5% (and god forbid you have one of those 30- or 35-year mortgages). So you need to make sure your home is appreciating.

To give you an example of how bad things can go, lets look at someone who bought an average-ish condo two years ago and is looking to sell. In spring of ’07 the “average” condo was going for ~$265,000, and lets say that person was smart enough to have 5% down and a 25 year amortization at 6% (the going rate at the time). So lets say they put ~$15,000 down, and finance the rest.

After two years they’ve made up $10,000 (actually closer to $9,200, but I like round numbers)… so they have $25,000 in equity, right?!

No. Problem is now the market rate for that condo is $227,000… and they still owe the bank $240,000.

They’re underwater for over ten grand, and we haven’t even factored in moving costs, realtor commissions and closing costs which is probably another 15 grand… and this was a person smart enough to have a down payment and not take a longer term.

If that person took a 0/40, that person would still owes that bank over $260,000, assuming they didn’t take the interest-only plan, which they might as well have for all they would have saved.

This is why I’m of the opinion that it’s really irrelevant how much someone thinks their house is worth, or how much equity they think they have in it. The only number that matters is how much you owe on it… everything else is trivial.

I’m also of the opinion that if you can’t pay it off in 20 years you probably can’t afford it… and if you can’t pay it off in 25, you definitely can’t afford it.

Anyway, end of rant.

Of course for the majority out there, they already have bought, and for those of you looking to trade up or down, it’s probably not a terrible time to buy actually, selection will never be better… just make sure you have the sold your old place before you even think of committing to another.

Like I mentioned before, for these people the property ladder is all relative… so if they overpay for their new place it really isn’t as big a deal since odds are someone overpaid for their place proportionately.

Though, if you’re looking to upgrade in a big way I might suggest holding off on that… cause if you’re living in a place worth $300,000, and looking at something worth $800,000, waiting until we’re closer to the bottom would be well worth it. All percent declines are not equal when it comes to nominal dollars, if the market goes down 10% sure your selling price would drop 30K, but your buying price would drop 80K… 50K is a pretty nice return for sitting on your wallet… and assuming we return to the mean, our drop will be a lot more then 10%.

And don’t get scared by the prospect of interest rates rising… because interest rates going up, forces prices down. What should scare you is the prospect of buying in at inflated prices and todays ultra-low interest rates… cause in five years you’d have little equity and the mortgage will be coming up for renewal, and if rates are high then, at that point you’re screwed.

So, long story slightly longer… here is what I’d look for to indicate the market is coming back into balance.

  • Prices have stabilized for six months or more
  • Absorption Rate consistently below 4
  • Active Inventory consistently in the 3,500-4,500 range
  • Sales consistently in the 1000-1500 per month range during non-spring month

If I had to guess a price range, I’d say look for detached home median prices to be $250,000 or less, and the residential average $210,000 or less. Now, this is highly speculative, but if I saw prices go appreciably below those, I wouldn’t be surprised if we overshot the landing and might see a small bounce back to the long-term mean… but I kind of think we’ll just sort of level off around there and prices will remain fairly stagnant for quite a while afterwords.

As I said before, my advice is wait.

We’re a long way from any of that happening in my estimation, so I advise taking some time now to learn about the market.

There is tons of inventory, so you’ll never get a better chance to see just what’s out there. Look around, you don’t need to buy. Go to open houses, or take a weekday afternoon off and tour a bunch of places. Learn what you like and dislike, and decide what you really want so that when it comes time to buy you’re going to make the right decision.