‘Conventional’ knowledge, until the last couple of months, was that home prices bottomed in late 2009. Recent data on home sales shows a local maximum in 2010 followed by a further decline – leading some economists to believe we are now in a “double dip” where housing prices will continue to decline in the immediate future. The most recent data point is from Zillow, estimating that (a record) 28.4% of all single family homes are currently underwater – meaning mortgage holders owe more than their house would sell for on the market. Full disclosure: I’m currently testing the real estate market on the buy side.
First, the Local Maximum
2010 saw the government’s first time homebuyer credit (if you qualified, you were credited $8,000 back at tax time when you purchased a home) affect some parts of the market – maybe even enough to arrest a temporary market downswing. The law was signed into affect on February 17, 2009 and worked when deals closed up until September 30, 2010 (after a few extensions). Now, $8,000 in credit in the same year doesn’t mean that all houses were priced $8,000 more than they otherwise would have been. A paper out of Duke has the numbers – the 16 market areas tracked averaged a 6.1% increase in prices from the credit – which of course was lost at credit expiry. Yes, the first time homebuyer’s credit was a huge success… at temporarily stopping the decline in home prices.
Furthermore, just like the Cash for Clunkers Bill, the credit may have taken used housing inventory off the market – since home prices were temporarily increased, buyers accelerated their purchasing schedule and sellers accelerated their selling schedule (the latter point is more important). On the margins, that would mean that houses sold immediately after the credit were of somewhat lower quality than the ones offered before – since the circumstances of the sale mean that the credit ‘exuberance’ is no longer priced into the sales. It may mean that houses which previously would have had buyers affected by the credit are more distressed if they have to sell immediately after. For reference, up until recently the average holding time for houses in the United States was 6 to 7 years.
… And the Double Dip
So, here we are today, still feeling the lingering after effects of the huge housing bust. This time, there are fewer government programs artificially propping up the price of homes (although there certainly are programs still in effect – Fannie Mae/Mac are still around, the FHA is issuing many loans, the mortgage rate is being held extraordinarily low due to a few factors, and the tax code is written to encourage home-ownership). Are houses cheap? It depends on who you ask. For years, the National Association of Realtors has been publishing a “home affordibility index”. Even in the wake of the housing bubble popping, the NAR has never claimed that houses were unaffordable. In retrospect, that seems ridiculous – ask the people who purchased from 2004 – 2007 (and that goes for almost everywhere in the country!) and get back to me on that point.
Furthermore, home prices are declining in the midst of incredibly low mortgage rates, which are still below 5% on 30 year fixed mortgages in most of the country. We would expect that, absent other factors, home prices would actually be higher in low mortgage rate environments since the same payments can service more debt in a mortgage. However, those other factors are certainly revealing their import currently.
Back to me – why am I even considering purchasing in current market conditions, especially in a place like the San Francisco Bay Area? Or, more broadly, what would one look at if they were trying to buy a home?
- Contrarianism – like Marketwatch/WSJ’s Brett Arends, you might notice the number of housing bears outnumbers the bulls (or, they are at least louder!).
- Cash Flow – Will a house you purchase rent for a good amount immediately after purchase? An example – if you purchase a house for $480,000 and it rents for $2,000 a month, it’s returning (gross – tax, maintenance, vacancy costs and other factors do need to be factored in!) 5% a year in the absence of any appreciation… this is a marginal purchase. The same house renting for $4,000 a month suddenly becomes much more interesting – the ‘rent multiple’ is 10, or $480,000 / ($4,000*12) = 10. In reverse, you get the yield of 10%. (Get expected rent from City-Data, Redfin Demographic Info, Zillow Rent ‘Z’Estimates, and Craigslist)
- Your Personal Cost to Rent – This calculation is a bit more complicated, but, unless you have cash to purchase a house outright you have two options – rent a house or rent money (mortgage). Renting a house is an easy calculation – what is your annual rent divided by the cost of an equivalent house. Be sure to factor any and all HOA and additional fees into your calculation. If it’s over the cost of a mortgage, so currently 5%, you are in the marginal purchase zone – but it may be safer to tack on at least another percent for insurance/maintenance, etc. Let’s call the rule of thumb 1.5%… so if you can get a 5% mortgage, you’d want the rent cost to be at least 6.5% before you even considered looking around. For more complicated examples, including ones where you assume home appreciation and rent increases, try a calculator such as this one at the New York Times.
Don’t forget rents can fall too, so nothing is fool proof… and I’m also not a personal financial advisor so take it all with a grain of salt! However, I’m interested in your thoughts as well – are you considering buying? Renting? What’s your thought process? Are we in a double dip?