I've received a great deal of email since I shared my house-hunting experiences with you good folks back in April. Many of the initial responses to our story of real estate woe expressed similar frustrations, though a few of you remain convinced that there will be no end to the climb in home prices (it's worth noting that about half of the latter responses came from real estate agents... hmmm).
More recently, however, folks have been checking in to see how our situation has changed, or hasn't, over the past seven months and what that means for my current outlook. So, I thought this would be as good a time as any to provide an update.
First off, let me say something that I didn't spend much time on in the last go-around: Everyone's housing situation is different. When I spoke of overvaluation in The Housing Frenzy, I was referring to the Washington, D.C., area and a few other large metropolitan markets. I don't mean to suggest that housing prices are overvalued across the country, because, well, they're not.
Indeed, there are still plenty of places out there where property values are quite reasonable (though they're mostly swamps, deserts, or the front row of a Vegas tiger act). If you're in the market and need help, the Fool Home Center offers a wealth of information and the latest mortgage rates.
Everyone has been focused on the housing market lately, what with interest rate wars and the news surrounding government oversight and accounting practices at Freddie Mac
Frankly, I don't subscribe to the whole bubble argument. Home prices are very location specific, after all, and the demographics are completely different from one area to another, facts that make such broad comments nearly worthless, if not alarmist.
That said, I still have very real concerns about prices in many urban areas across the country, and I think consumers have every reason to be as cautious with the purchase of their homes as with any other purchase that they make. I mean, hey, it's only the largest purchase that most people ever participate in.
Before continuing, I think it's important that you know a little more about what kind of person I am and a bit about my plans so you understand where I'm coming from. Here are a few personal factors that are influencing my housing decision:
- We are still familiarizing ourselves with the D.C. area, and are not yet committed to a specific location, which means the time we spend in our next home may be shorter, or longer, than we think.
- Financially speaking, my wife and I are fairly conservative people. Most often, we do buy what we want, but we're usually reserved with our spending, and we tend to save our money for larger things that we find particularly enjoyable (like travel).
- I've never paid sticker price for anything that can be negotiated, and I don't see that changing anytime soon.
OK, with those factors in mind, I'll let you know that my opinion of the current housing market hasn't changed. Despite interest rates being at 40-year lows, I still find home prices in the D.C. area uncompelling. So, let's get on with the reasons behind that opinion.
The housing market has cooled over the past seven months, but that really just means people are paying sticker prices instead of bidding homes insanely above their true value.
Housing is still subject to the rules of supply and demand, as is any other market. It's true that homes are not an optional purchase in the strictest sense, as people must have a place to live; however, where to live and what to live in are very much optional.
The rental market has been softening in the D.C. metro area over the past year, and this has created somewhat of a disconnect between the cost of renting and buying (rental rates are falling while home prices have remained relatively strong). Despite this, a steady supply of new properties is coming onto the market, particularly in the high-end, luxury category, which competes directly for the dollars of many first-time homebuyers.
These luxury apartment complexes are luring would-be buyers with favorable locations (which help to avoid a nasty D.C. commute), amenities such as pools and exercise facilities, and services ranging from dry cleaning to a concierge who makes dinner reservations or books tickets to a local play.
Indeed, my wife and I took advantage of this phenomenon when moving to D.C. back in February. Three "luxury" apartment complexes, located just a few minutes from the Fool's Old Town Alexandria headquarters, had opened for business within a few months of each other, and all three were offering substantial discounts to quickly build their occupancy rates.
In exchange for signing a 12-month lease (I figured it would take us that long to become familiar with the area anyway), we received two months "free," and paid no fees or deposits.
This is likely to widen the rift between renting and buying, and something will have to give. As is the case in New York and San Francisco, young professionals drive a big part of the D.C. housing market and competition for their dollars is growing.
To share a personal example, my wife and I recently considered renting a property within walking distance of the Fool (our lease ends soon). The home was offered either to sell or rent, so I had the benefit of comparing the monthly payment on these two options.
In this case, renting the property would cost 38% less than purchasing it (assuming an 80% first, a 15% second, a 5% down payment, 20% tax savings, and taxes of $506 per month for the City of Alexandria). One property certainly does not make a trend, but this example is holding true for many of the most desirable areas in Washington, D.C.
Also, generally, the more expensive the property, the more you can save as a renter. The reason for this is, interestingly, rents don't typically increase in direct proportion to an increase in the price of the home.
Some would argue, "What about the equity you're building when buying as opposed to renting? You're just throwing your money away as a renter." This is a common misconception, which is encouraged by many real estate agents and mortgage brokers.
The truth is, for the first five years, you're really throwing money away in either case (other than the fact that you're getting a place to live, that is). The only difference is where you're throwing it. Renters are enriching the owner of the apartment community, but buyers are enriching the bank that holds their loan (i.e., the true owner of the property).
Assuming you don't lose 15% of your principal value in the short term, the typical mortgage payer will own just 1% of his home after making payments for five years. That's hardly a significant amount of ownership when you consider the current cost savings and added flexibility of renting in this market, not to mention the fact that you're not putting a great deal of capital at risk.
If you actually manage to invest any of the money you save, you'll make renting that much more favorable.
Price still matters
In this "high-bidder" market, many have assumed that the price they're paying is what the home is actually worth. "Besides, someone else will just come along and snatch it up if we try to deal," they say. In this market, that's largely been true, but the problem is that someone else will only come along and snatch it up until there is no someone else.
And when that happens, prices aren't going to be so frothy anymore. Sticker price will be an exception again, as opposed to a rule, and gone will be the days of bidding $20,000, $40,000, or even $60,000 over what the seller is asking.
In the case of those folks who paid $60,000 more than the home is worth just to beat out competitors, what happens when there are no competitors? I'll give you a hint: The house starts selling for what it's actually worth again, and that means someone just lost 60,000 bucks in value.
Granted, it won't happen overnight, but those who think it won't happen at all are kidding themselves. Though home prices will never behave like that of stocks, prices in overheated markets such as Washington, D.C. and New York City could easily drop 15% over the next few years. That may not sound terribly significant, but on a $300,000 home, that's a drop of $45,000.
Could you afford to walk away with that kind of loss? Even if you could, I doubt you'd want to, and that means making some potentially life-altering decisions if it should become necessary for you to move, or if you simply want to.
And by the way, if you're thinking that an appraisal offered by the mortgage provider is proof of the home's real value, think again. These folks are motivated to close the deal, and usually the appraisal value is miraculously equal to whatever you're willing to pay.
Say it ain't so-so
Unlike the steamy housing market, the overall economy has been tepid at best. Despite some recent signs of life in the industrial sector, consumers remain more debt-laden than ever and the jobless rate has stubbornly remained above 6%.
In my first discussion on the housing topic, I mentioned that consumer debt being at all-time highs is a concern, and that hasn't changed. A recent report by Bill Dreher, a retail analyst with Deutsche Bank
A debt-laden consumer and a so-so economy don't bode well for housing prices in major markets. Indeed, we've been looking for a pickup in industrial spending to help take the burden of economic growth off the shoulders of the weary consumer, and there are signs that this is beginning to happen. But businesses don't typically buy houses, people do.
Increased industrial spending could decrease unemployment rates (though I doubt it, as efficiency gains have allowed businesses to do more with less), but interest rate increases loom within that scenario. Higher rates would take a big bite out of home affordability, especially when you consider that only a small portion of the population can afford the average purchase price in major cities now (as low as 20% in some areas).
The Foolish bottom line
Again, I want to stress that I'm speaking from my own personal situation, and what I've said here won't apply to everyone. For instance, I have a friend who just refinanced his mortgage, replacing a 30-year fixed with a 15-year fixed, which means he'll own his home free and clear in just 15 years. He's planning on being in the home for at least 10 years, perhaps forever, so short-term price fluctuations mean nothing to him.
If that's you, buying can still make all the sense in the world, but don't assume you'll make money at any price just because that's been the case for the past several years.
I have specific concerns about the markets in Boston, Boulder, Denver, New York City, Miami, Oakland, Sacramento, San Francisco, San Jose, and Washington, D.C.
The supporting logic for "getting in now" just doesn't hold water for me, and I see nothing wrong with avoiding some serious price risk by renting in the short term, if you share a situation similar to mine. Above all, be cautious, be wise, and be Foolish.
Mathew Emmert is discovering that, in this housing market, "bargain" means: a home in the middle of a flood plain. He doesn't own any of the stocks mentioned in this article, but he does write the Fool's latest newsletter, Motley Fool Income Investor . If you could use a little extra cash to make that next rent payment, consider a free trial. The Fool has a disclosure policy .
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