Buy a House Now? It Depends...

Submitted by Rich Toscano on February 27, 2011 - 3:31pm
Last week I discussed housing valuations -- how expensive local homes are in comparison to their historical relationship with rents and incomes.  To sum up the conclusions, San Diego homes in aggregate are right in the middle of the valuation range that has prevailed for the past thirty-odd years.  However, due to super-low mortgage rates, monthly payments on San Diego homes are substantially below their typical historical levels.

This article will deal with whether it makes sense, financially speaking, to buy a home in a market characterized by middle-of-the-road prices alongside dirt-cheap monthly payments.

The answer, as you might imagine, is that it depends on whether you care more about future change to prices or to monthly payments.  Below I'll discuss different circumstances under which buyers might care more about one or the other.  But first, I actually want to describe prospective changes for each.

continue reading at voiceofsandiego.org

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Submitted by SD Realtor on February 27, 2011 - 8:16pm.

I expect you to pay me my royalties in the next day or two for stealing my thoughts exactly. Very well written.

Submitted by moneymaker on February 27, 2011 - 8:51pm.

So Rich! When are you going to buy? I know it is a personal decision that depends on many factors, but I just have to ask, as I'm sure others are curious as well. I have a friend who has the means to buy, he will be financing, and I'm not really sure why he seems to be dragging his feet. It's not about the down payment, job security, FICO score, or anything else I can think of that might make some hesitate.

Submitted by MostlyLurk on February 27, 2011 - 10:21pm.

How close does the PITI have to be to the rental value of a particular house for it to meet the criterion below from Rich's article?

"You are buying a home that is reasonably priced on a historical basis compared to area rents."

What are the risks and benefits of continuing to rent, waiting for prices/monthly mortgage payment in the more overvalued areas to fall?

Should I be getting myself used to the idea that there are some neighborhoods where I might be better off renting versus buying over the long term (more than 10 years).

It would be awesome to have the historical data for rent vs monthly payment for specific neighborhoods.

Submitted by saiine on February 27, 2011 - 11:26pm.

MostlyLurk wrote:
How close does the PITI have to be to the rental value of a particular house for it to meet the criterion below from Rich's article?

"You are buying a home that is reasonably priced on a historical basis compared to area rents."

What are the risks and benefits of continuing to rent, waiting for prices/monthly mortgage payment in the more overvalued areas to fall?

Should I be getting myself used to the idea that there are some neighborhoods where I might be better off renting versus buying over the long term (more than 10 years).

It would be awesome to have the historical data for rent vs monthly payment for specific neighborhoods.

Sigh, I have so much to learn. Great article Rich.

Lurk, check this thread: http://piggington.com/historic_rent_prices - Not sure what you mean by monthly payment though?

Submitted by Rich Toscano on February 27, 2011 - 11:31pm.

MostlyLurk wrote:
How close does the PITI have to be to the rental value of a particular house for it to meet the criterion below from Rich's article?

"You are buying a home that is reasonably priced on a historical basis compared to area rents."

What are the risks and benefits of continuing to rent, waiting for prices/monthly mortgage payment in the more overvalued areas to fall?

Should I be getting myself used to the idea that there are some neighborhoods where I might be better off renting versus buying over the long term (more than 10 years).

It would be awesome to have the historical data for rent vs monthly payment for specific neighborhoods.

Yes, it would. Unfortunately it's a pretty subjective exercise. In some neighborhoods, it's probably not reasonable to expect rents to equal PITI (not after adjusting for opportunity cost of down payment anyway). But in some places it is, and in some we are already there. Sorry I can't be of more help on this question, as I just don't have the data... this is an area where everyone needs to do their own research. (Though anyone is welcome to share their research here. :-)

Submitted by Rich Toscano on February 27, 2011 - 11:48pm.

threadkiller wrote:
So Rich! When are you going to buy?

I won't be buying any time soon, but that really doesn't mean anything. I own a business, with employees, and have significant potential for income fluctuations. I want to be able to rapidly scale back my expenses if needed, and it's just easier to do that as a renter.

So for now I'm not interested in owning a home, and that's the main reason why. That primary consideration has nothing to do with the market.

However, adding somewhat to the decision is that fact that I like living in Cardiff, which still seems to be pretty overpriced. So there's a bit of a sub-market consideration there. And it helps that I rent a house that I would be perfectly happy to live in forever.

Submitted by carlsbadworker on February 28, 2011 - 11:07am.

Rich Toscano wrote:
the future is fairly unknowable. Those who depend on a specific path for home prices do so at their own risk.

The future is always unknowable...at any point of time. But rational thinking is still pretty powerful to help guide the prediction. I only have one question on the housing market that I am unable to answer: what is going to happen to "shadow inventory"? Can it be absorbed in the normal housing up-trend or it is too big to be resolved without price drop?

Many discussions have been focused on the effects of government inflationary policy and their willingness to go further. But I have still not got satisfactory answer to whether the government can use its power to resolve the problem of "shadow inventory"...if it exists at all. Now that the stimulus money has went away and sales have dropped...I don't care about the resulting price of the home that much...but I do wonder if the sale volume is higher comparing to the default volume?

P.S. Did some quick research and add a few more data points:
http://boombustblog.com/media/wpmu/uploa...
http://www.standardandpoors.com/ratings/...

Submitted by sdrealtor on February 28, 2011 - 11:45am.

I may not be in the majority but I dont beleivew it is too big to be absorbed. Construction of new homes has been virtually halted. I expect the "Shadow inventory" to gradually reach the market over the next 2 to 5 years (perhaps longer) on a slowly measured basis as it has for the last 3 years. Prices should continue trading in a narrow range (+/-) for the foreseable future. Expect more of the same. Its a long road back but we are heading back in the right direction.

Submitted by Rich Toscano on February 28, 2011 - 12:10pm.

carlsbadworker wrote:
Rich Toscano wrote:
the future is fairly unknowable. Those who depend on a specific path for home prices do so at their own risk.

The future is always unknowable...at any point of time. But rational thinking is still pretty powerful to help guide the prediction.

The full thought that you partially quoted was:

"with neither serious over- nor undervaluation to be our guide, the future is fairly unknowable."

I think it's pretty clear that I am saying that the future is a lot more knowable (though not entirely so, obviously) if there is an extreme over or undervaluation present.

carlsbadworker wrote:
I only have one question on the housing market that I am unable to answer: what is going to happen to "shadow inventory"? Can it be absorbed in the normal housing up-trend or it is too big to be resolved without price drop?

Many discussions have been focused on the effects of government inflationary policy and their willingness to go further. But I have still not got satisfactory answer to whether the government can use its power to resolve the problem of "shadow inventory"...if it exists at all. Now that the stimulus money has went away and sales have dropped...I don't care about the resulting price of the home that much...but I do wonder if the sale volume is higher comparing to the default volume?

P.S. Did some quick research and add a few more data points:
http://boombustblog.com/media/wpmu/uploa...
http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245286096914

I don't think there is a satisfactory answer... I just don't think it can be answered. Not by me, anyway... maybe by someone smarter than me.

I think there is a chance that not too much will come of it (that we'll have slightly elevated inventory for a number of years). But it's also possible that it will be much worse. I put this in the category of potential risks against which one would like to have a margin of safety, which (lacking said margin) weighs against buying if you care about price.

Submitted by researcher9 on February 28, 2011 - 1:06pm.

Rich,
In context of your article, what %age point you are taking as "very large down payment"? For a typical North County Coastal SFR price tag of around 800k, what would you consider as "very large down payment" ... would it 30, 40, 50 ... , 70 or 80% of purchase price (800k)?

Thanks,

Submitted by Rich Toscano on February 28, 2011 - 1:21pm.

There's no specific cutoff... the lower the LTV, the more benefit you are getting from the mortgage rate subsidy. Personally I would put as little down as I could without significantly raising the rate on my loan, but that's just me.

Submitted by SD Realtor on February 28, 2011 - 1:46pm.

I agree with the shadow inventory being absorbed over time as well. Typical forclosure timelines are what, 400 - 500 days correct. Also what many people do not have any clue about are bulk purchases. Look back at some of the loan programs that are made available to institutions for large bulk purchases of non performing assets and securities. The incentives are STAGGERING. A few weeks ago Rich had a link posted about an investment group that had just added an 800 million dollar purchase to a previous 400 million dollar purchase. Obviously not all of this is residential but some of it is.

So yes it is completely conceivable to me that shadow inventory will be less problematic then possible interest rate shock. Especially if you get interest rate shock prior to all of this inventory being digested.

Submitted by Scarlett on February 28, 2011 - 2:21pm.

We've heard quite a few reports - predicting that house prices will drop anywhere between 5 and 15% in 2011, most around 10%. Sounds suspicious that they agree at least on the price direction. Why would that be? My thought is, they KNOW. well, kind of. maybe the banks KNOW what changes will happend - perhaps the release of the shadow inventory? or specific changes in lending and so they are pretty sure about what would do the prices. In other words, it's not really a total guess, it's actually a very reasonable and probable assumption based on what they KNOW. But I wouldn't be shocked to see finally the shadow inventory put on the market and marked accordingly. I don't think they know that well how much the rates will become, and how people will react, and how the prices will be affected. People may simply shift to ARMs rather 30 yr FMR.

Submitted by sdrealtor on February 28, 2011 - 3:15pm.

Trust me when I say, the banks arent that on top of things and dont know WTF they are doing. All tehy know is how much they can afford to write off each year so the drip out the inventory via foreclosures and short sale approvals according to that.

Submitted by Rich Toscano on February 28, 2011 - 3:33pm.

Scarlett wrote:
We've heard quite a few reports - predicting that house prices will drop anywhere between 5 and 15% in 2011, most around 10%. Sounds suspicious that they agree at least on the price direction. Why would that be? My thought is, they KNOW. well, kind of. maybe the banks KNOW what changes will happend - perhaps the release of the shadow inventory? or specific changes in lending and so they are pretty sure about what would do the prices. In other words, it's not really a total guess, it's actually a very reasonable and probable assumption based on what they KNOW. But I wouldn't be shocked to see finally the shadow inventory put on the market and marked accordingly. I don't think they know that well how much the rates will become, and how people will react, and how the prices will be affected. People may simply shift to ARMs rather 30 yr FMR.

I think you're giving these people way too much credit. A more plausible reason for why they all agree is that it gives the professional forecaster comfort (and a certain level of career protection) to be in the company of other forecasters.

Submitted by speaker on February 28, 2011 - 5:03pm.

Rich said:
"And it helps that I rent a house that I would be perfectly happy to live in forever."

Well, that's the tricky part. I would love nothing more than to stay in my current rental forever because I love the location and the rent is cheap. However, the landlord has decided to sell the condo I live in so now I have to look for a new place to live. Your article has convinced me to look into buying right now, though.

Rich, there is one big issue right now that complicates things in regards to your post. By putting as little down as possible in order to take advantage of low rates (think FHA financing), the PMI payment has been increased significantly. For a 350,000 mortgage using FHA financing the monthly MI is approximately $270. Then once you factor in HOA fees (and Mello-Roos?) that reasonably low priced home is now very expensive to own and much more expensive to own than to rent the equivalent.

Submitted by researcher9 on February 28, 2011 - 5:35pm.

speaker said:
"By putting as little down as possible in order to take advantage of low rates (think FHA financing), the PMI payment has been increased significantly."

I agree. I am in the same dilemma ... I think if you DONT have some savvy investment plan; where you can really invest the cash (that you saved by NOT putting towards a higher down payment), and generate some decent returns (atleast 5%) with minimal risks, then it DOES make some sense to move this cash towards down payment and lower your PMI. It sounds better than letting it sit in some savings/CD account yielding around 1%.

Submitted by Rich Toscano on February 28, 2011 - 5:54pm.

researcher9, a CD may yield 1% right now but what do you think the average CD rate will be over the the next 30 years? Quite a bit higher, I am guessing. You need to compare prospective return on that saved money over the life of the mortgage, not over the next year or whatever. (Not that a CD is an optimal approach over 30 years anyway... I know you weren't suggesting as such, but I want to make sure people don't think I am suggesting as such either!).

Anyway, your and Speaker's points about PMI are valid. Of course, you have to add up the numbers in your own area, including MR, etc. But 20% down would get you 80% financed at these low rates, and that is a hefty chunk of LTV, so if the prices were reasonable that would probably be a good approach.

On the other hand, the % that PMI adds is not too high, so in the grand scheme of things you are still getting a very low rate (ie low historical monthly pmt) EVEN if you take the PMI route.

Submitted by carlsbadworker on March 1, 2011 - 7:25am.

SD Realtor wrote:
I agree with the shadow inventory being absorbed over time as well. Typical forclosure timelines are what, 400 - 500 days correct. Also what many people do not have any clue about are bulk purchases. Look back at some of the loan programs that are made available to institutions for large bulk purchases of non performing assets and securities. The incentives are STAGGERING. A few weeks ago Rich had a link posted about an investment group that had just added an 800 million dollar purchase to a previous 400 million dollar purchase. Obviously not all of this is residential but some of it is.

So yes it is completely conceivable to me that shadow inventory will be less problematic then possible interest rate shock. Especially if you get interest rate shock prior to all of this inventory being digested.

You are giving institution too much credit. What are they going to do with the houses? They will not likely want to be landlord and the houses are back onto the market (even though not in form of foreclosure).

Submitted by outtamojo on March 1, 2011 - 9:07am.

Rich Toscano wrote:
Scarlett wrote:
We've heard quite a few reports - predicting that house prices will drop anywhere between 5 and 15% in 2011, most around 10%. Sounds suspicious that they agree at least on the price direction. Why would that be? My thought is, they KNOW. well, kind of. maybe the banks KNOW what changes will happend - perhaps the release of the shadow inventory? or specific changes in lending and so they are pretty sure about what would do the prices. In other words, it's not really a total guess, it's actually a very reasonable and probable assumption based on what they KNOW. But I wouldn't be shocked to see finally the shadow inventory put on the market and marked accordingly. I don't think they know that well how much the rates will become, and how people will react, and how the prices will be affected. People may simply shift to ARMs rather 30 yr FMR.

I think you're giving these people way too much credit. A more plausible reason for why they all agree is that it gives the professional forecaster comfort (and a certain level of career protection) to be in the company of other forecasters.

Dead on Rich, reminds me of this quote:
"A sound banker, alas, is not one who forsees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him".
- John Maynard Keynes

Submitted by davelj on March 1, 2011 - 10:42am.

outtamojo wrote:
Rich Toscano wrote:
Scarlett wrote:
We've heard quite a few reports - predicting that house prices will drop anywhere between 5 and 15% in 2011, most around 10%. Sounds suspicious that they agree at least on the price direction. Why would that be? My thought is, they KNOW. well, kind of. maybe the banks KNOW what changes will happend - perhaps the release of the shadow inventory? or specific changes in lending and so they are pretty sure about what would do the prices. In other words, it's not really a total guess, it's actually a very reasonable and probable assumption based on what they KNOW. But I wouldn't be shocked to see finally the shadow inventory put on the market and marked accordingly. I don't think they know that well how much the rates will become, and how people will react, and how the prices will be affected. People may simply shift to ARMs rather 30 yr FMR.

I think you're giving these people way too much credit. A more plausible reason for why they all agree is that it gives the professional forecaster comfort (and a certain level of career protection) to be in the company of other forecasters.

Dead on Rich, reminds me of this quote:
"A sound banker, alas, is not one who forsees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him".
- John Maynard Keynes

Yes, Chapter 12 of the General Theory... by far the most valuable chapter of the book.

In summary: "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."

Until that changes - and it never will - we will always have boom-bust cycles. Such is the nature of humanity.

Submitted by jeeman on March 1, 2011 - 11:00am.

Buy a stable stock paying a dividend that is more than your mortgage payment. Dividends are taxed at 15% federal, and you get to deduct the mortgage interest at your regular income tax rate.

Jeeman

Submitted by JBurkett19 on March 1, 2011 - 2:15pm.

Brilliant Article. Nothing was left out. Rich, you're the best.

Submitted by Rich Toscano on March 1, 2011 - 6:23pm.

JBurkett19 wrote:
Brilliant Article. Nothing was left out. Rich, you're the best.

Now that's my kind of comment. ;-)

Submitted by loutran on March 4, 2011 - 9:11am.

My phd economist wife read your article and confirmed my theory, you are the man!

Submitted by SD Realtor on March 6, 2011 - 10:48am.

Carlsbadworker how can you say I am giving the institutions to much credit? Obviously they have weathered the storm so far. Also do you want to comment on the profits that these same institutions have presented during this recession we are in? Clearly the institutions have done fine and clearly the govt is in their back pocket.

In a rigged game I put my money with the "house" not the public.

Submitted by Chunkymutt on March 7, 2011 - 2:21pm.

I've been lurking here for about two years or so, nice blog, very informative. Three years ago my wife and I made the decision to temporarily leave San Diego for an overseas assignment in Naples, Italy. We made the decision after we both decided that the housing market in San Diego was on "Charlie Sheen". We decided to leave, save, and return when the temperature was more favorable. Well, we're almost there. I'm not calling it a bottom...but more so moving towards normalization. We've looked at about 8 properties in the Carlsbad area over the last 3 weeks, all homes overpriced, damaged, claiming sq.feet with no permit, (in one case, for 500K you get a home with a roof that is splitting away from the home, the floor is buckled inside too (MLS# 110009360)-look at the south side from Google earth. My point, there is still a fair amount of silly stuff going on out there and the realtors have just changed their tune. What pisses me off the most, these realtors are the same group who convinced some people to buy in 2005, made a profit off that sale, now making another paycheck off of the sale of that same asset in 2011 now that that asset has been put back on the market. I have realtors emailing me telling me to drop my present realtor, other realtors telling me that "this is the bottom", "now is the time to buy", "let me show you the comps", "let me help you figure out what it is you want". What realtors haven't figured out is that buyers are onto the game. When buying a home, the buyer is trying to purchase the best product for the least amount of money. Across the table are people who need you to purchase a big heap of garbage for the highest price possible, the realtors, building inspectors, local municipalities, sellers, brokers, loan officers, banks, and any other parasite that makes money off of the sale of a property. -Buyers have figured out that everyone is against them, and if you were smart, when you hear any of the above give (you) some advice, do just the opposite.

Submitted by sdrealtor on March 7, 2011 - 2:40pm.

Or find one who isnt full of it. There are plenty of them out there but you absolutely need to be careful and do your own due diligence as well.

Submitted by carlsbadworker on March 11, 2011 - 3:25pm.

SDR, my point was the institutions are just like banks that who got the houses in the foreclosure process. They are not the ultimate owners of the house, so the inventory just got delayed but doesn't disappear from the market. Their financial strength is irrelvent (we can even say that for the banks after we got rid of mark-to-market).

Submitted by SD Realtor on March 11, 2011 - 8:17pm.

I understand however the facts are the facts regarding the way the liquidation of properties has progressed thus far. Left on their own, the institutions would have failed or been forced to liquidate. Look at all the measures that were taken to prop them up. There will be years of inventory to ultimately liquidate and there will be no rush to push it through the system.

What compelling argument can be made that shows there will be any change from the way things have gone thus far?

I recall posting back in 06 and 07 that people should not underestimate the power of those in power. Unfortunately it pretty much played out that way.

Why will it change?

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