Money Management and the Economy

Monday, April 14, 2008

Don't buy a house, Sell if you can

You aren't smarter than the market. It really is that simple.

Remember the adage, "buy low, sell high"? That applies to the real estate market too. This may be obvious to most people, but apparently not to the financial advice industry. Buying a house right now is a very high risk investment. In fact owning a home is a high risk investment, if you think your home is an investment.

Of course, most people don't own their home as an investment, they own a home to live in.  But the cost of owning one's own home the last couple years has been very high in most markets.  And unlike past situations where real estate prices fell, this one preceeded the onset of a broader economic slowdown rather than resulting from it. A weakening economy should push prices even lower in the short term. 

Long term, the situation could be worse. The market fundamentals such as rents, household income and historic rates of appreciation all indicate the current market is still overpriced even with its low interest rates. If interest rates go back up to more normal levels, or when they go up, housing prices are going to take another hit. People buy houses based on how large a payment they can afford. That is what helped create the current housing mess. And when interest rates go up, the price of the house they can afford goes down.

It may well be a decade or more before housing prices get back to where they are now, muchless the peak of a couple years ago. And in real terms, when correcting for inflation, it may take much longer than that.

Inflation is actually one of the positive indicators for people who own a home or are thinking of buying one. Because as the cost of other goods and services go up, the relative cost of housing should go up as well. That changes the market fundamentals by creating higher family incomes and higher rents. On the other hand, inflation also drives up interest rates.

So buying a home is a risky investment. But worse, for most people it is a highly leveraged risky investment. While "no money down" is largely a thing of the past, we are a long way from requiring the traditional 20% down to get into a home. If you put 5% down on a house and it loses 10% in value the first year, you have lost your entire "investment" and now owe the bank more than you have in the house. Fortunately, unlike with securities, banks do not make margin calls and demand you invest more. While people have benefited from that leveraging in a boom market, they are going to suffer as prices continue to fall.

What this means is that if you have found your dream home and realistically intend to live in it for 30 years, then buying a house may make sense. Your housing costs are protected from inflation and you get the benefits of owning the home you live in. In fact, current low interest rates make buying attractive for someone planning to hold onto their house and pay off the mortgage over the next 30 years.

But if you don't know that you will be staying in the house you buy or are thinking about moving out of one you already own, look for a good rental situation instead. Finding a good landlord may be easier than finding a house worth the price. If you intend to use your house as your primary retirement savings you might want to consider selling it and getting that money invested in something more stable. Your money will be safer in the stock market. If you want to speculate, try pork bellies.