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Buy Now?!?

Let’s look and some numbers and see if there is any truth to the statement, “now is a great time to buy if you own a house in this market and want to move up into a more expensive home.” The theory is that equity gain by buying the new house at the same discount as he is forced to sell the current house creates instant gain. Let’s see how it pans out if we apply some numbers to it. Simple numbers, we’ll ignore transaction costs in the first round and we assume that he is willing and able and does not want to move into a rental. I haven’t looked at this before so we’ll see where it goes.

Joe lives in a house that he paid $200,000 and is now “worth” $300,000. He wants to buy a $500,000 house. He has $100,000 in equity. He lists the house and sells it at a ten percent discount at $280,000. He then turns around and buys the $500,000 for the same 10% discount at $450,000. He’s moved up and has created $30,000 (he gained $50,000 on the purchase but lost $20,000 on the sale).

In its most simplistic form, is that correct? We’ve ignored transaction costs. He’s got $130,000.

Let’s move in some more realistic facts of the transaction. He paid 6% commission on the sale ($16,800). He needs $90,000 for 80/20 conventional loan on the $450k purchase so we’re $23,200 ahead and now has $90,000 in equity in the new house where he only had $80k in the old house. ($130k-$90k-$16.8k=$23,200). Closing costs eat up another $6000 so now $17,200 ahead.

Unless I have missed something (entirely possible), we can say that he has more equity, has moved into a nicer house and has a 30yr fixed loan and a pretty good historic rate. We don’t know if he dumped an ARM that is about to reset or traded across so we don’t know if he took a big hit in payment or not. If he had a $150k loan at 6% (simple numbers) his payment would have been $900. Same theory it is now closer to $1500 all other things being equal.

Joe is happy?!? It looks like it depends. He can’t tell where the market is going to bottom out. If it drops more, he would have done even better by waiting. If it goes up, he starts gaining. Since he is already in the market, it works differently than for someone that is not. In 2005 many said they couldn’t sell during rapid appreciation and move up. Looks like they can now.

16 Comments on “Buy Now?!?

  1. The qualifier that the scenario is only for those who already own makes it almost meaningless.

    That’s what I find so frustrating about the housing bubble lovers. They act like we live in a static culture where everyone already owns a dwelling. They discount the effects their house price appreciation has on those wanting to buy such as the young people starting families. You can’t dismiss them as simply having sour grapes for not having bought pre-bubble. They were in high school.

    The bubble-lovers aren’t thinking of anyone but themselves and as such, no one should really care if they get burned or have to watch their equity evaporate.

  2. 2000 census says that of 223737 housing units, 124767 or 55% of them were owner occupied. Is it meaningless to them?

    Naysayer is right that it ignores a large segment of the population but I don’t read his comment as arguing the premiss of my post. I’ve never stated that real estate is universal.

  3. Ok, well, perhaps the thread should be titled, “Is it Time to Move Up?”

    Time to buy as it is most often used refers to new buyers.

    Not to be argumentative. 🙂

  4. What about people trying to buy their first home? All sign seem to point to wait at the moment.

  5. I love this real estate math. Because its “worth” more than you paid, you must have made money. This is the kind of thinking that gets people in trouble. A house is only “worth” what it can be sold for. The “discount” is an illusion. Just because a house might have sold for $500k 12 months ago, when even your dog could get a mortgage, that doesn’t mean its “worth” that much now. If you can’t sell the house for $500k, then it isn’t “worth” $500k, so you have created nothing.

    And last time I checked, 10% off of 300k leaves 270k, not 280k.

    Cheers

  6. Monty is right. My morning math is off. So that changes my figures to $7200 ahead. “Worth” has to be illustrative here. There has to be an anchor to do the “real estate math” from. What if we say that the discount is 10% less than what the same sellers would have sold for a year ago? Concept hasn’t changed, has it?

    My dog is disappouinted that you think he no longer qualifies. He was so dreaming of a new dog house. 🙂

  7. Fair enough about the anchor. My main point is that there is no inherent value in a house, and a lot of people get themselves in trouble thinking that there is, and that it never goes down.

    Presumably, this guy in your scenario isn’t doing you a $50,000 favor, so the house really isn’t worth $500k, or he would have sold it for that.

    I think a lot of people get this idea in their heads that because they could have sold for X dollars a year ago, that their house is somehow innately worth X, and that it inevitably must return to that point sometime soon. I have friends in Las Vegas paying a massive mortgage on an empty house because they think it’s “worth” the ridiculous valuation they got at the peak of the bubble, and, of course, they can’t get that much for it now. Who knows how much money they will throw away waiting to sell it for what its “really worth”. Completely crazy.

    By the way, I love your site. We are living out of the country now, but coming back to the area in a few months. So I am always on the lookout for news about the Portland market.

    Cheers

  8. We’re assuming Joe will be able to find buyers at $280K (or really $270K if it’s “10% off”). The plankton is dieing off right now and the fish are starting to look hungry… The “plankton” being the first-time buyers; the analogy being that plankton is at the bottom of the food chain and thus is needed for every other level of the food chain to survive – when the planton dies, eventually the fish die, and ultimately the sharks die. The first time buyers are having a tough time getting credit now and that will have an effect all the way up.

    But what if Joe is wrong and the market goes down another 10% and that house he bought for $450K would only find a buyer at $405K (and that after some months)? Or what if at the end of 2011 (assuming he’s buying now) it would only find buyers at 30% less ($315K)? You could argue that his original house also went down in value during that time, and yes, that would be true, but his monthly payment for the new place is quite a bit higher than it was for the old place – doesn’t the leverage work both ways?

    Take a look at Mish’s article yesterday entitled Housing: worst is yet to come. He points out that the subprime ARM resets are only the beginning. There are large numbers option ARM resets going out into 2011. Take a good hard look at that chart he’s got there and ask yourself if this is a good time to buy (or even move up – a 30% haircut on $450K is a lot more in dollars than it is for a $200K house – in fact, Joe already has an equity cushion of $100K if he stays in the first house and weathers the stom. Even if it goes down 30%, he will still be at least even). I think that it’s possible that we could see a 30% decline over the next 4 or 5 years. In some parts of the country the 30% decline over that period is virtually guaranteed at this point. The question is: will we see that here? I think it’s a possibility and I’d give it at least a 1 in 3 chance at this point.

  9. What Joe has actually done in this scenario is leverage up his risk exposure in an asset class that has just peaked at the very top of the largest bubble in living memory, with perhaps the notable exception of the Florida Land rush. Incidentally that was the last time we had such high levels of Interest only products being used – and as we all know that ended well once the Ponzi scheme it was collapsed.

    Now is the time to be downsizing risk exposure in this asset class if anything.

  10. Unless Joe is an investor, Joe should stop taking this kind of real estate “advice”. When people look at their homes as investments, they get into trouble. Your home is your home. Buy what YOU CAN AFFORD. Don’t think about or bank on price increases. Assume things will stay flat or even go down. Then buy what you want to live in no matter what the market does and hope for the best.

    Now if you want to talk investments, (plexes, apartment buildings, commercial land – retail, industrial, land, etc.) that’s a different stories.

    When Realtors confuse “home” with “investment”, and inexperienced home buyers listen, it’s the buyer who loses.

  11. This is “funny” math to put it politely …

    If Joe discounts his house by 10% and buys another house at a 10% discount, then it’s probably more honest to simply say that the market is down by 10%. It’s kind of funny to say that a house is worth $500K even though the seller could only get or was willing to settle for $450K.

    Once you have put it into more simple language like this, the math is more transparent, too. Joe bought his house for $200K and sells it for $280K, so he’s made $80k (plus any amount of principal he’s paid down, which you don’t seem to count in your scenario).

    He now takes the $80K and puts it into his $450k house. He still has $80k of equity. No money gets “created” in the process of buying a house. But what Joe has done is increased his leverage. Joe used to have a 29% stake in his house (80/280), but only has an 18% stake in his new house (80/450). So if his new house appreciates by 10% in the future, he’ll get a much bigger return on his $80K than he would have in his old house. Conversely, if prices keep dropping, his $80k stake will get wiped out sooner than it would have in his old house.

    Now when you start adding transaction costs, Joe’s outlook become less favorable. If Joe pays a 6% commission to sell his $280k house, his $80k profit dwindles to $63k. So he is actually worse off, not better off, after buying the new house.

    In addition, he’s going to start a new mortgage, which means that his payments will be almost all interest again, and he will pay down very little principal over the next few years. Joe has also tacked on a few years to his mortgage payments: If his previous house had 25 years left on the mortgage, and he buys his new house with a 30-year mortgage, he has just signed on for 5 extra years of mortgage payments. And since it’s a bigger loan, it’s more interest, so Joe loses again.

    There are good reasons for moving up to bigger and/or better living arrangements. But the idea that doing so will “create money” out of thin air is a misunderstanding. All you’re really doing by “moving up” is increasing your leverage, and that can work for and against you.

  12. What is not comprehended is that discounts may not be linear at all price ranges…Mid-end houses are likely to suffer less than low-end as people who buy them can afford to pay more. By moving up, he is entering a different market with different competition…

  13. Yes, buy now. Today. Even though the rest of the country is going through horrendous reversals of the housing market Portland will continue to defy the trend. Everyone wants to live here. The UGB will keep prices up. All the Californians burned out of their houses will make demand skyrocket.

    Did I forget anything?

  14. Did I forget anything?

    You forgot that the sun shines just like it is today every day of the year. 😉

  15. Why is Joe wasting so much money paying a ridiculous 6% commission when there are plenty of agents who will slap it in the RMLS for $500, which is all most “full service” agents do anyway. Oh wait, they’ll also put it on trulia.com for you, wow, thats workth 16K.

  16. I’m amazed that so many agents are still getting six percent, or that a new model hasn’t emerged yet that won’t gouge sellers. The coming housing crash will no doubt address that.

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