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I live in the NW US. I've been considering buying a house for some time now. But the market value of a house has been on a downward trend for years. I thought that around October last year the market had turned (and dramatically) but that turned out to be a bump related to an expiring tax credit. Since then, the market in my area is on a downward trend (-6.8% YOY if I recall correctly).

Currently, I'm renting. So I'm trying to decide when is the right time to buy when the market is trending downward, but may start trending upward.

Here's my thought process that I'd like some feedback on.

  1. By renting, I'm losing money that I could be applying to the principal on a home.
  2. However, only a portion of the total house payment actually goes to principal. I think in the first year or two, this portion is quite small.
  3. House prices are currently dropping and don't appear to be hitting an inflection point.

Based on those points, it seems like there really is a sweet spot (?). Here's my thought process: since house prices are dropping, the total principal that you'd pay is also dropping, so at some point the amount of principal payment that you lose by renting will be greater than the amount of principal loss due to loss in market value of the property. The loss is increasing at the same time the value of the property is decreasing.

So the optimal time to buy is when prices are at or past an inflection point and the amount of money that I'm losing by renting is greater than the amount of value that the house is losing (per year for both).

This assumes that when prices start to increase they will continue to increase until they level off to a rate of increase that's roughly equal to inflation -- i.e. no treble-dip in house values.

I'm also factoring out a) psychological benefit of owning your own property (dubious) and b) costs associated with owning a home that aren't present in rent or are factored in already. I'm willing to just let those two cancel out for the sake of argument.

The big question: is this sensible? Am I missing something? Ideally I want to find a "Go" point for buying a property and avoid being upside down in said property a year later.

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4 Answers 4

The rent versus buy question is a deeply personal one in which your personal desires for a living space need to be carefully combined with what makes economic sense. Do you want your own place with all the joys of having it be yours and all the pains of having to handle all the maintenance and be the one ultimately responsible? Have you tried living for a few months putting aside the amount required for not only a mortgage payment but the taxes and insurance on a house/condo in your price range to see if you can really afford it? You can use a real estate website such as trulia to see the assessments of some for sale homes and figure out tax values. The average home insurance in the US is around $900/year if I remember right - more for homes that are more expensive and less for less expensive ones, with flooding and other hazards as a factor. Make sure you can afford to pay for all these items.

From a financial perspective realize that you'll always be spending money on your living space. Even if you pay for a house with cash you will be paying property tax and maintenance and would be wise to continue paying for insurance. The value of the house at that point is, as contributor fennec often says, the rent you aren't paying.

I personally don't recommend trying to time the market. You can't predict the future - will real estate in your area be a double dip or has it bottomed and is it going up? What you can do is buy a home only when you are sure that you can deal with its relative lack of liquidity by staying there for a long time. Five years is usually a reasonable minimum.

There is a way that I recommend figuring out if it is likely bad financial decision to buy, and that's by looking at a financial comparison of renting versus buying. In some cases even with the bursting of the bubble it is still a bad deal to buy. DC went from renting being more cost effective to buying, but San Francisco is one area where buying is still not necessarily the best choice. To figure out what the case is for your area, look at the New York Times rent versus buy calculator. Find a home for rent on craigslist similar to what you'd look to buy. Find a home for sale on one of the MLS aggregator sites that represents something you think you'd like. Plug in the numbers. Figure out how many years you'd have to stay in your purchase for it to be a good deal.

In the likely event that the calculator says buy, start saving if that's what you really want. You're never going to be able to absolutely guarantee that you won't be upside down. What you can control is getting as much principal in that house as you can. The more you have, the less likely you will be upside down. Build a down payment now, reap the rewards later.

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Agreed. Trying to time the real estate market is like trying to time the stock market. Why would you have a better predictive powers than people who study this all day long as their full time job? –  Michael Pryor Mar 9 '11 at 22:13
    
It does seem reasonable to say that the rate of increase of property values will get back to normal someday. So this market correction will play itself out. I'm not necessarily looking for the "perfect" time to buy, but I would like to find a time that's more like "ok now the storm has passed and the numbers make sense, so go ahead and buy sometime in the future". –  jcollum Mar 9 '11 at 22:48
    
On a side note, the rent vs. buy calculator says that house prices would need to appreciate at 6% annually for renting to be worse than buying inside of a 6 year timespan. –  jcollum Mar 9 '11 at 22:54
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@jcollum - historically up until the bubble they appreciated at an inflation-adjusted rate of about 1% (not sure what the non-adjusted rate was). That's from Case-Shiller. –  justkt Mar 9 '11 at 23:11
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Last article I read discussing case Schiller stated that after inflation, housing, prior to the the bubble, had risen 6% over the 100 years prior. That's 6% for the whole period, not per year. The index started at 100, and was106 when the bubble kicked in. –  JoeTaxpayer Dec 6 '12 at 2:25

"the total principal is also dropping" - you mean you're paying it down, right? All else the same, if you found a house whose payments are less than rent, and planned to stay long term, buying can make sense. But let's not forget the other costs and risks. How badly do you want to be a homeowner?

Adding image from another post here: enter image description here

This shows that housing prices have fallen below the long term trend line and equilibrium level.

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No, since property values are dropping the cost to buy the house is decreasing over time. When you buy a property the principal will be locked in, but if you delay buying that principal is dropping (currently). –  jcollum Mar 9 '11 at 22:44

In Orange County (southern California), one agent has blogged pretty extensively about using rental parity to determine when it is time to rent or buy. Rental parity is achieved when the cost of renting is equal to the cost of owning; in theory, if you buy when a home is selling above rental parity, you're overpaying, and you'd be better off renting. He has many posts on the subject; a few you might care to read would be this one, and this other one.

You might get a better sense of how to calculate rental parity by looking at an example or two. There is also the NY Times calculator mentioned in other responses, and the Patrick.net calculator. Be aware, the calculators are garbage in, garbage out. In other words, you have to consider the input carefully. In particular, I found the defaults on the Patrick.net calculator were not realistic. So far as I am aware, the agent at OCHousingNews does not make his calculations public (though I have never actually asked). He's using a spreadsheet which I have never seen. That is another option, if you care to do this kind of analysis yourself. Search around, you can find a spreadsheet that someone has posted here and there. But keeping something like that updated is not trivial.

In my experience, in practice, it's difficult to be totally rational and mathematical when it comes to many decisions, and as other respondents have noted, where you live is one of those decisions. Too, saying "buy when rental parity is achieved" is sort of like saying "buy low, sell high," as though it were perfectly clear when stocks are at a bottom and/or a peak.

In our case, we bought a house about 12 years ago, before rental parity was being discussed in the blogsphere. Looking back, we supposedly bought at the wrong time, according to that agent's rating system, but it turned out fine for us. Our house has appreciated, whereas the S&P 500 is basically where it was 12 years ago. Had we been thinking in terms of rental parity, we might not have bought at that time. Of course, your mileage may vary, and hindsight is always 20/20.

I think the most helpful advice I can offer was something I got from a real estate agent around the time we were looking. He told me "when you're looking at houses, be sure you like the floor plan and the location, because those two things are not easily changed." That advice really helped us to see things more clearly.

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The ultimate purpose of Case-Schiller is to build contracts that you can use to stop worrying about this, for a price. You or your lender might buy cash settled put options based on the index, and hope that if your home falls in value, the your options become "in the money" to make up the shortfall.

The major problem that I can see with this is finding people to take the other side of that contract. Renters would be the primary candidates, but Americans are on average so overweight in real estate that there really isn't anyone underexposed to real estate who would benefit from diversification, and the tax advantage will give people far cheaper avenues address this.

Viewed in this light, your question has a sort of obvious answer: Case-Schiller is historical data, and you need to know about the future historical data. Case-Schiller can't do it alone, but you can use futures markets to predict it. Problem you'll have is that the market itself will optimize this temporal trade: if there's a market drop anticipated, the market will charge you more for market drop insurance.

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