Is It A Good Time To Buy Real Estate?

As I write it this, the national housing market seems to be recovering slowly, although it is showing signs of slowing down again.

But certain markets seem to be going crazy.

Southern California, where I live, is one of them and the real estate market is on fire right now.

I’m currently in the market for a house myself, and I’ve also received several queries from clients asking if it’s a good time to buy real estate.

My misgivings about the real estate market in Southern California have been building over the past year, during which time home prices (and rents) have jumped about 20-25%. Despite the rental price increase, it is cheaper to rent than it is to buy.

My major concern was that Private Equity firms bought more than 20,000 homes last year as investments.  While this forces prices upward in the short-term, I worry about what will happen if they decide to sell them all at once.

Private Equity firms are not long-term investors. Highly opportunistic, they’ll bail as soon as something else looks better. Even if nothing does, they probably will start looking to liquidate in about three to five years.

On the negative side, the median wage has been roughly flat for the past five years – and 11% of LA County residents are on food stamps.

Mortgage applications have also been declining every month for a year, as fewer people now qualify for mortgages.  However, this has been offset by an increase in the number of all-cash home purchases.

Currently, 30% of all home sales are to all-cash buyers. Based on anecdotes from real estate agents, investors and lawyers, it seems like there are a large number of rich business owners from South East Asia are looking to park money in the SoCal real estate market.

If history is our guide, then foreigners are more likely to invest in real estate at market peaks rather than market bottoms.

The last time we saw a large influx of foreign buyers was during “Baburu Keizai”, or Japan’s bubble economy in 1990. It was said that a square inch in Tokyo’s Ginza district was more expensive than a square mile of land in the US.

And it ended badly for Japanese investors.

With home prices reaching astronomical levels all over Asia, could it be we’re going to see history repeat itself?

Given this economic backdrop, why would I be willing to buy a home in this market?

Why would I be willing to tie up a major portion of my networth in an illiquid asset with uncertain prospects?

Why would I be willing to join the 39,000 foreigners who moved to Los Angeles County in the past year and maybe buy at the top of the market?

Why would I be willing to pay 20% more to own a home vs. renting it (even after factoring in the tax break)?

Why would I promote the current home-buying frenzy that has resulted in 87.8% of homes having multiple offers, and 53% of them selling for over the asking price?

Is it because I think home ownership is a good investment?

Do I think that paying 4.7% over list price and besting four other offers is the hallmark of a smart investor?

No, not at all.

The best reason to buy your own home is for your own personal reasons, not economic ones.

Despite what the media tells you, your home is not your largest investment. If it is, it just means you’ve done a lousy job of saving and investing for your future. Catherine Rampell over at the Washington Post has an excellent article on the “fetishization” of home ownership.

Over the past century, homes appreciated at 0.3% over inflation, and far, far less than the 10.11% of stock market returns.

Your home is not an investment. It’s a money pit.

You buy it because it provides shelter, warmth and a safe, stable place to raise a family. And especially for men (who become more grouchy as they get older), it provides a place to barricade themselves from their neighbors!

Your home is your largest liability, and should be treated as such.

As a liability, you need to make sure you don’t become house-horny and bite off more house than you can afford. (House-horniness is an emotional condition that stems from lusting over champagne homes on a beer budget, and often results in misery: source Dr Housing Bubble)

Keeping your loan balance under 3.5 or 4 times your annual household income will help prevent becoming house-poor. (Ideally, you want it around 3 times household income).

When considering your purchase, don’t forget to include property taxes, insurance costs (which should also include an umbrella policy), HOA fees or maintenance, and larger utilities & water bills.

Since you can no longer complain to your landlord or building supervisor if something breaks, it’s now your responsibility to fix everything. So count on additional headaches too.

As embarrassing as it is to admit that we got in to a small bidding war during what’s possibly a market peak, at least we are in a position to afford it and not be house poor.

And unlike the previous bubble, I can take solace in the fact that I’m competing with all-cash buyers and not minimum wage workers with NINJA loans (No Income, No Jobs or Assets).

But that still doesn’t make it a good investment!

The point is not to confuse a home purchase with an investment.  Unless you’re planning to rent out all the spare bedrooms and cover all your costs. (Something I would have considered if I was 20 and single).

With an investment, you expect to make money, either through regular dividends or interest payments, or when you sell.

With your own home, the best you should expect is to break even when you sell (after considering inflation and opportunity costs).

I don’t expect to sell this home for decades, but when I do I know inflation will have boosted its value. It’ll probably sell for five times it’s currently worth – but that will be because everything will cost five times more, not because it’s a great investment.

So if you’re in the market for house as well, make sure you buy something that won’t make you house poor and because it’s the right time in your life to make that sort of long-term commitment.

Also be cognizant of the fact that you could be living in your house for a lot longer than you realize.

If property prices drop you could find yourself underwater with no down payment for a larger home. Alternatively, if the economy recovers causing a spike in interest rates, you might not be able to afford a bigger house with the larger mortgage payment.

Owning a home also limits your mobility in terms of future employment opportunities.

But so long as you have a stable job, can afford the payments and are okay with the possibility of having to stay put for longer than expected, you should be fine.