I was wondering what your thoughts were in regards to buying a home today. What is your outlook for the housing market? We have seen prices jump recently and I was wondering if you think this will be a trend in 2013. Do you really think it is safe to buy a home as a good investment?
Ana – Morgan Hill, CA. December 10, 2012
Ana, this is a common question I get and no doubt one that is asked throughout the entire United States.
I can say for certain that nobody knows exactly what will happen in the future, but with some solid research, one can come to a pretty sound prediction.
For several years, when this housing crisis started, I stated numerous times in my radio programs and articles that buying a home was not a sound investment as there appeared to be no end in sight for declining property values. I stated this between 2007 through 2011. I also predicted that in late 2011 and 2012 you would see the market settling down and possibly seeing it hit rock bottom, which would then be a time to consider buying again.
What we have at this moment is what I call the basketball effect. Meaning, when you have a basketball and hold it up high, then drop it, the moment of impact and the moment in which it bounces back up is the fastest jolt upwards. It continues in a fast upward movement for the first one to two feet, then starts to slow down as it travels higher.
I think that we have seen the bottom of the market and what you are seeing is the initial bounce upwards in property values. While I do see the upward trend in real estate continuing, it cannot sustain such a rapid appreciation as it is seeing now. Having said that, I see a rapid push upwards in prices through late spring and maybe even mid to late summer of 2013. Once the dust has settled, or better yet, once the ball slows down a bit, I see a healthy 2 to 3% in annual appreciation over the next few years in most areas. I say most areas because real estate is local, some areas do better then others, and some not as good. In fact, there still may be certain areas in the country that have not gotten out of the housing crisis.
The key is what your area offers in terms of jobs, among other amenities including what rents are doing in the areas you want to live in. A home that is worth $400,000 in today’s world, in your area, will probably rent for anywhere from $2,200 to $2,500 per month.
If you buy the same home, it will have a mortgage principle and interest payment of approximately $1,733 based on a 3.5%, 30 year fixed rate mortgage, and would require you putting $14,000 as a down-payment if you secure an FHA mortgage which only requires a 3.5% down-payment. Add property taxes of $416 if you are buying in California, homeowner’s insurance of approximately $90, plus FHA Mortgage Insurance of $402.08 and you have a total payment of approximately $2,641.08.
If you quickly do the math, you would be paying a couple hundred more as a mortgage payment instead of renting, could be a little more or could be a little less. For the purpose of this analysis, let’s pretend that you could rent the property for $2,400, which would mean you are paying $241.08 less by renting. Right?
Well, being a homeowner does have its advantages that are numerous including the tax deduction that you get to use for the interest and property taxes that you pay every year. On a home like this, you have a write-off of $5,000 for property taxes and another $13,500 (approximate) for interest, totaling approximately $18,500 in tax deductions for owning your home versus renting. Depending on your tax bracket, you could be saving $300 or more every month when using this tax deduction, which would mean that you are probably paying the same amount every month in buying versus renting. Of course, you always want to discuss and confirm your actual figures with a qualified CPA or tax advisor.
What you have to remember though is that you have a fixed payment for the next 30 years which will drop actually, once your loan balance and comes down and the value of your property goes up thereby eliminating the need for that pricey monthly mortgage insurance of over $400 per month. If you rent, unless you are renting from your parents, your rent will go up probably every year and before you know it, you are paying a lot more to rent than to actually own your own home.
If property values rise by 2-3 % per year as I am predicting, you have another $10,000 per year (using 2.5% yearly appreciation rate) in equity that you are gaining. You can look at it one of two ways, as a piggy bank of savings that you should use towards your retirement, or as an offset of your mortgage payment that you are putting away, because you should not use it and instead let it grow, making your effective mortgage payment $833 less per month because that is how much you are gaining in appreciation every month. Now do the math and your mortgage payment of $2,641.08, minus the tax break of approximately $300, minus the $833 in monthly appreciation gives you an effective payment of $1,508.08. Try and rent the same house for just over $1,500 and you will probably not get too far.
If you look forward ten years from now, the home you purchased for $400,000 will be worth $512,033.82 using a very conservative 2.5% annual appreciation rate. Your loan balance will be $298,006.12 and you would have $213,166.08 in equity all while having the same mortgage payment month in and month out. Renting the home at $2,400 per month with a yearly 5% increase in rent will have you paying $3,723 in year 10.
More than anything, I think in the grand picture, people need to realize that real estate should always be considered a long-term investment. If you are looking to buy a home and plan on selling it within 2-5 years, you may want to reconsider as there are closing costs in selling as well as buying in the first place that could offset your profit when you sell. Don’t buy real estate short term, think 10-15 years or more and before you know it, you will be sitting on a nice little golden egg for retirement or other future plans.