As a practicing real estate broker you would assume I would be an evangelical advocate for purchase. In general I am HOWEVER as a seasoned real estate broker I am a bit concerned about the existing market conditions in the Denver Metro area. In some neighborhoods I have witnessed prices and sales volume up 50% in 3 years and some 100% gains since the depths of the Great Recession. Of note Denver was NOT as hard hit as Las Vegas and Phoenix where such gains after an over-sold condition may be warranted.
Thus the following are the 5 questions I usually ask of prospective buyers and not only 1st time buyers. Of note I personally am going through a similar exercise as I am under contract to sell my residence, which I have called home for 28+ years. Due to the inflated (in my humble opinion) market and lack of inventory; the 5 questions are hitting me personally. Here you go and I must advise please be honest as the questions are also a self-assessment of sorts:
How long are you planning to stay in the Home/Neighborhood/Area?
The reality; it is unlikely we will witness the gains we have had during the past three years. Simple economics would argue median incomes cannot match the gain in housing prices especially in the upper-tier of the market. Thus I advise clients unless they plan to stay in their residence a minimum 3-5 years (assuming this is not a fix and flip situation), may wish to reassess purchases.
The purchase and selling of a residence is not only time consuming, it is also capital intensive. Costs usually associated on both sides include brokers fees (usually paid by the seller in Denver), mortgage applications/origination, appraisals, title insurance (usually paid by seller) and so forth.
In general the longer you retain your residence the more time you have to recoup costs and based on dollar cost averaging (yes values can decrease), the more opportunity you have to enjoy an overall increase in value. Of note for those who retain a house for less than two years and if there is an increase in value, must factor in capital gains taxes (sometimes can be offset by expenses incurred concerning the divesting of the residence).
In the question I mention neighborhood and area. Do you have young children or planning on having children? School districts are a major motivator concerning one’s residential address. When childless; the gentrifying neighborhood may be the hip choice yet when the children come into the picture and Kindergarten is around the corner all of a sudden the school district and distance to school is of paramount concern.
My opinion, if planning to stay 3 years or less, consider renting.
House Prices Always Go Up, Right?
How we have short memories. While the market slide beginning in 2007 may be recent memory and quite severe, it was not an anomaly. When I purchased in 1989, the seller had purchased the home in 1984. Five years later he sold it for 30% less than the purchase price 60 months earlier (not accounting for inflation). The seller brought cash to the closing table to satisfy the mortgage and compensate the brokers. This was an era before the term short sale and “jingle-mail” entered the popular lexicon.
More recently, the median home price in the United States dropped nearly 13% between 2007 and 2009, falling from $247,900 to $216,700. In some overheated markets, such as Las Vegas prices declined as much as 62% from their peak.
Before buying a home, consider how your personal finances would fare if your house’s value increased slowly or not at all. With 3% annual price appreciation, a $250,000 (considered a starter in Metro Denver) house would be worth more than $337,000 in 10 years. With a 1% annual price increase, the same house’s value would grow to just $276,000 over the same time period. Barring a recession, nominal inflation of 2% would keep up however due to the added expenses concerning home ownership; one could envision a scenario of flat and potential decrease of value. For my economic pundit peers, yes during inflationary times, houses in general increase in value HOWEVER with high interest rates associated with the taming of inflation, transactions become muted as affordability becomes more challenging).
I provide the above scenario as I have witnessed some buyers placing all their eggs in the housing basket assuming the gains will outpace other investments. Trust me I am the first to argue a home is a place to sleep at night; the brokerage firm holding your stocks or the bank holding your CD’s are not leaving the light on for your arrival to bed down for the night.
Shelter is needed I agree. However one should not look at their house as their sole investment or worse an ATM i.e. Home Equity Lines of Credit. I view a residence as shelter and if there is an increase in value an added bonus.
If I Rent I am 1) Throwing Away Money and 2) Making my Landlord Rich?
On the surface such an argument does have some merit. Also I will avoid getting into the issues concerning home ownership restricting mobility concerning employment opportunities. I understand the line of most brokers i.e. owners are building equity in a valuable asset that can boost their long-term net worth whereas renting is spending not saving.
Home ownership has additional costs beyond the Principal and Interest on a loan.
Taxes: While metro Denver has in general low property taxes, it is still a recurring monthly expense. In the upper-tier of the market i.e. $500K and above, one can easily allocate $500/month just on real estate taxes.
Insurance: Home Owners Insurance in Colorado can be costly due to our climate i.e. hail, wind, heavy snow and other perils. While we do not have to worry about earthquakes; insurance rates in Colorado continue to escalate due to weather, cost of labor, materials and related factors; such rates rarely go down over time.
Basic Maintenance: I tell my clients to consider budgeting at minimum 1%-2% of their homes value towards maintenance and upkeep. This does not necessarily factor in unforeseen costs i.e. new hot water heater, roof repairs, HVAC and so forth. Condo owners you are not exempt, this is what monthly HOA fees are for.
In a rental such costs are borne by the landlord. However I will advise if renting do consider “Renters Insurance”, usually inexpensive and offers piece of mind. While you may have budgeted for your Principal, Interest, Taxes and Insurance, there are always other costs that can be budgeted for as well as surprises.
If I rent am I missing out on the tax benefits?
To be honest many homeowners do not realize the mortgage interest deduction is oriented towards larger mortgages and financial outlays. First as a homeowner you must itemize your deductions when claiming the mortgage interest deduction.
With the existing low-interest rate environment (and yes rates are still at historic lows) your itemized deductions should exceed the $12,600 standard deduction for married couples? This is OK if you have an upper-tier house with a large mortgage. Yet the reality is each year that goes by your deduction decreases as a larger portion of your monthly payment is allocated towards principal. Thus the deduction over time will decrease. (Of note, there are interest only mortgage instruments, unless truly financially savvy or blessed by your CFP or similar, I suggest avoiding).
When Does Buying Truly Makes Sense?
I always look at a rent versus buy scenario and run numbers accordingly usually in conjunction with a client’s financial and/or tax advisor. Yet sometimes I take the simple approach, which is basically, is it cheaper to purchase than to rent?
Beyond the down-payment (and please note I am not trivializing this, however when loans are available with 5% or less down, saving for a down payment is not as onerous as when I purchased my primary residence in 1989 and had to come up with 20%+) I look at basic monthly outlay after answering the prior questions.
Let us assume in metro Denver you are interested in a home that after the down payment the monthly PITI/Mortgage is $3,200. Now what if you could rent a similar property, apples to apples for $2,850/month?
One could argue for $350/month extra or $4,200/year you can have the security (and expenses) associated with home ownership.
Yet one could also argue that $4,200/yr. can be invested after taxes into a Roth IRA or similar instrument. For the uber conservative that person could buy bonds and secure a safe 2% return. For the more aggressive; there is the potential to be investing with returns of 5% or higher annually over a longer period; not unheard of (coupled with dollar cost averaging) and with a Roth monies going in post tax, comes out tax free. There are also options to use the monies for a down payment, however there are some tax implications, which are best, discussed with a tax advisor.
I also advise clients at the beginning of their home search consider using a price-to-rent ratio calculation. Price-to-rent ratio is calculated by dividing the home value by the annual rent amount. Generally speaking, if the price-to- rent ratio is less than 20, buying might be a better option. However, if the ratio is greater than 20, renting might be better. Needless to say, any ratio or comparison is meaningful only if you are comparing similar properties.
In closing I am just throwing our scenarios and “food for thought”. I am in a similar situation. As mentioned I am in the process of selling the residence I have been in for 28+ years and have enjoyed immensely. However due to the physical design and other factors it is time to move on. Assuming I close, I will be, guess what living in a rental! Yes I will be paying rent.
My personal view at present; I am more comfortable having the proceeds from the sale liquid and when the correct residence comes available for purchase at a price I feel is appropriate, I can proceed sans the restraints of trying to sell my residence and/or using a contingency clause which is never popular. In the interim, the money from the sale of my residence post taxes will be invested in short-term bonds throwing off income while retaining a margin of safety of the underlying principal.