Herman School of Business
Buy or rent?
Maybe one of the hottest topics today is the declining value of real estate. The vicious cycle of easy mortgage money, coupled with giving credit to buyers with no money down forced the prices of houses through the roof over the last six or eight years. As banks clambered for more money to lend…because their books showed enormous profits from the “origination fees” and the fact that in theory they were borrowing money for 2 percent and lending it out for 5 percent made the whole economy explode with growth.
After all, even if you weren’t selling your house the value was doubling right before your eyes. And those commercials to pull out some equity and have a good time were very compelling. Geez, honey…we are rich! Or so homeowners thought. But a funny thing happened that unbelievably no one expected…people couldn’t afford the payments on the house they should not have bought. And those loans were hemorrhaging at the banks sucking up what were supposed to be profits. And people with no equity and payments over their heads just quit making any payments…until the banks foreclosed and put them out. And suddenly your neighbor going belly-up caused a huge drop in the value of your house…back to where it was when all this mess started…but you had refinanced which was the equivalent of “buying” your own house at a higher price. And now you ask yourself if you can afford your own house.
But Americans are always on the move. Let’s go over here and live. Look at this great deal on this foreclosure over here. Wow, we should grab this house being sold due to the divorce of this couple fighting over money issues.
Wait.
If you want or need a house in most parts of the country and think you are getting a great deal…you may be wrong. Suppose you buy the house for four hundred thousand dollars. While you could rent one for a year at thirty thousand dollars. By next year that same house might be about three hundred and fifty thousand dollars, which means you would be saving fifty thousand dollars on the purchase, and that saves you tens of thousands in interest over the life of the mortgage. And that is a real twenty thousand dollars extra in your pocket right from the get-go.
We haven’t admitted all the bad we have to face…with the election coming in a few months many things are being pushed under the rug as the Republicans can’t let the democrats waltz into the White House without a fight. But once the election is over…the new President and Congress will have to “fess up” and we will see more housing mess, and lower prices next year.
Rent now and save money buying next year.
- Posted: 12 August 2008
- Comments: 2
- Category: Business success
Comments
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Written by Nika on 13 August 2008
I believe you have oversimplified the housing situation, and the options that are available. The real estate market like the stock market is on a long-term growth trend even when you take into consideration the crashes and corrections. A few years ago we entered a period of what Allan Greenspan called “ Irrational Exuberance” where prices began to rise above the long-term trend creating a bubble.
When the bubble burst prices snapped back falling below the long-term trend. In most if not all markets prices returned to levels where they were 3-5 years ago. If gains in the last 3-5 years had been double-digit then the declines were also double-digit. Since prices are now below the long-term trend there will be pressure for prices to stabilize or rise slowly. Further double-digit declines are not likely in most markets.
Take a look at job growth in the area where you want to buy. If it is stable org rowing housing prices should stabilize if the job rate is declining then a little more caution is in order. Even in a declining market I don’t expect the cost of building materials to fall or the cost of labor. When housing rebounds new construction will be higher protecting the value of what you buy now.
As I said before it is not that simple and maybe we will find more cost for the mortgage industry bail out after the election, but housing is more likely to return to its long term trend than to continue down in most markets.
The real answer to the “ Rent or Buy” dilemma is both. There is a thriving industry of real estate investors recycling foreclosure homes and selling them in like new condition on favorable terms. One of the most popular options is “rent to own” where a buyer rents a house while repairing his credit with the option to buy at a preset price in one or two years. This is a great deal even for buyers with perfect credit.
In Herman’s example you rent to own a house worth $400,000 with a 2year option to buy, rental rates are going to be comparable with a slight premium on the rent to own option. If Herman is right then at the end of the option period the house is worth $350,000, you can walk away from the option or renegotiate the sale price. If values return to their long-term trend then the house is worth $425,000 and you buy at the bargain price of $400,000. Either way you win.
HERMAN SAYS: Thanks for your detailed analysis...you left out the factor I believe was a major influence....people got loans they should not have obtained forcing prices up too fast....overbuilding occurred....now you have an 11 month inventory and no bank liquidity....look for short term prices to fall. Also...while long term trends are great...those about to retire just took a huge hit in both the stock market and their home values...long term trends don't help the short run problem.“There’s no disaster that can’t become a blessing, and no blessing that can’t become a disaster.” – Richard Bach
Written by KCKeith on 12 August 2008