Here in Thoughts On Money [TOM], we prefer to discuss relevant topics that are financial planning-centric, timely and surrounded with misconceptions. The housing market has become a hot topic recently, with current home prices checking all the boxes for a great topic to discuss here on TOM.
In the last 12 months, the median sales price of houses across the country has jumped 15% – 20%, depending on the area you live in. My wife and I bought our house in October of 2019 and recently had to have our home appraised, which was a value 33% greater than our purchase price just two years earlier.
A jump in prices of this magnitude typically leads to three different types of responses:
- Sell while the selling is good
- Buy before it’s too late
- Wait to purchase until prices normalize
For many savers/investors, their residence makes up a significant portion of their balance sheet, which means that this is a crucial planning topic to discuss. The direction of the wind or the emotion of the hour should not dictate your buy and sell decisions when it comes to your home.
For some, you might be advising your children on their first home purchase. For others, you may be nearing retirement and considering moving closer to the grandkids. And perhaps some are newly minted empty-nesters wondering if downsizing is a good plan. Whatever your lot in life, you want to be equipped with a sound decision-making process regarding any sort of housing transaction.
As you can derive from the three common responses, I listed above, a jump in prices typically leads to rushed decision-making. A feeling or need to “strike while the iron is hot.” In the world of financial planning, pressure to accelerate a decision typically precedes bad decisions. So, slow down, have a process and method for assessing your big financial decisions – not this “ready-fire-aim” behavior that riddles our current modern financial culture.
The natural response to home price mania is, “Why!?” People want to know what is the trigger that has caused home prices to spike.
Here are some possible culprits:
- The top three largest age demographics (by population) in the US are 25-29, 30-34, and 35-39, the prime ages for first time home buyers and second home “upgraders,” potentially causing a spike in demand
- Interest rates, and mortgage rates, are at all-time lows, perhaps motivating renters to lock in mortgage payments that are comparable to their current cost of rent
- Volatile currencies around the globe lead foreign buyers to want to park their surplus funds in US real estate
- The COVID moment has people spending a lot more time at home, and the psychological impact of this might just have people on the hunt for that new dream home with more space
- The delayed impacts/pains of the slowdown in new home building post-financial crisis causing a pinch in the overall supply
Are there other potential causes? I’m sure. Do some of these factors have a greater impact than others? Probably. Do I have the secret formula for exactly why prices have moved the way they have? I do not.
Should I Buy?
Let’s start by addressing those potential buyers out there.
First, for those thinking about upgrading, moving, downsizing, etc. – basically anyone who plans to sell one home and buy another. Let me ease your anxiety. If you are concerned about the inflated price tag you have in front of you (as a buyer), that’s understandable, but here’s the good news, you will be able to sell your current home at a similar and relative premium. It’s a net-net transaction, so no stress is needed.
Next, some advice for those first-time homebuyers making the leap from renting to owning. Again, let me remind you, this should be a well-thought-out decision, not a FOMO reaction to what your friends are doing or what your family might be pressuring you to do.
My wife and I waited a long time to buy our first home, and I am glad we did. When I was single, it was more cost-effective to rent with friends; when I was first married, we were content with a one-bedroom place, and we knew our stay there wouldn’t be long-lived. In the next chapter of our life, kids entered our story, and it made sense to buy. One-bedroom homes can be challenging to sell, and transaction costs can be hefty when you are only living somewhere for a few years. Our need for less space and our understanding of our time horizon meant that renting made the most sense until it didn’t. When we did buy, our first mortgage was a lower monthly payment than the rental we were leaving.
If you buy right now, are you going to pay a premium? Yes. When valuations are stretched and you pay a premium, does this have an impact on your future expected returns (growth)? It does indeed. The good news, though, is your house really isn’t intended to be an investment, it’s your home. The motivation to acquire a home is to have a familiar place to rest your head, a place to make great memories, and a place to call your own. The average homeowner will stay in their home for 7+ years. This means that paying a premium will dilute itself over time, and the transaction costs will dilute themselves over time – just like looking in the rearview mirror, things shrink the further you get away from them.
So, if you’ve done your diligence and concluded that you want to make this house a home, your content putting down some roots, and the cost of purchasing pencils out in your financial plan, then I would not sweat trying to “time the market.” Most folks will own three or four homes in their lifetime – sometimes you will buy at the top of the market, and sometimes you will buy at the bottom of the market.
Should I Sell?
I can make this one really simple. If your sole reason for selling is to try to time the top of the market, make a quick profit, rent for a bit, and buy later, then I think that is bad financial planning, and it’s not advisable.
If you’re considering downsizing and the additional capital boost would benefit your financial plan, I think this could be a viable planning consideration. If you want to sell a home at a California price and use the proceeds to move and buy a home in Texas, again using the additional boost of capital to benefit your financial plan, this too could make sense.
Timing markets is a fool’s errand, whether that be with stocks, real estate, or any other type of asset. Sell decisions should be rooted in a reasonable strategy mapped out in your financial plan.
Should I Do Anything?
There are two important figures to know when it comes to your home: (1) how much your home is worth and (2) how much you owe on your mortgage. The difference between these two numbers is your equity, and you should have growing equity when home prices go up and assume your mortgage is being paid down.
I find that investors often have difficulty grasping what this equity is and what it means to their financial plan. A savings account just seems more tangible – money saved that can be pulled out at the ATM and spent at one’s leisure. Sometimes I will encourage clients to look at their home equity as just another savings account, and I highlight that withdrawing from this “savings account” is a bit more complicated. One would need to resource a home equity line of credit or cash-out refinance to resource this money.
Why does this framing matter? So much of financial planning is about planning what resources to use for future expenses. This equity could be a resource worth considering. Maybe you have some home remodeling plans or an aspiration to acquire a family vacation home. It could make sense to resource equity to meet these financial goals. One must place all potential resources side by side and weigh out the pros and cons to decipher what strategy makes the most sense for their plan.
With interest rates at all-time lows, and home equity growing across most balance sheets, this discussion becomes very relevant. Not a riddle to solve in this article, but a conversation to be had with your advisor.
Here’s what I hope you gathered from today’s discussion. Financial decisions, especially big ones, should not feel rushed and should not be rushed. You don’t have the crystal ball, I don’t have the crystal ball, and perfect timing is only stumbled upon because of chance or luck, not skill. For most of us, our homes are a significant portion of our balance sheet, which means that decisions regarding our homes fall into that BIG financial decisions category. BIG financial decisions should be conversations you have with your advisor, and you should lay out multiple options to determine what tailored approach best fits your objectives. Lastly, I want you to remember that you have this other “savings account” out there, and it’s called home equity; sometimes, this “savings account” may be an essential resource to factor into your planning.
And that’s it. That’s all I’ve got for you.
Until next week…