First Time Home Buying: Fast Path To Wealth, or Not?

Unrealistic Expectations:

“I’ll be here for two years – help me find a condo that I can sell when I leave for a profit of at least $50,000″.

There is nothing like the exuberance of youth, especially that of a young client who has never seen a real estate market do anything but increase in value. Strong rising markets can do that – create expectations of a fast path to wealth.

It’s hard to be the bearer of bad news, but someone has to do it. So, I did what I had to do – I gave my client graphical evidence of a market that moved in the opposite direction.

Armed with that new information, my client’s next quandary was whether or not this is the ‘right time’ to buy.

It’s a great question, one that all first time home buying enthusiasts definitely need to think about. But to me, it’s incomplete. Here’s a better question: ‘is this the right time for me to buy?’

It’s only a two word difference, but those two words could save your bacon.

Without them, the question of whether it’s the ‘right’ time to buy boils down to a question of market timing. In other words, it focuses on the one thing over which none of us have even a single ounce of control – short term swings in the residential real estate market.

By ’short term’, I mean anything from a few months to a few years. If you could reliably predict where the market is headed in the next few months to few years, you could become incredibly wealthy.

Unfortunately no one, and I mean no one, can reliably make that sort of prediction. We can make our best guesses, even our best estimates. But the world is shrinking, and there are simply too many natural and man-made events that can blind-side the world, affecting everything, right down to house prices wherever you happen to live.

Getting Personal:

But add the two words -’for me’ – and the question takes on a whole new dimension. Instead of focusing on market timing, it now focuses first and foremost on your assessment of your personal situation over the short term, without ignoring the long term.

In the long term, real estate prices trend upward. Historically, they move upward at a rate slightly higher than inflation. Over the long haul, real estate gains real value, even after taking inflation into account.

Although the long term trend line is up, it isn’t a straight line to the top. There are many hills and valleys along the way. Each ‘hill’ represents a period of climbing prices. And you can guess what each ‘valley’ represents.

Risk and Risk Tolerance:

The question – is this the right time for you to buy a home – is mostly about risk, and your tolerance to it. Looking ahead at your personal situation, how well positioned will you be to make it across a ‘valley’ within the next few months to few years?

Risk comes in many forms but two big ones are risk of transfer out of the area, and risk of loss of employment (or business) income. How probable, or improbable, is it that one of these circumstances will come your way in the next ‘little while’? That’s your call. But if your employer has a policy of transferring people every two or three or four years, and doesn’t offer any kind of home ‘buy-back’ guarantee, you’re vulnerable!

And how well positioned will you be to deal with the consequences of a duress sale triggered by one of these events coming your way when the real estate market goes down, not up? Again, that your call.

Two Approaches to Market Timing:

What about market timing – is it relevant in any way to your buying decision?

There are at least two schools of thought on that.

One school is that as long as you have done your risk assessment and feel reasonably secure you’ll be able to tough out any short term drop in the market, it’s always a good time to buy. Why? Because in the long haul, real estate values always go up, and in the process, you will gain from the investment leverage that a home purchase offers.

What is ‘leverage‘ all about?

It’s about acquiring an appreciating asset using borrowed money. With a traditional home mortgage, if the home you purchase goes up in value, you don’t have to share the increase in value with your lender. So, for instance, if you invest $10,000 of your own money and borrow $90,000 to buy a home for $100,000, and the home increases in value by 10%, the return on your investment isn’t 10% – it’s 100%!

Now I admit, this example may be a bit overly simplified: it doesn’t take into account that pesky mortgage payment you make each month. Doesn’t that dilute your return on investment?

Maybe so. But advocates of this school of thought point out that you are getting value in return for your mortgage payment – in the form of a place to live. It’s a good point, although if you’re a hard nosed ‘number cruncher’, you’ll want to compare your mortgage versus your cost to rent.

Yet a direct comparison of monthly costs is only part of it for some – many home owners value intangible benefits of home ownership. Things such as a sense of community, of stability, of pride of ownership, and even status can all value for many – except perhaps the hardest nosed number crunchers.

But number crunchers will quickly recognize the tangible income tax advantages of home ownership: for Canadian resident taxpayers, the gain in value on your primary residence is not taxable when you sell it! And American homeowners get a big tax break with mortgage interest payments being tax deductible. ‘Tax free’ and ‘tax deductible’ are concepts we all understand and cozy up to.

Before moving on to the other school of thought, just another few words about leverage are needed. Used wisely, leverage can be the key to the accumulation of wealth over the long haul. But it can magnify your woes in a falling market if you aren’t careful.

Using our hypothetical $100,000 home purchase we mentioned earlier, suppose the market drops 10% instead of rising. Your entire initial investment will be wiped out, along with your equity in your home. Ouch? But if you don’t have to sell when the market is depressed, your pain will pass when the market moves back into positive territory.

Now, about that other school thought on market timing. It pays attention to market timing. One way of looking at it is that market timing becomes part of your personal definition of risk and your tolerance to it. Another way to look at it is simply a question of how to maximize your gain. Buy now, or buy later.

Waiting To Buy:

Whichever way you decide to look at it, you will look like a genius if you delay your decision to purchase and the market slides below where it is today. In that scenario, by waiting you could end up with a nicer home for your money, or you might decide to spend less. It gets better – you will stand to realize a bigger gain in the long haul because you were better positioned from the start.

But nothing is without risk. The risk of waiting is that the market isn’t ready to stop rising just yet, and when it does finally slide, it doesn’t slide back to today’s prices. Unless you’ve been saving like crazy, that likely translates into a larger mortgage or a lesser home. Oh yes, and a less favorable starting position to maximize those long term gains.

The Bottom Line:

What’s the bottom line of all this? Just this.

Don’t fall prey to ‘hype’ or headlines of real estate mania or real estate bubbles. Here are two better choices. Ignore issues of market timing and focus entirely on your personal circumstances. Alternatively, form your own opinion about market timing, and act on your own opinion.

Can you do that – form your own opinion? Sure you can. If you’re serious about first time home buying, you’re going to discover relevant facts, opinions and comments just about everywhere you look. Figure out what makes sense to you, and go with it. Remember, your reasoned opinion is as good as anyone else’s.

But remember. Always, always look at your own situation, and be ready to be wrong if the market gallops off in wrong direction for the next few months or years.