One of the most common questions I receive is: “What will the real estate market do in the coming year?” Well, I don’t have a crystal ball, (wish I did) but I can look at data and see where things are trending.
There are very few experts that don’t agree that the real estate market has hit its bottom and is on the rise. But what will the rise look like and will it be sustainable?
I read an article recently by Robert Aldana that likens what is happening in the real estate market to bouncing a basketball; he calls it the “basketball effect.” “Take a basketball and hold it up high, then drop it. That first bounce is the basketball’s fastest upward bounce. During that first bounce, it begins to travel slower the higher it rises.” Why this is relevant is that we are seeing the initial bounce in property values?
I do believe that an upward trend in values and sales will continue through 2013. We will not see the appreciation acceleration at this same level however. I do think that we will continue to see good appreciation through the spring of this year. As I’ve mentioned before, one of the things driving appreciation is the lack of inventory. I think this year we will see more homes coming on the market that are standard sales not distressed sales. Once that happens, the market’s appreciation should slow to a healthy rate of 2-3 percent over the next few years.
Please keep in mind that real estate is extremely localized and you need to consider how your area is doing with relationship to jobs, rents and other economic factors before making a buying decision.
One of the other driving factors in the market is household formation. Household formation, as I’ve talked about before, is increasing. The graph below demonstrates why it’s so important:
We have seen large growth after the almost historic shrinking in 2006. Growth started in 2010 with 357,000 new households, 2011 near a million, and it’s predicted that 2012 rose to over 1.3 million.
This helps drive the residential sales market as well as the rental market. But is it smarter to buy than to rent? Let’s do the math: if you purchase a $400,000 home with a FHA (Federal Housing Administration) loan, at 30 years with a fixed rate of 3.5 percent and put $14,000 down, it will cost approximately $1,733 a month (for principal and interest – you would also have to add on taxes and insurance). In California taxes and insurance would cost you about $150 to $200 a month for a $400,000 home.
Once you add the tax deductions for mortgage interest and property taxes you are SAVING $500 a month and building your wealth.
Another consideration is that your payment will remain fixed where rent will continue to rise as does the cost of living.
Now if you are an investor and want to buy this house to use as a rental does that math still make sense?
Well, two things we should add to the equation is 1) appreciation of the asset 2) depreciation of the asset for tax purposes. Right now our tax laws really benefit the landlord.
If we use the same math with a mortgage payment plus taxes and insurance you are paying $2,640 a month, now subtract the tax break and appreciation you receive (about $1,100 a month) and your effective payment is $1,500. If you rent the property for $2,200 a month you will have a positive cash flow. But now consider what that will look like 10 years down the road.
If you want to learn more about investing, make sure you register for my upcoming class in February. It is online and there will be only one class a week for 4 weeks.