In the midst of everything going on in the world, buying real estate in today’s market can actually be a very smart move for those looking to invest in property, whether for themselves personally or as a rental. Most of the Denver area is in a seller’s market, which means prices are higher because of demand from buyers with low supply. We say “most of the Denver area” because the downtown zip codes are actually sitting in a buyer’s market right now, specifically 80202. We believe a lot of this has to do with the recent protests and buyers not being as comfortable being downtown for showings as they were before Covid-19 and the protests.
So, does it still make sense to purchase knowing we are in the midst of a seller’s market?
Low Interest Rates Today v. Foreclosure Opportunities Next Year
Rates are historically low today, as low as 2.75% for a purchase loan. Some buyers are holding off and waiting 6-12 months from now to purchase a home, in hopes the prices will be slightly lower, thinking there might be a large amount of foreclosures after forbearance periods are up and after the country sees the final effects of the setbacks caused by the past few months. Which businesses will survive and which won’t, potentially causing unemployment numbers to increase and homes to go into foreclosure.
However, this move could hinge too much on unpredictability causing buyers to miss the opportunity to increase potential earnings by taking advantage of today’s historically low rates.
Let’s look at a home worth $400,000 today and say the price drops 15% to $340,000 in the next year, look at what happens if you purchase at today’s rates of 2.75% and a price of $400,000, versus next year with the assumption you can get that same home for $340,000, even if the rate only goes up to by 1.50% to 4.25% (considering 5% down):
$400,000 PURCHASE W/ 5% DOWN AT 2.75%
$340,000 PURCHASE W 5% DOWN AT 4.25%
You can see that the total interest paid over 30 years is $70,554 MORE for the home purchased at 15% less next year, with a rate increase of only 1.5%. That’s a 39% increase in interest cost if you were to wait and hope for a deeply discounted purchase price, and that is if the rates ONLY increase by 1.5%.
On the other hand, housing prices are not expected to drop a whole lot. We entered Covid-19 in a position that many might compare to 2008 where housing costs are high, demand is high, and supply is low. That being said, in 2008 homes were overleveraged and there was little or no equity behind the loans. In today’s market these homes will have that equity that was missing in 2008-2011. Therefore, sellers will have more options to sell, refinance or work with the bank on a new agreement, prices will not have to drop drastically because of the market and their built-up equity.
Renting v. Buying
Some prefer the simplicity of not being a homeowner, having someone to take care of everything that you don’t want to take care of, and others just don’t know when the right time to enter the home ownership market is, so renting makes most sense.
Let’s take a look at the market and compare both renting and owning and try to forecast what the difference might be in the long run: forecasted appreciation v. forecasted annual rental increases. Here’s our example: buying a home in today’s market at a price of $470,000 versus renting something comparable in today’s market.
The table says it all. For renters who want the simplicity of not owning and caring for a home, based on the numbers above, one might argue it could be feasible to hire the support needed to maintain the property. It’s one reason many choose to own condos, keep the simple life and remove the undesirable parts of home ownership. Many worry they would be stuck in the home if they want to move, in this case, they could either sell that home to access the equity, or turn around and rent the property out at the going rates mentioned above. Another reason many choose to purchase a condo, an easier rental pool.
Speaking of accessing the equity in the future, there are ways to do that in the future, without selling or losing the rate locked in today.
Cash Purchase v Borrowing to Purchase
We will start this section with a clear note, please contact your financial advisor to consider what is best for you and your portfolio. If you don’t have one, we have several we can connect you with.
The benefits to using cash:
- The cash buyer is probably going to be the most attractive buyer making an offer, sellers love cash because of fewer potential contingencies, plus cash gives the buyer more control over the closing timeline, most times.
- A loan will add additional costs in fees and interest.
- Getting a mortgage can seem like a hassle or some feel their current situation will not allow them to qualify for a loan.
- No worries about missing a mortgage payment during risky or rough times.
Disadvantages to using cash:
- Tying up money in one asset class. Opportunity cost: are there better investments to invest the cash in, that could possibly provide a better return?
- Loss of financial leverage
- Using this oversimplified example, suppose you bought a $400,000 home with cash, that has since risen in value by $100,000 and is now worth $500,000. If you had paid cash for the home, your return would be 25% (a $100,000 gain on your $400,000). However, if you had put 20% down and borrowed the remaining 80%, your return would be 125% (a $100,000 gain on your $80,000 down payment). This does not take mortgage payments, tax deductions, and other factors into consideration, but that’s a general principle. It also does not take into account what you did with the remaining $300,000 and the potential gain made on that.
- Sacrifice liquidity.
- Potential tax deduction.
The bottom line is that you will want to work with your advisor to determine what makes most sense for you, deciding on the option that will give you the biggest bang for your buck.
Whether you are in a buyer’s market or seller’s market today, here are the things to consider:
- Rates are historically low and make a big difference in the overall investment when you purchase today versus risking lower prices in the future.
- 90% of homes in forbearance have at least 10% equity.
- Rental rates are high today, so you can choose to:
- pay those rates,
- pay the mortgage company and gain equity,
- and/or let someone else pay you those rates.
Cash is king, so make sure you are doing what is best for you and your portfolio to get the highest return on the investments made with that cash.