Like most real estate questions, the answer is “it depends”.
I know, you asked a simple question. You’d like a simple answer.
Okay, I’ll give you a simple, unambiguous answer straight out of the agent training manual: “Now is a great time to buy or sell real estate.” But don’t dismiss this as sales hype. Any market that appreciated an average of 15 percent per year from January 1992 to its most recent low point of November 2001, like Palo Alto real estate did, [and over 12 percent annually since then] while giving you tax benefits, a wonderful environment and relief from landlords—that’s usually a good place to be.
So should you be wheeling and dealing in any market, good or bad, up or down? To answer that, let’s first take a quick look at how the real estate market works.
I mentioned 15 percent average annual appreciation. Unfortunately that doesn’t mean you’ll make a quick 15 percent profit if you buy today and sell in a year. Real estate is most often a buy-and-hold asset, not something day traded for quick profit.
That’s an extremely important concept. Real estate prices have gone up but over the long term, and not at a steady, predictable rate. In the short term, real estate can soar or crater, or it can doze for years.
Every ten years or so, real estate goes through a boom-and-bust cycle. That “ten years” isn’t engraved in stone, and it’s not something you can bank on, but it’s a handy and fairly reliable number. Beyond these short-term cycles, the long-term price trend has always been up, so if you keep your home through more than one cycle you can probably make a profit in any market. But sell your home in 3, 5 or even 7 years and you’re still in that first cycle. Then, how profitably you sell depends on where in the cycle you bought (boom, bust or flat) and where in the cycle you sell. In other words, how well you’ve timed the market.
Now let’s meet…
The first rule of real estate.
Which is: It’s impossible to time the market, except accidentally.
From this follows the great paradox of real estate: most buyers buy, and most sellers sell, when the market is against them.
Note I said, “when the market is against them”. I didn’t say that buyers buy and sellers sell “at the wrong time”. There’s a huge difference. Most buyers and sellers are swept along by enormous economic waves that leave them little control over when they buy and sell. Buyers buy when they can. Sellers sell when they have to.
That’s why so few people go against the market, buying when real estate is down (and cheap) and selling when it’s up (and expensive). Most of them don’t have that luxury.
What causes this boom-and-bust cycle?
I’ll give you the condensed Reader’s Digest version, without the boring stuff where the market is at or near equilibrium and neither buyer nor seller has a clear advantage.
In a hot market, tidal waves of motivated homebuyers hand the advantage to sellers. Prices skyrocket as buyers compete for the best properties. Homeowners “should” sell now, yet many don’t. Why not? They could sell easily and profitably, but if they’re selling to move up to a better home in the same area (instead of cashing out to a cheaper area) then selling puts them in the same pressure cooker as the buyers competing for their house. That plus high demand keeps inventory low.
Plus there’s no economic pressure to sell. The good jobs are here, not in Portland or Boulder or India.
So demand exceeds supply, particularly if the market heats up during the winter months when inventory is usually low, like the infamous November of 1999.
This overheated market eventually has two results.
First, prices keep rising until they make sense to only a handful of buyers. More and more would-be buyers voluntarily leave the market “until prices go down”.
Two, buyers leave the market involuntarily as the economy softens, stripping jobs, wealth and confidence from the area.
But just as demand for housing drops, home sellers start flooding the market with inventory. Why? Some sellers simply hope to catch what’s left of the wave, but as we’ll see in a moment, many homeowners must sell.
So is the real estate market just one huge example of really bad timing and lemming-like behavior? No, it’s just buyers doing what they do—buying when they can—and sellers doing what they do—selling when they have to. It’s an example of an inefficient market, one in which supply and demand aren’t always in synch. Because of this, buyers and sellers often swim upstream against the market to achieve their goals.
Let’s look at buyers first.
When is a good time to buy?
Believe it or not, home buyers have good reasons to buy when prices are rising and the market is beating them up.
If prices are going up, that means the economy is awash in at least two of the great drivers of real estate, credit and confidence. You have a good job and a great future. You like the area and want to put down roots. Rents are high and going higher as more and more people come here. Why throw away your money on rent? Why not buy a house?
Or, as we’ve seen since 2004, low interest rates can drive up prices even when employment and confidence are only marginally acceptable. [Or as we’ve seen since late 2005, rising employment and lack of inventory locally can keep prices going up even when confidence is flat and interest rates are rising.]
This brings us to another great paradox: rising prices make real estate look like something to get into, and soon. A rising market suggests a never-endingly rosy future for whatever that market is selling. Positive market momentum in real estate makes it easier for buyers to justify taking on a major financial commitment. The wind is at their back.
In fact, rising home prices initially fuel a seller’s market. Buyers feel pressure to pull the trigger now before they’re priced out.
Finally, buyers get plenty of affirmation in a rising market. Everyone they know is buying real estate, or thinking of buying real estate, or wishing they could buy real estate, or talking about real estate. Real estate is a happening place.
Not everyone is swept into the market, of course, and some of the participants are there simply to feel the vibes, as if a real estate boom was one long New Years’ Eve celebration. But enough real buyers jump in to create big momentum, so much, in fact, that prices can rise for a short time even while every other market indicator declines. Then, inevitably, gravity takes over.
Bargain-hunters take note: the best time to get a good deal is when prices are falling. But that’s easier said than done, because it demands a leap of faith that many buyers won’t or can’t make when the time comes. Home prices fall because the economy is tanking, and most would-be buyers are too worried about their jobs to go into serious debt. Then the conventional wisdom around the office water cooler is that only fools are buying houses. But the contrarians are right: buy when buying is out of style. That’s when you get the screaming deals. Conventional wisdom is always conventional and rarely wisdom.
Next, let’s look at sellers and their motivations.
When should I sell?
For many sellers this question is irrelevant.
Sellers can be divided into voluntary and involuntary sellers. Let’s look at voluntary sellers first, those homeowners who can sell whenever they want.
For voluntary sellers, the “when should I sell” question is extremely relevant. Should I sell now or wait? If you bought thirty years ago you can sell in any market, up, down or sideways, and make a killing. It’s just more fun selling in an up market, especially if you like everything going your way.
Should you try to time the market to hit a peak? That’s a tough question, especially if you know that someone who sold their house in March 2000 got 40 percent more for it than if they’d sold it just six months earlier. Then market timing looks extremely compelling. The problem with this strategy is that it’s impossible to execute without a generous helping of dumb luck. No one hits that narrow window of opportunity except by accident. The lucky few who sold in March 2000 had probably been preparing to sell since late 1999. And no one can predict what the market will be like next month or next year. Think about the sellers who brought their home on the market not in that golden March of 2000 but exactly one year later, in March 2001, just in time to see prices fall through the roof.
But what if you weren’t foresighted enough to buy thirty years ago? Just to break even, you’ll need to sell your home for at least 10 percent more than you paid for it. Where’d that extra 10 percent come from? It’s your costs to sell (commission, inspections) plus your costs buying your next home (closing costs). That’s the bare minimum. You may have other expenses (paint, carpeting, landscaping) just to make your house competitive, especially if you’re selling in a buyer’s market. Flaws in your home that were minor in a seller’s market become major in a buyer’s market.
It’s important to note that a slow market may be a great time to sell for the move-up buyer. Real estate typically cools from the top down: quite often top-end prices take a bigger hit than entry-level homes. You may get a little less for your present home but you’ll pay a lot less for the one you move up to. In 2001 the under-$1M market lost about 15 percent in value, the over-$1M as much as 35 percent. That means you save several hundred thousand dollars at a minimum. However, the opposite has been true since 2008: since then, the low-end markets have taken a huge hit, the mid-range and top-end markets far less, although as of 2012 prices are recovering strongly throughout the range.
Next let’s look at involuntary sellers, those who sell because they have to, regardless of timing and market conditions. Here’s where “Should I sell now?” becomes largely irrelevant. Like many buyers, involuntary sellers often must jump into the market when it’s running against them.
Job transfer, job loss, divorce, retirement, failing health, the need to settle an estate: life changes like these are compelling reasons to sell, and they don’t respect real estate cycles.
Involuntary sellers bring down prices in a soft market. It’s a showdown and the side with the strongest motivation loses. Life-change sellers need to sell or really want to sell. Buyers don’t need to buy. They can stay where they are, and in a down market they often do.
Selling versus renting.
Some unsuccessful sellers, especially in this area, have the luxury of keeping their homes and waiting for a better market. They either have deep pockets or they’re too sophisticated to be stampeded into giving their house away. So they stay in their houses, or move and lease them.
I think you can make a case that renting at a monthly loss is better than selling at one huge and unrecoverable loss, but consult your tax advisor. The big advantage is that by renting out your home you’re still in the market. Home prices have always recovered. Hold on and you’ll be there for the upside. Sell and you’ve lost any chance to recover.
But there are some real drawbacks to renting out your home.
First, you’ll have stiff competition. In a soft market other unsuccessful sellers are also trying to rent their homes, just as jobs and renters are leaving the area. Rental inventory builds up, rents slide. Houses sit vacant for months unless they’re priced as real values. Anxious owners who are new to landlording may be tempted to take a chance on tenants of marginal quality.
Second, the market should recover, but when? Remember, real estate cycles generally run about ten years. Depending on when you bought within a cycle, it could take years for prices recover to the point where you’re comfortable selling.
Third, rents rarely cover ownership costs, especially if you’re making big loan payments. On the positive side, you’ll be able to deduct more home expenses than before, including the IRS’s gift to rental owners, depreciation expense, but this tax break has implications when you sell. Have your tax advisor pencil out the sell-versus-rent scenario for you.
Lastly, rental owners are landlords even if they hire a property manager. No big deal, you say, but trust me, as someone who managed property for nine years, it is a big deal. Not everyone is a born landlord. You’ll either get the midnight maintenance calls, or pay for the service calls, or both. You’ll have to stay on top of your tenants, or your manager, or both.
Hire a manager and you’re entrusting your most valuable asset to a small outfit in an industry where quality varies widely. The large established companies manage big properties, not your single-family home. It’ll cost you if your manager is incompetent or overworked. Poorly screened tenants will make your life miserable from the day they move in until the day the Sheriff’s deputies ask them to leave.
Try to sell with tenants in place and they’ll have little incentive to let buyers inside and keep the house looking good. What’s in it for them, besides losing their home? You may find yourself with a laundry list of deferred maintenance and cosmetic items that can’t be repaired while the tenants are there.
Selling without tenants is much easier and usually gets you more money, but deprives you of income while you’re paying for two houses. And remember, lots of other homeowners have your idea of selling as soon as the market improves.
Some of the rent-versus-sell decision depends on the condition of your house when it was rented. If it’s an original fifty-year-old rancher you’ll probably just need to hose it out, throw in some carpet and paint it before you sell. If your home is nicer than that, you may come back to find that the tenants used your granite countertop as a cutting board and skateboarded on your new hardwood floors.
So you’re thinking “okay, maybe selling isn’t so bad after all”.
Houses do sell in a bad market, but only for motivated and realistic sellers. If real estate is really in the tank, there’s a better than 50/50 chance that your home won’t sell the first time it’s on the market. Put it back on at a lower price and it may sell. People still buy in a soft market.
So there’s your answer. Is now a good time to buy or sell? It depends. But we already knew that.
Interested in buying or selling? Please contact me at firstname.lastname@example.org.
copyright © John Fyten 2004-2014