Now that I’m back in the property hunt, I realize more than ever that the best time to buy property is when you can afford it. Perhaps my belief is not as true for cities that are dying from the inside. But for those people who want to buy property because their incomes are growing, a baby or two are on the way, or they simple no longer want to be price takers in an ever rising rental market, buying property when you can afford to buy is most likely a good choice.
It’s important to realize that if you rent, you are short the property market. Every time rents and property prices go up, you’re losing. If property and rental prices go down, you’re winning. Over the long run, shorting the property market doesn’t make sense because property prices having been going up since the beginning of property ownership in our country.
Shorting the property market is like shorting population growth or inflation. Bad move if you want to build wealth. I encourage readers to be at least NEUTRAL property. And the easiest way to be neutral property is to own your primary residence. Your asset will rise and fall with the market, and your payments will remain fixed or go down in real dollar terms over time.
PROPERTY OWNERS: CAN YOU AFFORD YOUR PRIMARY RESIDENCE AT TODAY’S PRICES?
In some sobering news, I realize nine years later that I can no longer afford to purchase my single family house in San Francisco at today’s prices. I asked several property owners in Hong Kong, Singapore, Manhattan, London, and Paris the same question, and at least half of them admitted to no longer being able to buy their property if it were to go on sale today.
The combination of a rise in property prices, stringent lending standards, continued low interest rates, and a decline in my absolute total income means that I’ve got to look for property at roughly 40% less than the value of my current house. I just got done speaking with the mortgage broker who disallowed my current income from my online company because I don’t have a 2+ year payment history (I only started paying myself last November). Furthermore, he’s taken a 25% haircut to my rental income for calculation usage to account for vacancies, even though I’ve not had a month of vacancy in nine years.
The only income that he can use is my passive income and my consulting income. I don’t know why, but that’s just the way he says the underwriters will analyze my income profile.
Buying a place that costs 40% less than the value of my house means that I can afford an average two bedroom condo in a OK location, or a really run down house about 45 minutes away from downtown San Francisco. There is no way I’m renting out my SFH to go live out in the boondocks or in a condo with neighbors all around. I want to keep on moving forward, not backward just for the sake of building wealth.
I did some Saturday pre-open house scoping of several properties over the weekend, and each time I pulled up to a property, there were already people scoping out the place! Even at 10pm when I was driving home from dinner, there were three cars outside a property in Pacific Heights checking out the exterior. When I finally visited the property on Sunday, it was an absolute mad house.
WHY DIDN’T YOU BUY PROPERTY WHEN THE MARKETS WERE LOWER?
Because I was stupid. How about you? The biggest mistake one could have made was selling their property between 2008-2012, if money was the primary reason for the sale. The second biggest mistake is therefore not buying property between 2008-2012 given prices were depressed and competition was also much less. Nowadays, it’s common to see 10-20% overbids for coveted San Francisco properties, meaning that on average, 4 out of 5 buyers walk away disappointed.
I didn’t buy additional property in 2008-2012 because the markets were falling apart from 2008-2010, and I was already figuring out a way to leave a job that no longer paid as well or provided as much pride. Leveraging up felt like the wrong thing to do at the time. In retrospect, leveraging up was the absolute right thing to do at the time to create more wealth. Now that I’ve regenerated enough income to purchase a place, everybody else has made more income as well. (Related: Why You Don’t Feel Wealthy With Stocks At Record Highs)
It’s frustrating to think that even if you bid 10% over asking, you still have a high chance of not winning. Couple that with the fact that the markets are at all time highs and my interest in buying more property is quickly dissipating.
WHAT IF YOU CAN AFFORD TO PAY RECORD HIGH PRICES TODAY?
If I just said I’m losing interest in buying property, doesn’t that go against my thesis of buying property as soon as you can afford to buy? It doesn’t because I’m already long four properties. My thesis pertains to those who are still looking to buy or who only own their primary residence and are looking to go long the property market.
Again, over the long term, shorting the property market by renting is a losing proposition. Thirty years from now you will be paying even higher rental prices while owning no assets. Hopefully you will have used the savings you generated from not owning and invested it wisely to generate wealth. But we all know that few people are disciplined enough to consistently invest the difference over a long period of time.
WHAT DOES “AFFORD” MEAN? FOLLOW THE 30/30 RULE
Putting 20% down on a property is a somewhat arbitrary number dictated by lending institutions. With 20% down, you don’t have to pay the wasteful PMI insurance. There was a time that affording property meant putting 100% down. But thanks to the development of our banking system and securities system, we’re able to afford more than we ever thought possible.
I believe an individual can comfortably afford a property if they can put down 20% and have a 10% buffer in terms of savings or liquid investments. In other words, a person who can afford a $1 million dollar property can put down $200,000 and have $100,000 in a CD or stock account.
A general good rule of thumb is to also have the mortgage amount take up no more than 30% of your gross income. If you are making $6,000 a month, shoot for a $1,800 a month mortgage or less. If you do want to stretch, most banks allow you to go up to 42% of your gross income.
Affordability in large part depends on rates, future income growth, and job security as well. But in general, a 30%/30% rule is good guidance. You can take advantage of those first time homebuyer loans which allow you to only put down 3-5% as well. You just have to be honest with yourself whether you can really afford a home if all you can put down is a 3-5% deposit.
THE TREND IS ALMOST ALWAYS UP AND TO THE RIGHT
There will probably be many times when you can afford to buy a property, but don’t because you are unsure about your future. That’s absolutely fine.
What I’m suggesting is that you figure out your future as quickly as possible because the price trend for desirable properties in desirable locations is almost always up and to the right. As soon as you find that perfect property, you’ll realize that everybody else has found that perfect property as well. The only way to get that perfect property is to be the top bidder. The winner’s curse is a dangerous situation to be in because your offer price leaves you no room for error. Only you were willing to pay that top price at that moment in time.
I decided to buy my first property in 2003 because I knew that I would be in San Francisco for at least three years because that’s how long the Berkeley MBA part-time program would last. I felt with about 90% certainty that I would stay for at least five years after purchase, and I ended up living in SF for 11 years post purchase. The longer you can stay in your property, the better in general due to the outrageous cost of moving (5% selling commission, transfer taxes, etc). In fact, I encourage all property owners to go on strike and never sell your property so long as the selling commissions are so high. The linked article was written in August, 2012 and I’m glad I followed through.
TIME TO FACE REALITY
Here’s the simple fact about affordability: It’s your income growth vs. a property’s price growth. Given the median household income is roughly $51,000 vs. the national median home price of roughly $210,000, the median household income has to grow by at least 4X the pace of price appreciation for affordability to occur. Once affordability does occur, it simply might not last very long. Imagine if you lived in San Francisco where the median home price is $1 million dollars compared to the median household income of $74,000. No wonder why only 36% of residents own property.
If I can’t increase my income by 2X for two years, I can’t afford to buy a property of at least equal value to my current primary residence. There’s no point in buying a lesser property that lowers the quality of my life just to build more wealth. I’m at a stage in my life where I’m very focused on optimizing lifestyle over money.
I bought my house nine years ago (in contract end of 2004) when I just started making enough money to barely buy a single family home. If you were to ask me back in 2004-2005 whether I’d be making much less income as a 36 year old, I wouldn’t believe it and would probably feel a little depressed as well.
We all think we’ll just keep on making more money over time – at least until we reach our peak earnings years in our 50s. The reality is that life isn’t linear at all. Some of us burn out, change industries, go back to school, get married, have kids, experience poor health, or make bad investments. We must adopt a savings habit to help buffer when times are lean.
If you want to buy your first property and can afford to buy, then I suggest you do a lot of research now and buy. The most important step is to properly analyze the property’s cash flow just in case you have to rent it out.
Recommendations For Homebuyers Or Homeowners:
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Picture sources: Calculatedriskblog and Paragon Realty Group.