If you’re thinking about buying a home today, you need to also ask what if you buy a home at the top of the market? Will you be able to afford the monthly payments, insurance, and ongoing maintenance expenses if there is a downturn? If you lose your primary source of income, usually your job, will you also be able to afford your home? Buying a home with mortgage debt is a big decision. Please treat a home purchase with the utmost respect.
The demand for real estate is strong in 2021+ because mortgage rates are at all-time lows, the Fed said it will stay accommodative, there’s a new president who will stimulate us, and we’re all spending way more time at home.
The economy is recovering from the depths of the 2020 recession. However, we’re not out of the woods yet. It will still take a long time to achieve herd immunity, despite multiple vaccines.
What If You Buy A Home At The Top Of The Market?
One way to tell whether buying a home right now is a good time or not is seeing what the stock market is doing. The stock market reflects earnings expectations 6 – 24 months in advance.
You can investigate further and look at sectors in which your location has large exposure. For example, check out tech performance as it relates to San Francisco. Or take a look at bank performance as it relates to NYC.
Stocks correct swiftly, while real estate corrects slowly until everybody knows real estate is weakening. Then liquidity dries up and the floor drops out. If the stock market is correcting, it’s time to pay closer attention to any investment you make, especially with leverage.
Real Estate Moves In Cycles
What we do know about the real estate market is that it moves in cycles due to the desire for economic profits i.e. new construction to meet new demand.
Peak new construction tends to occur past peak demand, which ultimately leads to temporary oversupply and lower prices. This bust phase usually lasts between 1-3 years before a price floor is found. We are clearly in the hypersupply/boom phase of the cycle now.
What’s also important to recognize is that every real estate market is at a slightly different phase of its housing cycle. Here’s a nice chart by John Burns Real Estate Consulting which names cities in each phase of the housing cycle.
Given I had three properties in San Francisco with $2,000,000 worth of leverage in 2017, I found it prudent to sell one property and reduce leverage by $815,000 since I felt San Francisco was in the “Maturing Exuberance” stage. Institutional investors have all but pulled out of the California housing market, leaving retail investors fighting for scraps. I’m sure I sold early, but life is so much simpler now.
Reinvest In An Earlier Part Of The Housing Cycle
Real estate investors can look at the chart above and rationally make an argument that it would be wise to shift exposure from late phase markets to early phase markets to earn more money and protect against downside risk.
If you believe in such logic, then you should believe in my thesis of investing in the heartland through real estate crowdfunding. Personally, I reinvested $550,000 of my San Francisco home sale proceeds into 17 real estate crowdfunding projects across America. I earn income 100% passively and have successfully diversified my investments.
Below are my two favorite real estate crowdfunding platforms. They have been around the longest, have the most scale, and the best deals. Both are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eREITs. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
Buying At The Top Of The Market
Let’s say that despite all the signs that the real estate market is at risk of rolling over, you go ahead and buy property with leverage at the top of the cycle. What happens to your mind and to your money? I’ve got first hand experience since I bought my Lake Tahoe vacation property only one year after the peak.
1) You go in denial at first.
You will always stand behind your decision to buy at the very beginning. Even if you see a neighboring home on the market sit for longer or drop their asking price, you will justify your purchase by saying your home has a better layout or nicer amenities. You will tell yourself that you bought your home for a better lifestyle first and foremost.
After about a year, the elation of owning your home fades a little bit. It’s similar to the fading elation of buying a new car with a loan. You are thrilled for the first six months, but that thrill dies down while the car payments stay the same. You’ll go online to see the valuation of imperfect comparable home sales to justify your purchase.
2) You begin to accept your mistake.
Between 12 – 24 months, you start realizing that maybe you didn’t make the best purchase after all and start telling yourself, “In the long run, things will be fine,” in order to feel better. But the more you look at homes that sell for less, the more you beat yourself up about your purchase.
You start doing calculations on how much you could have saved on the downpayment or on the monthly cash flow if you had just been a little bit pickier or a little more patient. You look at the nicer homes you could have bought with what you paid and kick yourself a little bit. Finally, you tell yourself, “It’s just money at the end of the day.“
3) You start to think worst case scenarios.
Due to leverage, a 10% decline in the value of your home is a 50% decline in your 20% downpayment. Just as the stock market can correct 10% in a month, the real estate market can easily correct 10% in a year. Once the momentum to sell begins in real estate, it starts getting scary, especially if you own a condo in a large building.
During a worst case scenario, you start calculating how long you can keep the house before you run out of savings if you lose your job. You also calculate how low the house can go before it no longer makes sense to keep paying the mortgage. During the worst stage of a correction, you may really begin to freak out because you will know friends who have been laid off. You start wondering when you’ll be next.
4) You start to cut out all excess fat from your budget.
The great thing about being rational is that during difficult times, all extraneous expenses get slashed and savings rates go up. You might even try and get a second job or work a side hustle if you really start getting worried. Fear of financial ruin in 2009 is what got me to start Financial Samurai. I needed a cathartic outlet to release my fear. I needed something to do just in case I was one of the thousands of people who got fired from the finance industry that year.
During the financial crisis, I didn’t buy anything. I also hustled harder to build relationships with clients who were my only leverage to keeping my job. Instead of buying groceries, I took as many clients out for lunch and dinner to not only build better relationships, but save on food!
Yes, I took leftovers home to feed my wife as well. My clients were also worried about losing their jobs and also wanted to save money. When you go through a crisis with someone and survive, your relationship thrives in good times.
5) You either stick with the game plan, or stick it to the bank.
If things get really bad where you’re underwater on your home, you will need to make the crucial decision of either staying current on your mortgage or stop making payments. First, you must realize which states are non-recourse states so they don’t come after your other assets after you welch. By short-selling or foreclosing on your home, not only do you ruin your credit and dignity, you also hurt your neighbors who decided to keep paying.
But in America, it’s often every man and woman for himself. You can foreclose on your home like one financial pro did in 2011. He subsequently got hired by The New York Times to write about money advice and even wrote a book about how to improve your finances! This example is one of the reasons why I’m so bullish on America. It doesn’t matter what mistakes you’ve made or who you are, you can always come back.
Nothing Happens If You Decide To Keep Paying Your Mortgage
If you decide to keep paying your mortgage, then life goes on usually as planned. After all, real estate markets tend to recover over time. Few people go into buying the most expensive thing in their lifetimes without a long-term plan. You’re just annoyed that you paid full price for something when it went on sale just a couple months later past the return policy.
If you decide to foreclose or do a short-sale, then you simply lose 100% of your downpayment. You also hurt your credit score by the following amount according to FICO:
- 30 days late: 40 to 110 points
- 90 days late: 70 to 135 points
- Foreclosure, short sale or deed-in-lieu: 85 to 160
- Bankruptcy: 130 to 240
A foreclosure will be on your record for 7 years on average plus 180 days from the last time the account was paid as agreed. Your credit score will gradually improve over these seven years, but not fully until the foreclosure is off your record.
Those who’ve been through foreclosure and want to do conventional financing in the future will have to pay a higher interest rate (approximately 1 and a half to 2%) unless they put a sizable downpayment on their new property (more than 20% down).
If the real estate market seems frothy, please follow my 30/30/3 rule for home buying. If you do, you significantly increase your chances if being able to afford your home in a recession.
Just Have To Hold Onto Your Real Estate
Buying real estate at the top of the market stinks. I bought my Lake Tahoe condo after a 12% correction in 2007. At the time, I thought it was nice to save $100,000 from the original purchase price. Little did I realize the value of my condo would plummet by an additional ~30%. So many of my neighbors decided to foreclose and I was left helpless.
I felt like a real dummy buying the condo two years later. I felt so bad about my decision that I decided to become super frugal for the next five years. Further, I worked extra hours in order to get promoted and paid. But most importantly, I started Financial Samurai as a potential way out.
More than 12 years later, I’m at peace with my decision. Valuations have rebounded from the depths of despair. The mortgage balance is 40% lower. And the value of the condo has shrunk to a small portion of my net worth. There is also satisfaction that I didn’t welch on my debt.
Now, I cannot wait to take my little boy and girl up to play in the snow. I cannot wait to show them how to jump in the lake off one of the public piers. It’s going to be fun making roast marshmallows on an open fire after a rewarding hike. I cannot wait to tell him fun stories under the stars.
When his mother and I pass, I hope they have their own family to take up to the mountains one day. Maybe they’ll even have a picture of their parents on the mantle smiling and watching over thm.
Recommendations For Investors
1) Mortgage rates are at all-time lows. If you want to buy real estate or bought real estate at the top of the market, I highly encourage you to refinance your mortgage. Mortgage rates are at all-time lows.
Take advantage by checking the latest mortgage rates on Credible. Credible is a top mortgage marketplace where lenders compete for your business. Get free refinance or purchase quotes in minutes. A 15-year fixed or 30-year fixed looks especially attractive.
2) Explore real estate crowdsourcing opportunities. If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.