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Trade up on main home or buy a rental property?

We live in a median-priced home in Austin, TX. Although we could afford to move up to a more expensive home now (maybe $200K more), we want to wait about 4 years until the kids are ready to change schools. 

I am worried of course that property prices will rise quickly over the next 4 years and will price us out of our next home. What's the best way to mitigate that risk:

 - Just go ahead and move up now?
 - Purchase a rental property for about $200K, then sell both properties in 4 years to purchase the move-up home?
 - Try to find some other investment that will move like residential property prices in Austin. Is there a REIT like that? 

What do you all think, and why? 

Many thanks!!
  • May 20 2010 - Austin
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Answers (10)

I would not recommend a REIT since you have no direct control or ownership.  There are other reason to, but enough said on REITs.

If you've been in your home for over two years, then you qualify for capital gains exemptions.  That play play a role in your decision.  Check with your tax adviser on the tax related side of the decision.

Without knowing more about your situation, I would recommend investing in prudent income-producing real estate.  This is a great time to be buying as much as you can.  Rates are low, and deals are almost everywhere, so don't limit your search to Austin only.  There are better cash-flow and capital appreciation markets elsewhere.

Feel free to contact us for an analysis of your investment goals.

Continued success,

Marco Santarelli

  • May 20 2010
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Hands down, right now is the best time to buy.  Prices are at 2001 levels, interest rates are low, and there is a lot of inventory.

That being said, your question still depends on several factors.  Is your main goal to take advantage of current prices to buy a new home for yourself, or are you looking for an investment?  Which is more important?

If you want a new home for yourself before the prices go up, then you could buy now and rent or sell your current house.  This is a great option, if you can do it.  How are leases doing in your area, and, can you handle two mortgages?

If you want to take advantage of current prices to make a profit, then buying a smaller rental property now might be an option.  If you buy a rental property that will lease well, then you could make some money in a few years when home values increase.

I think it depends on which home you are more likely to lease, your own or the new purchase.

By all means contact me if you want to talk about it in more detail,
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Thank you!
  • May 20 2010
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It takes at least 5 years to cover the expense from the sale, realtor fees, document fees, etc...
  • May 20 2010
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I don't have a crystal ball but I don't think there will be an inflation bad enough that would make a difference.  Buying an investment and selling it in 4 years doesn't make sense, the cost invovled would take at least 3 years to recover, unless it's the deal of the century.

Naima

  • May 20 2010
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It sounds like your ready to make some kind of investment. What stands out about your contribution is it gives reasonfor your questions. Options are clear for you to do what is best for your family, but if your mortgage is confortable and credit is good. The time is now for any direction you go with. The bank has stop lending money to people with low credit scores ,but they still need places to live, so investing in a rental cant be a bad idea. You could have a mortgage as low as 4.5% at 30yr, 3yr, 5yr,7yr, 10yr, Keep up with Zilliow and CNBC this will keep you up on the Market.
  • May 20 2010
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That is a tough question to answer because non of us know what will be happening in the future.  I would never recommend buying a property with the intention of selling it in 3-4 years because the transaction costs will more than likely eat all of the gained equity.  There is always a chance too that the home will not appreciate very much and could leave you in a bad position if you need to sell it quickly.

As a Realtor and a Mortgage Broker it is easy for me to say it makes sense to consider moving up now.  Not just because of my profession but because although nobody can predict the future this is a great time to buy currently.  My 30 Year rates right now as of this posting are just 4.375% and that is with zero points of any kind.  That is the lowest they have been since last summer!  Also if you sold your home now you may lose some money but you would be buying a more expensive house with the same percentage discount.   Losing 10% on a $100k house is negated by saving 20% on a $200k house.

You may want to see if you can buy a home in the same school district as your children are in right now so that they do not have the stress of changing schools.  I know that would have been a scary thought when I was growing up. 

So, once again this is really a decision you need to think about yourself because only you can answer it. 

I wish you the best of luck.
  • May 20 2010
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Here are the price trends for the Austin area.  The graph below shows the 10 year average and median prices for single family homes in the Austin area.  You can see a better view of this and other market graphs on my website.  Residential prices are around 2006 / 2007 levels.



Some key points to remember before jumping into investment property are:
1.  30% down payment on investment properties
2.  Stricter qualifying on investment property
3.  You most likely will not be able to include the potential rental income as part of your loan application (so your current debt and income levels should be able to justify the purchase without the rental income included)
4.  Are you ready to be a landloard.  It takes time and resources.
5.  Be prepared to carry all costs of the asset if it sets unrented for a while of if bad tenants default on a lease.
6.  Be prepared to pay for repairs.

If being a landloard isn't your cup of tea, you might consider upgrading your primary residence.  Buyers in the $300k to $500k have a lot of leverage in the Austin market right now and there are a lot of great properties to choose from.  In the under $200k price range, buyers do not have a much leverage, and the people that took advantage of the buyers tax credit that ended in April chewed up a lot of the inventory in this price range. 

Either way you decide to go, this is a great site for searching for homes online.  

Feel free to contact me at 512-659-5506 or drop me an Email at allen@shipmanpartners.com.

Allen 
  • May 20 2010
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Keep in mind that your existing home value will likely rise along w/ that of any "move up" home.  As your equity grows, so will the amount you have to purchase the new home.  Your existing home is an inflation hedge in itself. If you're looking to hedge even further, investing in add'l resl estate is a good option. If you have the down pymt and can find rental property w/ positive cashflow after all expenses, it might be a good time to buy and hold long-term...even after "moving up". Any positive cashflow thru the yrs can be applied towards the "move up" home purchase down the road.
  • May 20 2010
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Hi,

Thanks to everyone who pointed out that the transaction costs on the rental property are likely to exceed any gains that I might get over the period I am looking at. I hadn't considered that!

Allen Shipman, your data was great, thanks! That actually caused me to look at this from a different perspective... to validate my plan of using REITs as a hedge against rising property prices, I compared the Austin property price increases against residential REITs and here's what I found:

The two time periods where housing prices were increasing in Austin the fastest were 1997-2000 and 2004-2007

If we look in detail at 1997-2000 (Internet/tech boom, the likes of which we may never see again), average property prices increased from about $140K-$195K, about 40%

Over the same time period (July 1 1997-July 1 2000), the following residential REITs had the following changes:
ESS: 27.95 -> 42.56 (+52%)
AVB: (6/1/98 - 7/1/2000) 32.66 -> 43.09 (+32%)
EQR: 21.00 -> 24.35 (+15%)
And the whole REIT market VGSIX: 13.11 -> 11.35 (-13%)

Over the other fast-rising time period (July 1 2004-July 1-2007) the average Austin house price went from 200K to 250K (+25%)
And the residential REITS changed over the same period:
ESS: 67.80 -> 120.22 (+77%)
AVB:  57.53 -> 124.34 (+116%)
EQR: 30.06 -> 46.45 (+55%)
And the whole REIT market VGSIX: 15.83 -> 24.43 (+54%)

I'm not sure why some of the REITs did not fare so well during the tech boom, but certainly during the last period of rising house prices, the REITs outpaced property in Austin by a significant margin.

Thanks again to everyone, the transaction costs of the rental property closed that one down, and Allen's data allowed me to compare REITs as a hedge against rising housing costs.
  • May 23 2010
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All mentioned above are great points.  Here are a few more:

1. When you purchase a home calculate 8% closing costs for when you sell it + buyer closing costs.  In short, it needs to appreciate 10% to break even.  This is usually a 3-4 year time period.

2. If you are looking to invest but also to move up do you "have to sell" your current home now or can you lease it?

Interest rates are great right now which has a major impact. For every 1% of interest rate increase you have 11.4% LESS purchasing power (and thus 11.4% higher mortgage).

Rates are expected to jump up by about 2% over the next year which would lower your purchase power by 23%.

If possible, I would suggest leasing your current place and buying a new place.  But make sure the new home has nice upward potential.

Many economists are predicting a somewhat a flat market (at least in Austin) for the next 2-3 years with a nice potential value increase in 2014.

I think interest rates are huge though.  Lets say you are in a $200k home right now and you could potentially afford a $400k home (with today's interest rates).

If you were to buy next year (assumming $400k is your limit now) then you would only be approved for $308k.  Major difference.

Rental Property vs Homestead upgrade means the following:  Rental property requires 20% down + has a higher interest rate (1% or more).

To me, keeping your current home and leasing it out is ideal (providing your home is in a price point where a lease will cover the mortgage).
  • May 25 2010
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