Why Buy a House?

I feel Jennifer’s pain.  Economic figures suggest that the whole world is falling apart and Armageddon is soon upon us.  With reecent memory of the deep recession of the early 80s and fear of a prolonged Depression of the 30s, it’s easy to become entrenched in the negativity associated with the real estate decline.

Yet, you should consider owning real estate. Warren Buffet, often referred to as “The Oracle of Omaha”, offers us these axioms.  My comments are below:

1- Wide diversification is only required when investors do not understand what they are doing.

All real estate is local.  Markets, and sub-markets, sometimes act in polarity rather than in concert.  While San Diego real estate was plummeting, Austin and Dallas were booming.  Today, properties in certain sub-markets of San Diego County are as much as 55% off of their high price and offer both utilitarian and intrinsic value .   The dramatic decline in oil prices (I told you that was coming) will affect the Texas market, probably for years to come.

Do your homework!  It is highly unlikely that you will be able to time the absolute bottom of the market.  When industry participants, like Jennifer, start getting despondent, I can assure you that bargains are being overlooked; I’ve seen this happen before.

2- Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.

Remember when you had your first heartbreak?  Your mother said, “Time heals all wounds!”.  She was annoyingly cheerful but she was right.  Once you got over the loss of fleeting teenage love, you realized that Mr. or Mrs. Wonderful was lurking around the corner and got on with your life.

Let’s find Mr Wonderful property, shall we?

You think it might make sense to buy rather than own but you don’t know when that actually pencils out.  Let’s assume you rent a house on 123 Ocean Street in Happy Beach, CA for $1500/month.  The house across the street, at 126 Ocean Street is offered for sale at $265,000.  Which price offers you the “ownership advantage”?   Let’s do some cocktail napkin* math to find out the answer.

Keep in mind that a majority of your mortgage payment is tax deductible.  Interest paid and local property taxes can be written off against your income (assuming you itemize).  Your household income is $75,000.  In California, the marginal state tax rate would be 6% and the marginal Federal tax rate would be 25%.  This means that about you’ll save about 31 cents of every dollar paid in mortgage interest and local property taxes.  If we divided 90% of your rent payment by (1-.31), we’ll get the approximate payment parity.

$1500 (.9)= $1350

$1350/.69= $1956

PITI payments are ABOUT $8/thousand.  Note Bene:  This is an approximate number.

Divide $1956 by 8 and you’ll arrive with 244.5  If you use a FHA loan, you’ll need 3.5% for a down payment.  Divide $244,500 by .965 and you’ll have a purchase price of $253,000.  This means you can pay up to $253,000, for the home on 126 Ocean Street, and pay less money, on an after-tax basis,  than what you pay for rent on 123 Ocean Street.

We buy property for appreciation and we’re not figuring in for that right now.  We just want to perform a rent V buy analysis, on a cocktail napkin*, to see what price you should pay.

3- We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

Gosh, this one is SO easy.  All you have to do is turn on CNBC or CNN to see all the Chicken Littles screech about the end of Western civilization; that’s FEAR.  You might consider greed as an appropriate response.

4- Our favorite holding period is forever.

If you can live with the house offered, for the rest of your life, and it costs less money to buy than to rent, you’re probably making a pretty good deal.  Sure, the market may decline another 5%,…or 10%,,,BUT…you’re holding time is forever.  YOu can afford the payment, can live in the house forever, and will withstand the volatility associated with residential real estate today.

You might even make some money, over time.  Be patient.  Good things come to those who wait.

* I used the term “cocktail napkin math” for a reason.   I have no doubt that one of my competitors will do a drive-by comment, questioning the veracity of my math.  I expect one of them to do that without reading this disclaimer.

An experienced loan originator can run a rent V. buy analysis for you.  I just want to arm you with some approximate numbers, to run without a calculator.  Contact one of the folks on the sidebar or contact me if you’re getting ready to buy a home; we’ll knock out the numbers, down to the penny for you.

December 12, 2008