Buying a House in Today’s Market

Since many of our members are considering relocating, downsizing and/or finding housing better suited to their future priorities (e.g. greater energy efficiency), we invited Patrick Killelea, founder of the housing news and forum site Patrick.net, to offer his advice to house buyers in today’s market. Patrick was one of the most vocal bloggers warning about the collapse of the U.S. national housing bubble years before it inevitably popped in 2007.

(A note to those of our readers who work in residential real estate: the views expressed here are Patrick’s own, which he has consistently maintained for years. While some of them are not popular with the realty industry, the resulting dialogue they have created about the structure of our national real estate model has been a healthy one.)

If you’re in the market for a house, there are a number of important factors to consider which your agent just isn’t going to tell you.

The first one is that you don’t need an agent! There is very little that a buyer’s agent can actually do for a buyer. Property for sale is easy to find, and the paperwork is very routine. The agent’s sole concerns are first how to manipulate you into signing a contract which will limit your ability to get rid of them, and second, how to manipulate you into bidding higher than you should. The agent’s financial motive is to make a sale and get a commission. No sale means no commission. They are going to push whatever pscyhological buttons might get you to buy. So agents invariably use the word “home” instead of “house”, because they hope it will trigger warm happy feelings, instead of the feeling of being trapped with excessive debt. Agents are going to stress how successful you’ll feel as an “owner” no matter how much you overpaid. They are going to imply that renting is a kind of failure, no matter how much money you can save renting the same thing.

Rather than using a buyer’s agent, it is often better to ask the seller’s agent to represent you for that one
property they are selling, because in that case, the agent gets double commission if you buy it. This gives the agent a motive to accept a lower bid from you rather than a higher bid from someone with his own agent. Since all bids are secret, it is trivially easy for the seller’s agent to hide higher bids from the seller. If you do have a separate buyer’s agent it is good to mail a confirmation of your bid to the actual seller himself (not to his agent) to avoid such bid-blocking. But check your buyer’s agent contract — you may have signed away your right to contact the seller directly.

The second factor to consider is whether the house could “support itself” with rent if necessary. If the rent could pay the mortgage, property tax, insurance, and maintenance, then you’re very safe from defaulting. If you become unemployed and cannot pay the mortgage, you can simply rent out the house and at least break even. You won’t be forced to sell at a loss. Unfortunately, most of the houses that can support themselves with rent are in poorer neighborhoods. High-status neighborhoods generally have house prices far in excess of the amount justified by local rents. Buyers overpay because the want the status of being an owner in
these neighborhoods. Renters can live in the same size and quality house for much less, but they don’t get the same status in the eyes of their neighbors. If you can afford to pay a lot extra for that “ownership” status, that’s fine. Just be aware that that’s what you’re paying for. To calculate the gain or loss from owning relative to renting, I’ve created a free calculator at http://patrick.net/housing/calculator.php

The third factor to consider is making an all-cash offer when high interest rates exclude weaker buyers. The savvy buyer wants interest rates to be as HIGH as possible when buying for cash. High interest rates mean that potential buyers who don’t have cash just can’t pay as much. This puts the all-cash buyer is a far stronger position. In addition, asset prices generally move inversely to interest rates, so a high interest rate increases the prospect of price gains when rates fall in the future, and those weaker buyers can once again bid. Finally, the all-cash buyer simply saves money by not paying interest, and these savings can be gigantic. The typical mortgage requires a buyer to pay more interest than he pays for the house itself.

The fourth factor to consider is how long you will live in the house. The typical buyer dramatically overestimates length of ownership. The median length of house ownership the the US is only six years. Half of all owners own for less than six years. That six percent agent commission over six years means an additional one percent per year. Think of that in terms of interest rates. An extra percent on your interest rate is huge. If you’re not likely to stay put for a long time, it’s probably not a good idea to buy.

The last factor to consider is appreciation. The housing bubble was mostly due to unrealistic appreciation
assumptions. Excessive lending can justified by assuming very high appreciation, so there was a motive on the part of both banks and buyers to assume that house prices would continue to appreciate at high rates. Bad lending based on unrealistic appreciation assumptions created a temporary positive feedback loop in prices. The prospect of negative appreciation was not even considered, and most rent-vs-buy calculators would not even accept a negative number. My calculator at http://patrick.net/housing/calculator.php is the only one on the internet that starts with an assumption of falling prices, even if only 1% per year.

While there are many other factors to consider when buying a house, I believe these five are the most important ones.

And for those potential buyers with time on their side, it’s prudent to look at the macro environment. At this point in the housing cycle, we are quite likely to see additional price declines nationally. Large numbers of foreclosures are still coming on the market, and the unemployment situation has not improved significantly. The Case-Shiller index clearly shows that a resumption of price declines is already in progress.

Low interest rates in the long-term bond market imply that investors are not expecting significant increase in interest rates soon. Nonetheless, rates may go up if we get salary inflation. Higher salaries due to salary inflation would give workers more money to buy a house, but on the other hand, higher interest rates would put downward pressure on prices at the same time. If you believe salary inflation is coming soon, it makes sense to lock in a low interest rate now. But given the continuing unemployment situation, salary inflation does not seem imminent.

Patrick

This What Should I Do? blog series is intended to surface knowledge and perspective useful to preparing for a future defined by Peak Oil. The content is written by PeakProsperity.com readers and is based in their own experiences in putting into practice many of the ideas exchanged on this site. If there are topics you’d like to see featured here, or if you have interest in contributing a post in a relevant area of your expertise, please indicate so in our What Should I Do? series feedback forum.

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