Current Prices and Future Outlook

Median home prices dropped by up to 40% in select markets in the country in 2008 according to Kiplinger.com. 2008 saw the peak of interest rate resets for the subprime mortgages. However, resets for many other adjustable rate mortgages will continue until 2011. According to Mark Zandi of Moody’s economy.com potentially 12 million houses could go into foreclosure. As such the pressure on housing prices is likely to continue.

According to Kiplinger.com, Fiserv Lending Solutions forecasts that the median home price nationally will fall another 9% in 2009, bottoming out in the last half of ’09, and increase nearly 7% in 2010. However Kiplinger expects the market to fall another 10% in 2010 before regaining its footing in 2011.

Figure 1 below shows the change in home prices from 2000 to 2008 based on the Case-Shiller 20-City Home Price Index.

Fig. 1 Year-Over-Year Percent Change in the Home Price Index, 2000 to 2008

The December 22, 2008 issue of Fortune magazine has an article about the 2009 housing outlook for the top 100 markets in the country. According to its analysis, only two out of the hundred markets is going to show gains in 2009. However, 47 markets are expected to swing to gains in 2010. Here is a webpage showing the 10 worst performers in 2009 from the same data. Eight of these ten markets are in good old California. The top ten worst markets include Los Angeles, Stockton, Riverside, Miami-Miami Beach (Florida), Sacramento, Santa Ana-Anaheim, Fresno, San Diego, Bakersfield, and Washington, DC in order from the worst to the tenth worst.

Mortgage Rates

Thanks to the rate cuts by the Fed, mortgage interest rates are expected to stay low. The 10-year Treasury note yields are at historically low levels. But increased perception of risk by lenders is keeping the spread between the note yields and the 30-year fixed mortgage rates high, preventing the mortgage rates from reaching the target of 4.5%. Figure 2 below shows a forecast of thirty-year mortgage interest rates from Forecasts.org.

Fig. 2 Thirty-Year Conventional Mortgage Interest Rate—Past Trend and Projection, 2006 to 2009

Crisis and Opportunity

Every crisis also presents an opportunity. My heart goes out to those who got caught up in the frenzied go-go years of cheap and easy no-questions-asked mortgages and rising home prices, and are now faced with potential foreclosures and financial hardship.  But for many buyers, lower house prices make purchasing a house possible, affordable, and profitable as an investment. Is this, then, a good time to buy a house?

But first, we should consider the merits of the idea of buying a house. Buying a house at the right time and for a sufficiently long time can have many advantages over renting one. It can give you better control over your living quarters, stability, tax deductions of mortgage interest payments, and a chance to build equity. Historically, over a long period of time, say greater than 10 years, house prices generally appreciate by more than inflation when compared with the original purchase price.

Even if the house prices go down after the purchase in a downturn like today’s, the loss in house value is only an unrealized paper loss. The loss is realized only if you have to sell the house during the downturn because of a move or a loss of income. It is always a better idea to get a 30-year or 15-year fixed mortgage rather than an adjustable rate mortgage or any of the newfangled exotic mortgages. That way the mortgage payments stay predictable and affordable.

If you already own a house and have to move because of a job or you have been waiting to upgrade from your starter house to a bigger house or a house nearer to the job, it could be a good time to purchase that new house compared to when the prices are high. In an up market or a down market the prices on the old house (the one you are living in) and the new house (the bigger or the better located one) will move in tandem. So, if the new house price is going to be higher, so would be the old house price, and vice versa. However, the price differential between the houses will be smaller in a down market, making your new mortgage a smaller one.

Purchasing an additional house for investment depends on a number of factors including the price, investment time horizon, mortgage rates, and rental income from the new house. You can do a quick analysis to see if you have positive cash flow. In other words you can compare your annual payments for mortgage, upkeep, and taxes with the annual rental income. If you expect more income than expenses, then you are cash flow positive and you would not have to keep sinking additional funds into the house after the first purchase. If not, then the additional money you would have to spend every year will take away from the total returns from the house when you sell it later at an appreciated price. You can roughly calculate what would be the break even sale price given your purchase price and annual expenses. You can then compare that with expected sale price to see if you are getting a reasonable return on investment.

If you are considering buying a house for investment, all indications are that you could wait for some more time, say at least up to six months for house prices to fall some more.

What do you think?

No related posts.