Rent or Buy? Yes.

$195,400 v. $5,400. That was the average net worth of a homeowner versus that of a renter in 2013 according to the Federal Reserve. That means the average net worth of a homeowner was ~36 times that of the average renter, a multiplier that some expect to increase to ~45 times by 2016. 

Compelling data, but is it a surprise to anyone that homeowners are generally wealthier than renters? Perhaps the more interesting debate is whether home ownership creates wealth or does wealth create home ownership?

The answer is Yes. After all, home ownership rates for those under 25 years of age is generally less than 25% (probably much lower in the Bay Area) and approximately 80% for those ready to retire. Its not rocket science here; younger people will generally have a harder time cobbling together a down payment, and therefore might rent or live with their parents until they accumulate enough wealth over time where owning becomes a viable option.

However, owning a home sooner rather than later can help build wealth too. A mortgage is like a forced savings plan. Every time a homeowner makes a mortgage payment, he/she is likely increasing their equity in the property, and thus contributing to his/her net worth. And of course in times of rising home costs, very few things outside of winning the lottery or owning shares of the next great tech company can build wealth as quickly home ownership. Keep in mind that a 10% increase in home prices may actually translate into a 40-50% increase in equity – that’s called leverage!

Does this mean that everyone that is currently renting should rush out and buy a place? No. No one knows if home prices will continue to rise and for how long and how far. Let’s not also conveniently forget lessons from the last decade; a rise in home prices does not actually mean much unless you sell. And a small drop in home prices can put a disproportionate dent in equity overnight – the flip side of leverage. For those enamored with the age old question of rent or buy from an analytical perspective, I would highly recommend the New York Times Buy v Rent Calculator. Keep in mind that we live in a highly efficient housing market, especially in the Bay Area, and there is probably not any material rent v buy inefficiency to exploit.  But the calculator is at the very least a great exercise in understanding the financial impacts of various costs that go into owning or renting. 

The rent v buy conundrum, for those qualified to do either, remains very much a life-stage or lifestyle choice too often disguised as merely a financial decision. The psychological and emotional commitment required to own is often more burdensome than the financial commitment, and you will be ready when you are ready. For others eager to buy but are not yet qualified, this will make you feel better: you are probably still very young and homeowners are more envious of your youth than you are of their homes or wealth!

While home ownership may not be for everyone, it often depends on timing, taste, and circumstances, there is no denying that real estate remains a great and relatively safe investment, especially over the long term.  As always, if you know of someone ready to buy, sell, or is looking to learn more about the process and prospects of either, I would be honored if you think of me. I would work tirelessly to ensure I exceed the already high expectations that would come from your trusted referral.

Is 30 The New 20?

How much do we need to put down?

One of the first questions that crosses a prospective homebuyer’s mind, save for cash buyers. Traditionally 20% down has been a rule of thumb. By reaching this threshold, borrowers generally receive favorable interest rates, avoid having to pay private mortgage insurance (PMI), and are usually perceived by lenders and sellers as strong on paper when making an offer on a home.

But if 20% down is the benchmark for a strong borrower and hence a strong buyer, why is it that in the Bay Area we often hear that 20% isn’t enough? Common sense begs the question:

Why should the seller care about the buyer’s financing? At the end of the day, the seller will walk away with the same amount of money, sometimes even more, by accepting a 20% down offer versus a 50% down offer or even an all-cash offer.

Turns out that sellers aren’t always looking for the highest offer. After all, even the highest offer is not worth much if the seller does not believe the offer will close. Sellers are usually looking for the highest offer that also has the highest probability of closing smoothly. This means in addition to the offer price, sellers will generally favor offers that include fewer “outs” for the buyer, i.e. contingencies, and favor buyers with loans that are less likely to fall apart during the sale (or cash offers where there is no loan risk). But if you are preapproved with a reputable lender, how can your loan still far apart?

Well, after an offer is accepted your lender will order an independent appraisal to confirm the value of the purchased property.  If the appraisal is short of the purchase price, the bank will only lend you the agreed upon % of the appraised value. For example, if you want to put 20% down on a $1M property ($800K loan/$200K down), but the appraisal comes in at $950K, the bank may only lend you 80% of the appraised value or $760K and you will need to put $240K down. In this case, the appraisal gap may effectively require you to put 24% of the purchase price down on an 80/20 loan. If you insisted on only putting $200K down, the loan would be $800K or 84% of the appraised value of $950K, and your lender may require PMI, charge a higher interest rate, or can flat out deny you the loan altogether.

As a buyer, you can protect yourself from this situation by:

• Attempting to renegotiate the price; or
• Holding extra cash in reserve to pay a higher down payment; or
• Including an appraisal contingency in your offer allowing you to back out if the property appraises for less than the offer price.

Sellers may protect themselves by:

• Asking you to waive the appraisal contingency (you may need to increase your down payment); or
• Eliminating your offer from the running in favor of an offer that is less risky to the seller.

Therefore in a multiple-offer scenario a lower down payment offer may be less competitive because if it comes with an appraisal contingency, the seller may regard the offer as risky. The lower down payment buyer may offer a higher price to compensate for the risk, but if the property does not appraise at the purchase price, what good is the higher price to the seller once the buyer backs out or can no longer get a loan? The higher the appraisal risk, the more the seller tends to favor buyers that can cover an appraisal gap, i.e. higher down payments. If the seller is confident the property will appraise close to the purchase price, a lower down payment may not be a disadvantage as long as the other terms in the offer are still competitive.

This is why in our hot Bay Area market, 25%, 30%, or even larger down payments have become more common, though offers and loans still come in all different shapes and sizes. A higher down payment may give you confidence in waiving the appraisal contingency, signaling to the seller you are both qualified to and highly committed in purchasing the property. As a seller, this continues to be great news. Prices are high, inventory remains low, and many buyers are stepping up to demonstrate how badly they want your home. As a buyer, this isn’t bad news; it’s just the reality of our Bay Area market. In fact, the current market may be more buyer-friendly than you realize or all of the sensationalized stories lead you to believe. Compared to earlier this year, many homes are sitting on the market longer and with less competitive bidding than we were accustomed to seeing in the springtime (read: lower down payments are competitive!). And keep in mind that even though 20%+ down payments are common, they certainly are not the rule. Many buyers are still landing the home they have always wanted with less than 20% down, and many lenders have special programs and promotions with great rates (will they be rising soon?) and no PMI requirements.

At the end of the day, a great agent can recommend and build a strong offer strategy regardless of the down payment amount. An even better agent will take the time to educate you on the merits and risks of your offer so you feel more confident and comfortable with the potential outcomes. When you are selling, a great realtor can make all the difference between identifying and attracting the most qualified and committed buyers versus generating unwanted traffic into your home and wasting time with weak offers. As such, if you know anyone presently or in the future that is contemplating a real estate transaction or simply wants to discuss the market or a property, I would be honored if you think of me. I would work tirelessly to ensure I exceed the already high expectations that would come from your trusted referral.

Bay Area Housing Bubble or Crisis?

The two most common questions I get asked as a real estate agent lately are:

• Will prices continue to rise?
• Are we in a bubble?

While no one can definitively answer these two questions, I can attempt to explain some of the underlying market dynamics and let you decide where you think the Bay Area housing market will go from here.

It’s easy to understand why demand for housing in the Bay Area is so strong. Our economy and job market is as prosperous as any in the country, if not the world. High salaries and fast-growing profitable companies are creating wealth and attracting talent, and foreign buyers are snatching up properties as long-term investments. But if population growth, rising incomes, and low interest rates are the basic drivers of strong housing demand, why are there not more homeowners stepping up to sell at record prices? Basic economic principles would suggest that more homeowners cash-in by upsizing or downsizing, moving across or out of town, or pocketing the profits and becoming renters, each of which would increase the amount of homes available for sale. Yet, we see relatively the same or even fewer homes for sale, but prices keep going up. Let’s examine why supply is so constrained:

Taxes – Taxes are impacting housing supply in at least 2 ways. First, property tax bills generally do not increase more than 2% per year, an inflation factor that lags far behind rates of property appreciation in most Bay Area markets. If a longtime homeowner sells his or her property and purchases another home, the new property tax will be computed on the market value of the new home, which may result in a sizable step-up in annual property tax liability, effectively increasing the costs of selling. Second, taxes on capital gains are scaring off some would-be sellers. While up to $500K of profit may be tax-free on a home sale, many Bay Area homeowners may be sitting on gains of $1M or more on their homes meaning they would face capital gain taxes on at least $500K or more of profit on the sale of their homes. If they wait until one or more of the homeowners passes away, the cost basis gets “stepped up” to market value and the heirs could then sell the property without having to pay any or only minimal capital gain taxes.

Post-sale options limited – It may be very lucrative right now for homeowners moving out of the Bay Area to sell, but those merely looking to upsize, downsize, or move across town face a quandary. Entering the market as a buyer or renter is enough to frighten many would-be sellers into staying put. Bidding wars, scant inventory options, and competition from overseas cash loom on the other side after the sale of their home. And despite low interest rates, mortgage financing is still relatively tight and some homeowners that purchased pre-recession may find it challenging to qualify for a new loan today.

Additionally, post-foreclosure inventory has mostly dried up and is at its lowest level in years, and the combination of low inventory, high demand, soaring rents, and low refi rates mean that more than ever would-be sellers are renting out their homes instead of selling. When you add this all up, only the most committed and persistent buyers succeed in purchasing a home as fewer homes are available to change hands.

So what needs to happen in order to reverse the trend? On the supply side, new construction would need to go up faster than demand growth. On the demand side, we would need to see an exodus of jobs and people. A natural disaster, another recession, or a sizable uptick in interest rates could certainly have impacts as well. Any guesses when any of these will happen?

Will the bubble burst? High prices may be the symptom of a bubble, but high prices alone do not indicate a bubble. Unsustainable trends generally accompany a bubble; which of the current market forces are the most unsustainable and which will be the one(s) that pop the bubble?

One thing I can offer with certainty is that the market will come back down again eventually…and then it will go up…and then it will go down…and then it will go up again. I just can’t tell you exactly when each of these will happen.

Good news is that there are great opportunities even in this market. With proper planning, sellers may be able to defer or mitigate their taxes, and studies show that it is still cheaper to buy versus rent in our region, especially while interest rates remain low. And having the right realtor in your corner can make all the difference between a quick sale and a profit-maximizing sale, or getting your offer to the front of the line and accepted in a multiple bid scenario. As such, if you know anyone presently or in the future that is contemplating a real estate transaction or simply wants to discuss the market or a property, I would be honored if you think of me. I would work tirelessly to ensure I exceed the already high expectations that would come from your trusted referral.