Wednesday, February 27, 2008

What a Fine Mess We are In

First off, I want mention that I consider a home a place to live, not an investment. But with that said, I still want to maximize my overall happiness and financial well being when purchasing a home.

My mom, who retires this month, sold her home in late 2006. She has become much more serious about getting back into the market lately, since her options for a reasonable return on her financial assets (i.e. cash from selling her home) have dwindled significantly with all the rate cuts.

While her situation is slightly different than mine, recent news about increased inflation risks also has me wondering if it might be better to purchase sooner than later, even though the housing market hasn’t reached bottom yet. I do think the Sacramento housing market will be one of the first to stabilize…..since it was also one of the first to crack. I also believe, with the recent acceleration in price drops, that we will see begin to see signs of stabilization sooner than some had predicted.

Much of my increased confusion comes from trying to weigh the uncertainty and risks involved on either side.

If inflation is going to strengthen to the point where it will overshadow the remaining reductions in the housing market, the time to buy is sooner, while rates are still relatively low (before the Fed raises rates to contain it).

If the economy cools, the credit crunch continues to deepen, and inflation is contained, it could cause the housing market to overcorrect, in which case it would be best to wait.

And of course, there is the dreaded third scenario, stagflation, which I have no idea how to handle.

It all seems so incredibly complex. I doubt many average buyers, like myself ,will be able to successfully navigate (after all, even the experts seem to be getting it wrong on a regular basis).

What I often wonder as of late, has always been this way, and I just wasn’t paying enough attention ……or are we really at a critical crossroad?


mbc said...

Diggin deeper and others think interest rates are on the way up because of inflation pressures, and I tend to agree. Going forward, any more softening of prices may be offset by higher rates. Of course, you could still wait for more price drops & initially finance at 7 percent (my guess for 30-year rates in a few months), with the hope of refinancing to a lower rate at a later date. However, rates may stay above 7 percent for a long time. Who knows, though. I thought the low rates of 2004-2005 would never come back, and they briefly did in January.

Jacob said...

I would rather get a higher rate and a lower loan. You can refinance if rates go lower also you can pay more to principal to lower your payments.

But you can't do anything about the amount you pay for the home once you buy.

But if you find the perfect home you have been looking for and want to stay for 10 years or more and can afford a real payment (not any of those i/o neg am crap) then it could be the right time to buy.

Buying Time said...

I think our best hedge against stagflation might be to buy a home sooner, that we can afford on one salary. Mr. BT and I have roughly the same salary, that way, if either of us gets laid off due to economy, we are okay....but also have a hard asset to hedge in case of inflation.

mcb44 said...

Here is a alternative point of view. A definition for Stagflation is, "A portmanteau of the words stagnation and inflation, is a macroeconomics term used to describe a period of inflation combined with stagnation (that is, slow economic growth and rising unemployment, possibly including recession)." This seems much closer to what we are experiencing now than just inflation.

If the primary driver for real estate prices is affordability, then the case can be made that the economic stagnation of stagflation would put additional downward pressure on prices.

In any case, this would be interesting to discuss and debate at your get together in April.

G Spot1 said...

There's been a lot of talk about interest rates lately independent of prices. Maybe I'm mistaken, but it seems to me that rates don't move in a vacuum - they directly affect what buyers can afford and thus have a bearing on prices. As interest rates continue to rise, they will cause buyers to lower their price range or drop out altogether. Simple supply and demand would suggest that this would put downward pressure on prices.

Maybe someone who has been around during periods of high rates has some insight into what has happened in the past. But considering that prices are just barely moving to a point that they are at a reasonable level of affordability, I can't imagine that interest rate increases aren't going to push prices down further.

Also, what's the higher rates going to do to all the ARMs that haven't reset yet? Recently there was some talk that the lower rates could stabilize the ARM problem, but looks like the rates on these hybrid and option ARMs are going to start spiking soon.

mcb44 said...


I agree about the relationship of interest rates to price, with the caveat that rates can change quickly, but downward price adjustments, in response, are much slower.

I suspect that's stating the obvious to regular followers of the housing bubble.

sacramentia said...

I think the ARM resets are going to be less of an issue this year because they are linked to the short term rates which the Fed has more influence over. The 1yr LIBOR is at 2.82, so an adjustable with a 2.5% margin would adjust to 5.32%. A year ago the 1yr LIBOR was at 5.39%. This is a huge difference.

G Spot1 said...

"I agree about the relationship of interest rates to price, with the caveat that rates can change quickly, but downward price adjustments, in response, are much slower."

Yeah, that's the frustrating part. High rates will also slow the recovery. I would prefer low rates right now and get the recovery going so that I can buy with confidence....

Patient Renter said...
This comment has been removed by the author.
Patient Renter said...

"I would rather get a higher rate and a lower loan. You can refinance if rates go lower also you can pay more to principal to lower your payments."

Exactly. Good scenario for example:

400k loan at 6%, 30 years = $2,398 a month.

326k loan at 8%, 30 years = $2,392 a month.

About the same.

So for this scenario the question is will rates jump more than 2 points, from 6% to 8% or will prices fall further? It's impossible to know what will happen, but plenty of price declines yet to come are damn near guarunteed whereas rate changes are not, and the refi option lives on regardless.

Buying Time said...

Sounds like I need to make a little RE buying model that can measure sensitivities to various macro economic conditions....yes, I am an uber geek.

Sippn said...

Skipping past all the over analysis, do you think your mom will really listen to your opinion?

sacramentia said...

It is a different situation if you have a pile of cash as opposed to purchasing a home highly leveraged.

Houses are a relatively good store of value during times of inflation. Average appreciation in California:

1978 - 21.9%
1979 - 12.1%
1980 - 15.8%
1981 - 15.5%

Inflation rates to help put it into perspective:

1978 7.61
1979 11.27
1980 13.52
1981 10.38

From 1978 to 1981: (annualized rtn)
DJIA - 1.3%
SP500 - 6.5%
NASDAQ- 16.9%

And Gold: (NY Market Price)

1978 193.55
1979 307.50
1980 612.56
1981 459.64

And you also get to add the net rent as a dividend to your home return when comparing to other places to put cash.

But even a lousy 4% return on cash is excellent when you are saving to buy an asset that is falling 20% y-t-y, so please don't take this post as a buy recommendation.