March 6, 2008


Hatteras Island Real Estate: Is it better to buy now or buy later?

By TOM HRANICKA


In today’s market, prospective buyers often comment that they are going to wait for property prices to decline further before they decide to act. It certainly seems logical that buyers would want to try to time their purchases to coincide with the bottom of the real estate cycle in order to pay the lowest possible price.  It is also understandable that the multitude of negative media reports can easily lead prospective buyers to believe that real estate prices have further to fall.

However, the reality of this decision-making framework bears closer scrutiny.  Two important questions are central to establishing the validity of the buyers’ hypothesis -- “How are you going to know when the market bottom has been reached?” and “Are properties really going to cost less in the future?”

The most realistic answer to the first question is, “You will know that the market reached bottom only when prices begin to rise again.”

Investment experts repeatedly make the point that it is highly unlikely that most buyers will be able to time the market and purchase at the exact bottom.

If, as the experts agree, a buyer is not likely to purchase at the bottom of the market, then the relevant decision is, “Do I buy now, or do I wait and buy later?” 

Current market statistics tell us that the majority of buyers are opting to sit on the sidelines and wait.  For your consideration, I would like to present the view that this course of action has the potential to end up costing buyers more in the long run. Here is why.

Think of the real estate cycle as a graph that might look something like this:


 
The median residential sale price on Hatteras Island for the fourth quarter of last year was $330,000.  This figure represents close to a 44 percent decline since the buyer’s market began in the summer of 2005.  For discussion purposes, assume that prices drop another 10 percent between now and the cycle’s bottom.  Once the low point has been reached, it seems reasonable to anticipate that it will take a while for most of us to recognize that the bottom has passed and that prices are once again on the rise.

At this point, it helps to recognize that the “purchase price” of a property is only one aspect of the property’s “cost.”  To simplify, let’s limit the ongoing cost of ownership to the monthly mortgage principle and interest payment on a loan with a down payment equal to 20 percent of the purchase price. For reference, interest rates on 30-year fixed rate mortgages averaged about 5.50 percent during January.

The math for a purchase at the fourth quarter 2007 price of $330,000 would look something like this:

•    Purchase Price = $330,000       
•    Mortgage Amount = $264,000
•    Monthly Payment @ 5.50 percent = $1,498.96/month

Now, let’s suppose that the decision to buy is made at a price of $313,500 – lower than the fourth quarter median selling price, but higher than the lowest price in the market cycle – and, let’s also project that the interest rate rises to 6.0 percent.

•    Purchase Price = $313,500
•    Mortgage Amount = $250,800
•    Monthly Payment @ 6.0 percent = $1,503.67/month

Because of the half-point interest rate increase, the monthly payment is higher than it would have been at a purchase price of $330,000.

Next, how would the numbers change if the buyer waited for confirmation that the market had turned, purchased at the $330,000 level and interest rates had also increased?    

•    Purchase Price = $330,000
•    Mortgage Amount = $264,000
•    Monthly Payment @ 6.0 percent = $1,582.81/month

As you can see, the buyer’s monthly cost of the property in these models actually increased by waiting for confirmation that the market has reached bottom before purchasing. It should be noted in the second example that while the monthly payment would be higher, the cost basis of the property would be lower, and the down payment would be slightly smaller.

How far-fetched is this hypothetical scenario?  After all, we have heard that the Federal Reserve is going to lower the federal funds rate at future meetings, and maybe prices won’t follow the pattern in our example. 

In fact, our simple illustration comes surprisingly close to the statistics that we have seen since the start of the new year.  The median residential selling price on Hatteras Island rose unexpectedly from $339,500 in December to $386,250 in February.  In addition, the interest rate on 30-year fixed rate mortgages offered by a major lender jumped from 5.375 percent on Jan. 22 to 6.375 percent on Feb. 25!

Furthermore, according to a Bloomberg News report last week, “Federal Reserve officials signaled they are prepared to quickly reverse last month’s interest-rate cuts after concluding that borrowing costs need to be kept low for now.” (When you read these reports, remember that changes in the federal funds rate do not have an immediate impact on long-term mortgage interest rates. Short-term interest rates on home equity lines of credit and construction loans are most affected by the Fed’s actions.)

What we have seen in this discussion is that we are probably far enough into the current real estate cycle to at least suggest that buyers may not save much, if anything, by waiting until they have confirmation - in hindsight - that a market bottom has been reached.  Buyers may end up paying more depending upon the swiftness of price and interest rate changes, as well as the point in the cycle at which their purchases are actually made.  Interestingly, this viewpoint is starting to appear outside of real estate circles.  Time magazine ran a similarly themed article in a recent issue and broadened the dialogue to include stock purchases as well. Since then, I have seen two additional articles that have encouraged buyers to consider that a change in the downward trend in the housing industry may not be far off.

To round out our assessment, it is also important to keep in mind some qualitative observations about market conditions.  These include the wide selection of properties from which buyers can choose in today’s market and the less stressful purchasing environment associated with fewer buyers competing for the same properties. These circumstances can be expected to change as we shift once again from a buyer’s market to a seller’s market. In addition, sellers can be expected to become less conciliatory during contract negotiations once they recognize that the cycle has turned and that they may be able to get more for their homes in the future.

My sense is that there is also some practical guidance for buyers embedded in the analysis that can help them to realize their ownership goals while reducing the risk of future uncertainties concerning changes in prices and interest rates. If a buyer is willing to concede that it is unlikely that they will be able to time their purchase to coincide with a market bottom, but the buyer believes prices will decline another 10 percent before the cyclical low point is reached, then, the buyer may want to submit an offer now that is 10 percent below the property’s asking price. If the offer is accepted, the buyer will have taken advantage of today’s favorable market conditions without compromising their beliefs about the near term direction of prices.

Perhaps the best summary of the perspectives presented in this article can be found in the advice of great investors like J. Paul Getty - "Buy when everyone else is selling, and hold until everyone else is buying.  That's not just a catchy slogan; it's the very essence of successful investing.”


(Note: Sources for this article include commentaries by David Knox and Cary Cowper.)



(Tom Hranicka is an associate broker with Outer Beaches Realty. Questions, comments, or suggestions for future articles may be sent to Tom Hranicka at P.O. Box 237, Avon, NC  27915, or e-mail to [email protected] )

Copyright©2007 Tom & Louise Hranicka.  All rights reserved.


   

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