Another Way of Thinking About Real Estate
"Opinion"08/24/2010
Paul Munnis
As real-estate sales have slowed, the inventory of unsold homes on the market grew to nearly 4 million in July. That's a 12.5 month supply at the current sales pace, the highest level in more than a decade. It compares with a healthy level of about six months.
In the Midwest, homes priced between $100,000 and $250,000 tumbled nearly 47 percent.
One reason the market is hurting is that buyers and sellers are in a standoff over prices. Many sellers are reluctant to lower their prices. And buyers are hesitating because they think home prices haven't bottomed out.
"It really is a self-fulfilling prophecy," said Aaron Zapata, a real estate agent in Brea, Calif. "If all buyers perceive that home prices are coming down, then they will stop making offers - and home prices will come down."
The other problem is job instability. People hesitate to buy because of fear of foreclosure. We will address that below.
When it comes to getting a price for a home being sold in this recession then we need to think about things a little different than the traditional gross profit model.
For example:
What if you bought a home for $220,000 five years ago? What if in order to rent a ½ acre 4 bedroom home with recreation room and home office you would have had to pay $2500 per month in monthly rental for the same or a similar home.
Then your cost of the same house, had you rented it for five years, would equal ($2500 * 12 * 5) or $150,000 cash flow over five years.
But you didn’t rent, you bought a home and your payments were $1250 per month and the payment included Principle, Interest, and Taxes. Your actual cash flow was ($1250 * 12 * 5 = $75,000), a savings of $75,000 in cash flow between renting and buying over five years.
Now you want to sell your home to relocate to a better job and the best offer that you can get is $185,000 for your house. That works out to a net difference of minus $35,000 over what you paid for the home. There are other expenses associated with the sale too: $10,000 for the realtor(s) and $3000 in closing costs. Thus you net only $172,000 at the time of the sale. You did get your down payment back and you did retire the mortgage balance so you are qualified to buy once again.
The real cost to live in this nice home was $48,000 over a five year period or an equivalent monthly rental cost of $800 per month; thus you lived cheaper and in better style that you could have lived had you not bought a home. It is not written anywhere that you should be able to live for free over a five year period.
Should you buy another home or rent after you relocate?
If we look at the cost of rental plus the returned capital from the sale then we have $150,000 rental cost avoidance plus $140,000 net proceeds from the sale so the real yield was $290,000; a cash flow advantage of $70,000 in virtual profit over the purchase price.
Plus you avoided $75,000 in direct cash flow expenses because your mortgage payments were cheaper than paying rent.
The home also provided you with a tax shelter and tax refunds as a result of your ownership status.
Now if you could purchase some low cost mortgage insurance to cover the unemployment risk then you would be in good shape.
We don’t look at things this way for we have been trained that we must buy low and sell high and pocket the difference as pure profit. Yet that is simplistic accounting.
Had you sat on a purchase and not bought but rented instead then you would have been out $150,000 in cash over five years. You might have settled for a lesser place but your quality of life would have suffered, you might have had to stuff the family into a two or three bedroom rental and the fit and finish would not have been as nice plus the choice of schools would have been limited too.
If you want peace of mind in a real estate market that is now flooded with homes and is lacking qualified buyers, then instead of cussing the realtor out for not getting you a doubling of your purchase price, then you might try my accounting method instead. You will sleep better at night.
As I see things today when an unqualified buyer asks a bank for a loan to buy a home the bank or the developer ought to offer to buy the house or keep it and then rent it to the prospect for a monthly fee on a fixed rental contract with the payments accumulating to form a down payment. In Minnesota we call this “Contract for Deed.” The bank and the developer would be way ahead in this housing market. The bank would get as much as twice the monthly cash flow as rent plus the tax deduction and the potential renter would get a housing solution. The problem has always been the twenty percent who trash a rental property. I’m not sure what the fix is to contain these people but we need to develop one under law and make it a contractual component.
If we want government to help out here then let’ look at the fact that government is accepting responsibility for creating jobs and is willing to use stimulus and other money to assure us of a return to prosperity. So why not offer people government backed, low cost mortgage insurance to make the payments when people are unemployed? It might be better than watching the real-estate market crash or pumping endless stimulus money into the economy.
Change is needed in the way that buyer and seller plus government approach realty for the market has shifted for good.