Is It Time To Buy A House?

Is it time to buy a house? Isn’t it always a good time to buy real estate? There are hardly any Realtors, builders or other industry participants who have ever said it is NOT a good time to buy real estate. There are some very good Realtors and builders, I know many, but let’s not forget these people are ultimately salespeople, not investment analysts equipped with the tools to know the real value and direction of real estate. You hire a Realtor to help you buy and sell real estate, but you should make your own determination as to when is the best time to do so. So that means you are left to your own devices as to determining if real estate is a good investment.

We have to discern if we are talking about buying a primary residence or investment property. Since buying investment property is a simple cash flow numbers analysis, I’ll restrict this blog post to buying a primary residence. And when buying a primary residence your first concern should not be if it is a good ‘investment’. You should not go into it looking for investment returns. It is a home, shelter, a place to live, sleep, entertain, raise a family, and enjoy the community and neighbors. But you do want to make a careful decision and get the best possible financial gain from your home that you can.

In general, real estate is usually always a good buy. End of discussion. In fact, I wish there was no reason for this blog post at all. However, all markets, even real estate markets, are subject to the whims of the economy and can get twisted and distorted. Recently, from the very late 1990’s through 2006, real estate went through a doozy of a fantasy world in most areas. Many larger, urban markets doubled and tripled in value. However, incomes did not double or triple and population growth did not double or triple. So why did real estate double and triple in some of these markets? The answer is solely: “speculation fueled by cheap money and easy loans.” There are no other economic, fundamental answers. There are lots of emotional answers, but no rational ones.

For hundreds of years real estate has been driven by income and population growth, there are no other proper building blocks to real estate values. So until real estate reverts to the mean, and comes back into line with income and population growth, my answer is now is may not a good time to buy real estate in some markets. You’ll have to do some research in your local market as to median income and median home price. Historically, the median home price is three to no more than four times the median income. In Washington DC, the median income is $99,000 and the median home price is $360,000 for a condo and $427,000 for a single family home. This seems to suggest that real estate here is not drastically over-inflated, and may be close to being in line with fundamentals. You should also research the cost to rent versus the cost to own the type of home you want to buy. The chart below, from real estate economist Robert Shiller, makes it pretty simple:

I know that one can’t be a market timer, but one can certainly use common sense. If you find that real estate prices are inflated when compared to median incomes, you may want to consider waiting to buy. However, if prices are no more than three to four times the median income, then you can feel comfortable that you are paying a fair price at that time. In many markets, real estate will still get cheaper…a lot cheaper. Combine all of this with the uncertainty with the economy in general (housing prices getting distorted may very well be the reason for the economic uncertainty we face) and you have a recipe for caution in buying real estate in some markets. It may pay to be more concerned with hanging onto your job, saving money, and fine tuning your 401k and other investments that are likely way down in value.

Everyone has a reason for why their market “is special and not subject to the same rules as other real estate markets.” I have heard them all, “New York never goes down”, “DC has the ever expanding federal government so we are immune”, “here on the West Coast you can’t develop any more land, because you hit the ocean!”, and my personal favorite, “they are not making any more land”. These are all non-sensical and emotional. In fact, they have “made land” before. For example, the “Marina District” in San Francisco was built up from marshland which was filled with rubble and sand pumped up from the bottom of the ocean. And you can always “make land” by building upwards, and building more densely. Stick to the facts and fundamentals. Look at median incomes, median home prices, population growth, and rents. The fundamentals say real estate in some areas got wildly distorted and disconnected from its fundamentals, and still has room to correct to the downside.

But let’s not forget that median incomes can go down (anyone hear about the rising unemployment in this country?) which further pushes real estate down values. And interest rates can spike (we do have a big deficit, big spending, and big government; all of which can cause higher interest rates) which causes real estate values to go down.

The chart below shows indices of real estate in several cities. You can see that prices were going up at a normal pace with inflation from 1987 to the late 1990’s, matching income and population growth. I could also have added data going much further back than 1987, but trust that the data shows modest growth, matching inflation in general. And then real estate prices got distorted in the late 1990’s through approximately 2006. What is the next stop for these indices?

Phoenix/Los Angeles/San Diego/San Francisco/Denver
YEAR PHX LA SD SF DNVR
1987 67.78 59.40 52.23 49.85
1988 85.82 69.83 62.47 47.44
1989 66.50 99.77 83.57 73.39 48.21
1990 65.45 96.55 84.03 71.86 48.73
1991 66.04 93.14 81.34 70.45 51.32
1992 66.68 85.82 77.48 68.58 55.60
1993 70.13 77.57 74.11 66.63 62.24
1994 74.90 76.39 73.44 68.31 67.58
1995 78.86 73.94 71.81 66.85 71.64
1996 82.48 74.52 72.22 69.21 75.19
1997 86.56 79.91 78.09 76.50 80.05
1998 92.20 91.78 88.90 85.40 87.43
1999 99.65 100.33 100.07 100.03 99.67
2000 106.02 110.71 116.96 130.07 114.55
2001 111.67 121.29 129.99 126.85 121.64
2002 116.75 143.98 155.20 143.84 125.73
2003 126.33 174.81 185.08 156.02 127.28
2004 152.33 218.24 234.41 187.17 132.76
2005 220.65 265.68 250.13 216.58 137.94
2006 221.39 270.70 239.70 213.42 137.66
2007 187.60 233.53 203.89 190.30 131.60
2008 123.89 171.79 153.27 130.84 126.38

Real estate will stabilize eventually, even in markets that are currently over priced, and real estate will remain a main ingredient in your finances and long term plans. First, we need some more downward price adjustments in many markets before it is time to think real estate is a safe purchase. How long will it take? I have heard from the media and interested participants that it is the market bottom in real estate prices every year since 2005. Eventually they’ll be right. I know one thing, watch the fundamentals, not the news nor the biased industry participants.