I am frequently asked by clients and colleagues: Should I buy a house to live in or should I just rent? Should I get rid of or reduce my mortgage by moving into a smaller property?
Is it a good time to invest in a property or a piece of land? There are so many foreclosures out there – maybe there are some bargains to be had?
With the volatility in housing markets around the world, it’s very hard to know what action to take. Economists talk one day of a possible fall of 30% in the housing market and the next day they’ve changed their minds and they predict just a 15% drop. Whom can you trust and how reliable is the information we receive in the media and in our papers?
I have many clients around the world who are just dying to get back into property investing – why? Because they see that they are getting a very low return on their money in the bank – very often only 1,2 or 3% if they are lucky. They want to have something that brings them an income for their retirement and also hope that the value of the property will go up over time.
Today, I’m going to look at the various options available to you and their respective advantages and pitfalls.
The first thing to say is please do not be fooled by the media’s constant reporting of “green shoots” of recovery. There is very little evidence showing any recovery. There are three main reasons why it is likely that house prices will continue to fall for the foreseeable future:
- rising unemployment. The more people that are out of work – they cannot afford their mortgages and thus have to relinquish their homes. This means that more properties for sale come onto the market and thus drive the prices down. For example, if there is too much availability of rice and no one wants to buy it, then in order to attract buyers, the price has to be reduced. The housing market is no different. If you really want to sell a house in a falling market, you need to price it at least 20% below the average price in that area in order to generate some interest
- banks are now wanting at least 20% deposit. During the housing boom, banks were lending money to people often without asking them for a deposit at all. I saw this happening when I had my property investment company in the UK – they were lending to people who were on unemployment benefit! How irresponsible can you get? So because the banks have got into trouble, they have now tightened up their rules and are asking people for at least a 20% deposit. So this means that fewer people can get mortgages and thus afford to buy a house.
- interest rates will go up in the medium term. The reason why prices have gone up for such an extended period is because interest rates have steadily come down, which has meant that your mortgage payments have steadily gone down. In fact, in the US, they are now at 0%. However, there are already signs that the banks are going to increase interest rates and it is more than likely that they will start to go up in the next year or two. What this means for the housing market, is that fewer people will be able to afford to take out a mortgage and so more houses will be on the market and thus prices will fall further.
So those are the reasons why property prices are likely to either fall or at least remain static for the foreseeable future.
With this in mind, should you rent or should you buy?
It depends largely on your financial situation.
There are six conditions upon which I would consider buying a property to live in right now:
- You find an absolute bargain. This would be based on you having done extensive research on all the other properties in the area. For example, if the average price right now is $200,000 and you find something for $100,000 that is a foreclosure, then that might be a good buy. However, it is only a good buy if you can afford it.
- You have at least a 20% deposit and you have at least 12 months emergency funds in savings to cover unexpected situations
- If you are buying the property with a spouse or partner, you calculate your outgoings for just one income or even no income for a period of time – what happens if one or both of you gets laid off for an extended period of time and you cannot find other employment?
- You calculate your costs based upon interest rates going up which means that your mortgage will go up - so you need to have plenty of buffer monies
- You include in your calculations, the possibility of other costs rising such as property taxes, utilities, telephone, food etc. Many Councils are saying that your property is worth $1M and they are charging you taxes on that amount when in fact you could only get $200K for your property if you sold it.
- You are willing to hold onto the property for at least ten years before you may see an increase in its value.
Remember to keep in mind that if you buy now, you may be sorry as the property you buy for $300000 may only be worth $250000 within a few months. However, I have a client in Michigan and her property a year ago was worth $1M – now she has it on the market for $250K and she still cannot find a buyer. If you do buy a property, don’t have expectations that that property is going to go up in value anytime soon.
If you can satisfy all these conditions and you are not going in by the skin of your teeth – then off you go – happy house hunting!
If you cannot satisfy all those conditions, then I suggest you stick to renting for now. In fact, rents should also start to come down too and you may be able to negotiate a better deal with your landlord. The advantage of renting is that you are not tied into any mortgage agreement and you can be more flexible. If prices continue to fall, you may find that you are in a better position to pick up a bargain when the time comes.
For those of you who are struggling with your mortgage payments at the moment, try to negotiate a better deal with your bank. They would still prefer to have you in the property paying part of the mortgage rather than going through the procedure of foreclosure which usually costs them a whole lot more money. I knew someone who was having trouble paying her mortgage and she managed to negotiate a year’s holiday from paying the mortgage while she got herself back on her feet. It’s a bit like the negotiation we talked about last week – you have to be willing to ask. Also, if one bank does not want to negotiate, try to find one that will.
Depending on the size of your mortgage, you may consider moving to a smaller property so that you can either free yourself of debt altogether or at least reduce your monthly payments.
If you owe a lot of money on your property and you can still get some equity out and get rid of your mortgage altogether, I would suggest that you seriously consider taking that option. Then you are free to buy later when the prices have come down further.
If you have a property in a block of flats, or a condominium, where you are sharing the service charges – if many people in that block of flats have their apartments foreclosed, then the people who are still living there have to take on the added burden of those maintenance costs and if there are a lot of people out of work and not buying merchandise, then cities have to make up the money that they are nto collecting for taxes in some other way. Chances are that one of the first things they will be do will be to increase your property taxes substantially.
People really don’t know what to do with their money and because property investment has been such a good bet in recent years, there are many people itching to get back into the market. But is this the right time? It’s very difficult to pick the top and the bottom of any market – even the experts will tell you that that is almost impossible, but what you can do is to see the trend. With the degree of change that is happening right now, trends are much more difficult to predict, and for the average person, who is not well-informed on the housing market, it is best to wait until things have settled down somewhat before making a major purchase.
For those of you who are looking to invest, here are a few conditions I would suggest that you consider before putting your hard-earned money into property at this time:
- during a recession or depression, people have less available funds and may not be able to afford to rent. So you may need to drop your rental price. This is all right is you have no debt on the property and you have paid in cash – then you will not be too affected if you cannot find a tenant or if rental values go down for a few years. So if you are paying cash and you don’t need a mortgage, then buying a “real bargain” in a good location is a possibility. However, once again, don’t expect the value of the property to go up in value anytime soon.
- If you are taking out a mortgage, I would suggest that you do not take out more than 50-60% of the property price. Then if interest rates go up, your property taxes go up, your property sits vacant for a year or more, you will stillbe able to afford the outgoings. But you must be prepared to sit on the property for a few years and have your money tied up. Remember that selling a property is not a quick exercise and you may have to wait several months or even years to access your cash.
Buying land is even more risky as you do not have a property on it to bring you a regular income. You would either have to hang onto the land until such time as prices go up – which could be many years away – or you could build on the land and hopefully find tenants to bring you an income. However, I know people who own sections around the world and they are having great difficulty selling them right now. Indeed, in Fiji, a couple have had to reduce their section by 50% and they still have not found anyone to buy it. I see this happening around the world. Land, unless you are using it for yourself, is largely unproductive and does not bring you an income. So unless you are using it yourself e.g. to grow vegetables, for farming, livestock and you have a business that brings you an income from your land, then it is not the best investment during a downturn economy.
Summary
Do not leverage yourself too highly – i.e. don’t take out too much debt and make sure you have plenty of buffer funds
In volatile times, best to play it safe and not to borrow too much. Remember if you buy with a 20% deposit and the house price drops 20% you have lost all your equity.
If you rent – you are flexible, you can move quickly and you will be able to pick up the bargains at a later date
Investors: - not the best time to be buying – not only are rental yields low, but leverage is not wise now as there is no promise of capital gain in the near future. If you are paying cash, the risk is much lower and you can afford to wait and sit it out
If you are buying without too much debt – i.e. preferably only 50-60% and you know you can afford the mortgage and rising property taxes and other costs, then ok, but if not, then wait.
If you want to extend or renovate your house – this is going to be a good time:
-builders are looking for work and are willing to negotiate on their labour costs.