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Buy now or wait?

The real estate market in New York is scorching hot. Bidding wars are aplenty and buyers are lining up to buy properties, usually above asking price. If you are considering buying, you may be asking yourself whether to buy now or wait. Looking at how the market is behaving, some people may be reminded of the bubble that was forming in the years preceding the 2007 real estate crash. Should you buy now or should you wait?

The answer is buy, and here is why:

Interest Rates



Interest rates are historically low but rising quickly. In the 2006 housing bubble, buyers were borrowing at between 6% and 7% interest rates. Rates cyclically fluctuated between 5.5% and 9% for the 15 years leading up to the 2007 crash, and rates in the 80's were over 10%. If history is any indicator, locking in a mortgage at today's 4.5% interest rate is a once-in-a-lifetime opportunity.

What does this mean in pure dollar terms? Let us look at a simple example, borrowing $500,000

Borrowing $500,000

Interest Rate

Monthly Payment

4.5%

($2,533.43)

5.5%

($2,838.95)

6.5%

($3,160.34)

7.5%

($3,496.07)


The difference between a 4.5% and 6.5% interest rate is $627 a month. A basic rule of thumb on a 30 year loan is each percentage increase in interest rate corresponds to around a 12% increase in your monthly payment. This math may not be new to some of you, but an interesting side-effect presents itself when we consider how this affects affordability.
Let us say that I am a buyer who is willing to pay $3,000 a month on a mortgage. In this situation, what property value can I afford?

$3,000 Monthly Payment

Interest Rate

Mortgage Amount

Property Price (Traditional Loan)

4.50%

$592,083

$740,104

5.50%

$528,365

$660,457

6.50%

$474,632

$593,291

7.50%

$429,053

$536,316


If I am willing to make a $3,000 monthly mortgage payment, then with a traditional mortgage I can afford a property worth $740,000 at a 4.5% interest rate, but something worth only $593,000 (20% less) at a 6.5% mortgage rate. This 20% number remains the same whether it is a traditional mortgage or a low-down payment mortgage such as an FHA loan.
Another way to phrase this same point: If a bubble is forming (we don't feel it is but explaining why is an entirely new article), then prices would have to drop 20% after the bubble bursts if interest rates went up to 6.5% and at that point you would only breakeven. To actually benefit by waiting, prices would need to drop more than 20%. From the highest point of the 2006 peak to the lowest point of the 2012 nadir, prices in New York fell about 25% according to the Case-Shiller Index. There is not much room between this 25% "maximum" drop and the 20%+ drop you need to benefit by waiting. And it is unlikely that someone will catch either the lowest or highest point of the market.

Yet another way to phrase this same point: If you wait a year and interest rates rise to 6.5%, you can consider that a 20% increase in prices over that timeframe because a 20% price increase would have the same financial effect as a 2% interest rate increase.

Interest rates are currently low due to ongoing government intervention (the Federal Reserve's bond buyback program). The scale down of this program has already begun, and interest rates will rise. In fact, they have already risen, from 3.5% a year ago to 4.5% today. A savvy buyer should assume that interest rates will rise up to normal market levels in the near future.

Buying vs Renting
The interesting thing about renting is that it is historically cheaper than buying. However, since the 2007 crash that balance has shifted to the point where the difference between buying and renting is marginal at best, and sometimes it actually makes more mathematical sense to buy. This is due to low interest rates and relatively stagnant property appreciation. Property values have not increased much over the past 8 years, but rents have increased significantly over this same timeframe.

Let us look at an example of renting a property in Midtown West vs buying a property in Midtown West. As of today (1/2/2014), the median price on Streeteasy for a one-bedroom rental in Midtown West is $61/sqft. The median price for a one-bedroom sale in Midtown West is $1,392/sqft. While this is not a perfect analysis (for example, the rentals on Streeteasy may be of lower quality and in general worth less than recently finished condo sales), it is a good illustrative example on how you should analyze your own Buy vs Rent situation.

800 Square Feet 1 Bedroom Midtown West

Expense

Rent

Buy

Rent

$4,067


Utilities

$200

$200

Mortgage


$4,514

Property Tax


$500

Common Charges


$500

Repairs/Misc Expenses


$100

Total

$4,267

$5,814




1st Year Interest


$39,796.00


The monthly cost of buying is $5,814, while the cost of renting is $4,267 per month. This may seem in favor of rentals, but there are a few other pieces of information that come into play.

First, what is your tax savings based on the mortgage interest deduction. If you were in the 28% tax bracket and were able to qualify for the maximum potential tax savings, your cost of buying would drop by $928, to $4,885 per month.

Second, how much do rental prices go up per year? In New York in the last year they have gone up by about 10%, but if we do a more modest 5% increase per year, that would mean that after three years your monthly cost of renting would have reached your monthly cost of buying. After that, your cost of renting would progressively get higher and higher compared to your cost of buying.

Third, by paying a mortgage you actually increase your equity over time. Once your mortgage paid off, you will own a valuable (and appreciating asset) in one of the most desirable real estate markets in the world.

This combination of historically low interest rates and a marginal difference between the cost of buying and renting make today a unique time to buy. If you are a first time homebuyer looking to make the jump, it makes sense to make that jump now. Waiting will not pay off.

Have any questions or comments? Send them to us at info@hlresidential.com!