Alternative Title:  What if 2007 IS the turnaround we've been waiting for?

Every day I read real estate market articles that fall into two categories:

1.  Focused on the Present: The bubble has popped and the market is crashing.  These are especially annoying when they include graphs showing the downturn.  Where were all these articles in late 2004 and early 2005 heading up to the peak of the market (at least in DC)?   Jon Zolsky had some interesting points about the media as an “amplifier” here.  I say they’re just late to the party every time there’s a market shift.  Topic for a good blog post: How long did it take them after the peak to start reporting it?  Is that a good proxy for how long the lag between market “recovery” and its reporting will be?

2.  Focused on the Future:  The market won’t turn around for a long-time because it’s so overvalued.  (Unless it’s a report from an organization actually related to the industry, in which case they argue that it’s always turning around 6 months from the date of the article.)  The Washington, DC, area is often considered a contender to be the first to turn around (see article here) because of its extraordinarily strong job market and relative, i.e., long-term, housing shortage (see slide 38 of GMU study here.)  Topic for a good blog post: there are almost as many articles describing the stock market as being overvalued compared to historical norms...why is there not a mass sell-off?  

This all got me thinking...What are the signals of the turnaround?  Housing starts, building permits, etc., of course.  But how much is enough to count as a “turnaround”?  What's the 'tipping point' for the public?  What exactly IS a turnaround, anyway?  No one in their right minds is expecting the 20%+  returns of the early 2000s.  So what’s a reasonable amount to expect?  We’re talking about a home, where the alternative is paying rent (or living in a box.)  It’s a place where you live and build a life, an “investment” that you use every day and to which you become emotionally attached.  As opposed to the stock market, which for most people is more of a passive investment.  What return should you expect? 

Of course there are the financial trade-offs (see Best Rent-vs-Buy Calculator post here), but every calculator relies on the alternative use of funds.  There’s a key factor unaccounted for, though – the fact that the overwhelming majority of people will NOT be investing those extra funds, but rather will spend the bulk of them on consumer goods.  Think about it…if you’re paying rent of $1500, and go to a mortgage payment of $2500, you make it work.  But if you decide: I’m not going to buy, instead I’ll continue to rent, then how many people really adjust their budget to “save” that extra $1000?  I’m betting not many.  So while the calculator is an important part of the decision to buy, it’s just one part. 

But back to my main point:  If we’re not expecting 20% returns, what exactly are we expecting?  Even the widely quoted 7% return includes those 20% years, so if we agree that those years were an anomaly, then we have to throw out the 7%.  So what do we want?  4%?  2%? Does it even matter?  Certainly we don’t want to buy if it’s a negative return.  What about 0% appreciation?  Is it worth the time and trouble to buy if you expect 0% return (let’s assume transaction costs are covered, so it’s truly a break-even proposition) in exchange for the qualitative benefits of owning a home?  Parts of the DC market, particularly close-in communities, remained very stable this year  and saw neither large drops nor large gains.  What if this 2-3% IS the new "normal" return on a home, meaning that 2007 IS the "turnaround" year, at least for some communities?   What if there's not going to be any more "turnaround" than that?? Will it be enough? Obviously not for many buyers, so what is? 

Maybe it needs to be much simpler:  If we were to ask current homeowners, “Would you have bought your home even if you knew you would never make a profit—but nor would you lose any money--on it?”  I’m willing to bet there would be a resounding ‘Yes’ from the majority.  I think most people, once they're in a home of their own, appreciate the sense of accomplishment, ownership, and permanence in a way that most renters can't understand.  

So maybe it doesn’t matter if there’s a turnaround or not…instead, what matters is: Do you believe that you’re going to lose money in the length of time you’re planning to stay in this home?  If the answer is no, then the decision should be to buy.  Undoubtedly for some neighborhoods the answer will be 'yes', and so then the follow up question is: At some point, your answer will become 'no'...how are you going to know when that happens?  (That's the subject of another post to come.) 

Edit>  Make sure to read my related post "When Will The Real Estate Market Turn Around?" 

Are you thinking of buying a home in 2008?  Contact me to discuss the current state of the market in specific neighborhoods.  You can reach me via my blog or website.