As I’ve worked with buyers over the last six months of the current economic “crisis,” I am regularly asked if the market has reached “bottom?” My response is generally in the form of an observation, that you don't know the bottom of any market (whether it be the real estate market, the stock market, or a commodities market) until prices begin to trend upward. Then you can look back with confidence and say “Oh, that was the bottom.”

Now of course there are, depending on who you talk to, some potential leading indicators as to where market begins to shift. In the real estate market many agents will use certain data points such as days on market, aggregate inventory levels, and to a lesser extent stabilizing sale price points to ascertain a market shift. I confess to using all of these and other data elements when trying to evaluate market conditions for my clients.

Just this week a client (We have been looking at properties for the last 45 to 60 days) asked the question “has the market bottomed?” With all sincerity, I gave the profound response of “don't know, the statistical indicators are conflicting.” In my particular market we are seeing increasing days on market (although a portion of this is likely due to seasonality) however we are seeing a stabilization in inventory levels and a stabilization in price points. However, although inventory levels are stabilizing, the makeup of the inventory is changing dramatically toward a heavy influence of short sale and foreclosure properties. Does this mean the market has bottomed? Can't say yet, however, it does appear we are seeing more realistic price points for listings than what we saw 6 to 8 months ago.

Based on this conversation, I put together a small spreadsheet for this client to illustrate the financial impact of waiting to purchase. The intent was to simply highlight the differences in out-of-pocket cost for my client based on a potential further deterioration in home price points counterbalanced by potential changes in financing costs. Here's a snapshot of the spreadsheet for reference.

My client’s purchase price point combined with his down payment capability would result in a mortgage near the $300,000 level. What I did with the spreadsheet was to calculate his monthly P&I payment based on various interest rates (at the time I did the spreadsheet 4.5% rates were being quoted). I then made the assumption that if the market were to deteriorate further from our best possible negotiated price point we would be able to reduce his loan cost by an additional $10,000 (use any number you see fit).

I then calculated the P&I (Principal & Interest) amounts for this new price point. For purposes of illustration for my client I made several assumptions that underlying loan costs beyond interest rate would not be impacted, that his creditworthiness would remain unchanged, the mortgage market would not seize up again, and the same property would still be available at a lower price point without additional buyer competition. Of course, assuming interest rates remain unchanged, it is always to the advantage of the buyer to purchase at a lower price. This analysis assumed that if the market in fact had reached bottom and the market and overall economy were improving there could be a corresponding upward adjustment to interest rates (as the Federal Reserve would attempt to control inflationary tendencies as our economy strengthened).

As seen in the illustration, interest rate increases of 0.5% or less have very little financial relative to the savings and should not be a detriment to attempting to get the lower price point. Of course the same cannot be said should not be able to achieve the lower price point (someone else buys the home while you wait) and interest rates increase in the interim. However interest-rate adjustments of 1% or more have sufficient impact to warrant consideration with respect to purchase price decisions. In my particular client illustration, an interest rate increase from 4.5% to 5.5% increased my clients projected annual mortgage payment by just over $1,500. This means that from a purely cash flow perspective, after seven years it would have been cheaper to pay the extra cost in the purchase price rather than wait for the “bottom” but incur higher financing costs.

Now, it would be possible to make this a much more complex analysis based on points, other closing costs, seller concessions, pro-rations and other data elements. However, I believe the net result will be similar. What this relatively straightforward analysis does indicate is that attempting to squeeze out an additional $1,000, $2,000, $5,000 may not be cost-effective if during the course of negotiations interest rates adjust (unless you have a long lock period for your rate).

For my client specifically this analysis was useful as his holding area for the upcoming purchase is likely to be in excess of 10 to 15 years. For someone who is looking to purchase and will likely move in under five years this analysis suggests it would be a wash to purchase now or wait. Keep in mind this is not a static assessment and will change over the coming months as we either experience improving economic indicators or stagnation continues as unemployment increases and economic output does not report signs of growth. As with everything, one must constantly re-evaluate their assumptions as to market conditions.