How not to approach rising home prices

My wife and I took the dog for a walk the other day in our neighborhood. About half a block up the street we met Heather and George as they were unloading one of those moving PODS thingies. We introduced ourselves and asked their life's story, or at least the part about buying the house they were moving into.

Turns out they were buying something better than they had before — trading up, in other words, as were the couple who sold them the house. Our direct neighbor, Elsie, works in a realtor's office and she confirms that this is happening all across town these days. Most of their clients are selling because they are getting something better.

Is the value of your home, and your equity, increasing? How does that growing equity make you feel? Does it make you feel rich? Well, OK, maybe not rich, but a little better off than a few years ago? Are you tempted by those ads home builders fill the weekend newspaper with? (If, of course, you still read newspapers.) Have you been invited to a friend's housewarming after they sold their home and bought a nicer one? Did you walk around their new home and say to yourself, “Hey, we could afford something like this. Why should we be the only ones left behind?”

A growing optimism

The times we live in impose a “feeling” on us. The German term zeitgeist (spirit of the time) is often used to describe this. The Roaring Twenties were famous for the general feeling of optimism and prosperity. The Great Depression brought, well, depression. The first decade of this millennium brought something akin to the Roaring Twenties as every neighbor and his dog were flipping houses and making thousands doing it. Then the Great Recession brought another round of pessimism, when everyone thought the world as we know it was coming to a speedy end.

Now, as that pessimism is fading in the rear view mirror, it's easy for things like a more stable job, growing home value and equity and a recovering 401(k) portfolio to draw us into the zeitgeist of today, one of relief and renewed optimism. Granted, it's nothing like the heady days of the postwar Golden Age or the Roaring Twenties, but it's not the pit of depression anymore, either.

There's another emotional overhang from the Great Recession many people feel. When their homes went underwater (i.e. they owed more on their home than its market value), there descended on them a feeling of being trapped. Honor dictated that they not join the almost 10 million people who lost their homes or simply walked away from them, so they stuck it out.

During a time like that, it's easy to project the frustration and feeling of hopelessness on the physical building you live in. Then, when the day finally comes when the value of your home is higher than the loan balance, there's a strong temptation to just sell and get the heck out of that home. And, while you're at it, why not see if you can get something better by trading up?

Yet there's another feeling riding shotgun with that one: When your income and wealth recover, it restores your sense of self-worth. Logic says you shouldn't measure your worth by your stuff, but we live in a culture which, right or wrong, does exactly that. And it's hard not to get sucked in, even if only a little, whether it's paying ridiculous prices for a cup of coffee at the place with the naked lady logo, or trading up to get a nicer and perhaps newer home.

Movin' on up

It's easy to be seduced by a realtor or neighbor who keeps telling you how much richer you are because your home price has gone up so nicely. (“You worked so hard for that equity in your home — you deserve it!”) It's probably worse here in Denver than most places: The local housing market seems to be hotter than other parts of the country, because many people are moving here for the legal marijuana. (I'm not making that up; we met a young couple who told us that's why they moved to Denver from Minnesota … without even having a job lined up.)

Home prices, of course, have recovered from the Great Recession in most parts of the country. CoreLogic, the real estate data tracking firm, recently released their report for August, which shows that prices continue to rise, although the rate of price increases seems to be slowing a bit.

corelogic homeprices aug 2014

The line dropping doesn't represent prices themselves, only the rate at which home prices are rising. As long as the line is above the 0 percent mark, it shows prices are rising, not falling. (The blue line represents all single dwelling homes, the red line excludes distressed sales.)

Why are people trading up their homes now? You might recall the post I wrote about seven months ago, showing why trading up at the top of the market is very unwise. The best time for trading up is in a recession, and the only smart thing to do at this time is to stay put — or trade down, if you absolutely, positively have to make a change. I was talking to a literary agent recently about my upcoming book on the four seasons of the economy, where I repeat that advice. When she read that part, she responded: “That might be too intuitive. I don't think people need to hear that.”

Really? What do you think? When you see so many people hurt by trading up the last time the home market was hot, don't you think they'd think twice this time around? Or is this just a new round of people heading for the most expensive lesson of their lives?

When it pays to trade down

Jenny and Karl (not their real names) bought a condo at the top of the market before the Great Recession. They're both smart and educated. It wasn't intuitive to them to not buy when prices were high, so they did. What got them was the zeitgeist pressure: “If you don't buy now, you'll never be able to afford it in the future.” Then their condo went underwater, like millions of others, and that grated on them every single day. They told us many times they would never have bought if they had known what would happen.

The logic is simple: To get the most value, you need to buy low. Yet very few people do. You'd think that when home prices dropped, sales would soar. You would be wrong. When the market hit rock bottom recently, people couldn't give their homes away. Buying low is not as intuitive as some people may think. Builders were stuck with unsold inventory for months, even years.

If it's intuitive to buy when the market is low, why didn't anybody do it? The only people who did were smart investors, who came out in droves and scooped up underpriced bargains by the handful, especially in places like Las Vegas.

Jenny and Karl's condo recovered in price, as did millions of others, and the time came when their home equity finally turned positive again. They sold their condo a couple of months ago, not to trade up, but to move out of town, to one of the smaller peripheral communities on the way to Kansas, where property prices are much lower than in the city. As Karl put it, “I'm dying in that place, man. The only way we're moving again is if the city limits expand and we become incorporated again.” In other words, they're using the high real estate market to trade down, not up.

They learned.

The sensible approach

We all make mistakes. My wife and I bought our first home at the top of the market, and it took us decades to recover from that. If we had waited just two years, we would have been able to save about 20 percent on the same house.

What should you do about home prices going up in your neck of the woods? To summarize the prudent courses of action:

  • If you're itching to buy your first home, you may want to think twice. See that chart above? Home prices go up and down. Be patient — it's not going to be too long before you can get the same home for much less.
  • If you're considering trading up, you will also save several tens of thousands of dollars by waiting just a little.
  • If you're an empty-nester considering scaling down, now might be a good time for that.

We have friends who recently retired and sold their home. They bought a motor home to live in, and travel the country. Who knows? They may be waiting for the market to drop before they buy again. Now that would be smart.

Hmmm … I've already started looking at Craigslist. This is a good time of the year to buy a motor home, isn't it?

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Money Saving
Money Saving
5 years ago

I think if most folks look at buying a home as an expense vs. an investment they will be much better off.

Buy within your means or below and don’t try to time the market. It is impossible and you’ll drive yourself crazy with shoulda-woulda-couldas…

NicoleAndmaggie
NicoleAndmaggie
5 years ago

Good thing you have a crystal ball.

jestjack
jestjack
5 years ago

Thanks for the timely article. DW and I just had this discussion. A couple we were friends with when the kids were little just made a Facebook post of their beautiful home. DW seemed to be puzzled/disappointed why they lived in such a cool place and we “stayed put”. So I did some “snooping” … these folks bought the new place for over $550K….have a mortgage of over $350K…an equity loan of $40K…and the most devastating fact…the State/County place the value of the property at $405K…$145K less than they paid. They have one child (20)left at home and the home… Read more »

Alea
Alea
5 years ago
Reply to  jestjack

Yes, your husband fell into the most destructive habit most of us have, comparing ourselves to others. Once we take the curtain of success away, we get the real picture, like you did. You were way smarter than the show offs.

Ray
Ray
5 years ago
Reply to  jestjack

You realize that being assessed for less than market value is a good thing, correct? It means you are paying less in taxes. The assessment has little bearing on the actual value of the home.

Claire
Claire
5 years ago

It depends on where you live and how the market in that area ebbs & flows. Right now, we’re looking for a house, although we’re ok where we’re currently at and not desperate to move. There are houses in my area that have been on the market for months & keep dropping their price. There also aren’t as many people looking this time of year, so we’re hoping we can get a deal on a home that way. We don’t want to have to deal with the springtime when the market gets many more buyers and people are often bidding… Read more »

Rail
Rail
5 years ago
Reply to  Claire

There are rumblings in the air that the housing market is getting ready to take off again. I don’t know what will happen, but if I was looking for a house now is the time to pull the trigger. Interest rates are already being held at insanely low rates by the corrupt FED and they can only go up. Fall is a good time to by as the market is soft with winter and the holiday season coming on and people don’t like moving (usually) this time of year.
Good luck Claire. Cheers!

Emily @ Simple Cheap Mom
Emily @ Simple Cheap Mom
5 years ago

I live in a city where the housing bubble never burst. It’s slowing now, but prices seem to always go up.

I don’t think anyone ever knows if the market is going up or down. The only thing I think we can do it make our buying decisions based on our needs and circumstances at the time and hope for the best.

Alea
Alea
5 years ago

Same situation here, Los Angeles in particular, not only are the home prices climbing but also the rents are climbing at the same rate. Everything new that is being built is full service with prices to match: a 600 feet single is $2,500, a one bedroom is $3,000 and two bedrooms for $4,000. I can’t afford to buy and the rents are the size of mortgages. Eventually something will have to give because at the moment I am locked out of both renting and buying if I need to move to another area.

Melody
Melody
5 years ago
Reply to  Alea

I grew up in Southern California, and everyone thinks it’s strange when I tell them that Cincinnati is my favorite place I have ever lived. I am able to live so much better here for so much less.

Rail
Rail
5 years ago
Reply to  Alea

3 Large for a 1 bedroom!!!!!! My God, I never knew how good we have it in Iowa. That kind of money is beyond insane. In the mid 90’s I rented a farm place with 2 other guys for 100 bucks a month. That’s $33.33 per person plus about $90 for electricity/well pump. I think the phone ran about $30 a month(what’s a cell phone?)and heat was the biggest expense in the winter, when L.P. ran about 42 cents a gallon for summer fill and 50-55 in winter. Plus we had a kerosene space heater we would run whenever someone… Read more »

Alea
Alea
5 years ago
Reply to  Rail

I don’t take home enough to even rent the single, never mind food, savings, retirment, car, and having a life. And nothing is built that is not high end. I really don’t need to be by the pool or use a game room, but would be nice to rent a nice clean apartment that is up to earthquake code.

Kyle
Kyle
5 years ago

Good article, but I think it’s important to keep in mind that home affordability is going down–While home price increases are moderating, mortgage rates are going up (I’ve heard to as much as 5.5% by the end of 2015?) That has a HUGE impact on affordability.

getagrip
getagrip
5 years ago

By the same chart as provided, above the 0 line means the market is rising. I won’t even go into how regional trends can be positive and negative to this chart and have their own swings. But by this chart someone wanting a house in 2002 would have had to wait 5 years to buy to see the dip in the market. The run up was occuring earlied, so someone in 2000 would have been waiting 7 years. I don’t think that counts as waiting a “little” while for a home purchase. Now someone in 2012 wanting to buy is… Read more »

Melody
Melody
5 years ago

I think the challenge here is that the going advice is “buy low, sell high”, but in the case of a home in order to buy low you have to sell the home you are living in at the low rates (unless you rented before). Similarly, if you want to sell high, then you will have to buy somewhere else to live at the high rates. Unless, of course, you can risk having two mortgages (and perhaps an investment property, this one is really hard to swing.

William @ Drop Dead Money
William @ Drop Dead Money
5 years ago
Reply to  Melody

Melody, you’re right: when you sell, you have to buy somewhere else. That said, you have three logical choices when you do that: trade up, even or down. Trading even has a high cost, what with commissions, etc., and the only reason people tend to do that is a move, job change, or something like that. That leaves trading up or trading down. When the market is “high” (admittedly a nebulous view, and not the same everywhere) trading up, while feeling right, is a trap… one that many are falling into as we speak. The best time (in general) to… Read more »

Marsha
Marsha
5 years ago
Reply to  Melody

Consider this example. Say your current home is worth $100,000 in a low market, and you want to buy a house that is “twice as nice.” It would cost you $200,000, for a difference of $100k in price. But in a high market, your current home is worth $200,000 and that better home costs $400,000. Difference of $200k to trade up. This is a simplistic example in which trading up when the market is up costs you twice as much in real dollar terms. Trading up in a high real estate market is always going to cost a premium. Of… Read more »

Petunia 100
Petunia 100
5 years ago
Reply to  Marsha

That’s all well and good, unless you don’t have much available cash.

Say you owe 120k on your home. If you want to sell when it is worth 100k and buy the new home when it is worth 200k, you need to cough up quite a bit of cash to make that happen.

If you sell when your home is worth 200k and the new home is 400k, you have enough equity to make that happen, you don’t need cash.

Ely
Ely
5 years ago

We bought our house at the top of the market, but for us it wasn’t a mistake. We were ready to buy, in stable jobs, and interest rates were low. The market in our area was not hit as hard as some; we were never underwater in our house, and what value it lost was quickly recovered. Not that we haven’t been interested in looking elsewhere, but since the two of us are pulled in opposite directions – he wants bigger, I want smaller, he wants out of town, I want in – we are likely to stay put. In… Read more »

Amanda
Amanda
5 years ago

“If it’s intuitive to buy when the market is low, why didn’t anybody do it? The only people who did were smart investors, who came out in droves and scooped up underpriced bargains by the handful, especially in places like Las Vegas.” Well, when the housing market was low, so was the job market. Lost my job (in architecture) when the rest of the building trades hit the skids in the recession. Was underemployed for 3 years (and had a baby, so that was a plus). My husband luckily stayed employed and even moved up salary-wise, enough to cover the… Read more »

Carla
Carla
5 years ago
Reply to  Amanda

Sounds like Portland to me.

William @ Drop Dead Money
William @ Drop Dead Money
5 years ago
Reply to  Amanda

Amanda, what you say is true… but it doesn’t have to be. If you understand the duration and structure of economic cycles, it believe it’s possible to prepare and benefit from the inevitable dips. So much so that I have a website dedicated just to that strategy. (You can just click the link on my name to judge if you think it makes sense.)

Jeff
Jeff
5 years ago
Reply to  Amanda

Also a lot of people kept worrying that prices were going to drop even lower so they kept waiting for the market to bottom out.

Eventually I just pulled the trigger myself, if you’re always waiting for a better deal you’re likely to end up with nothing in the end.

Melody
Melody
5 years ago

I grew up in Southern California, and everyone things it’s strange when I tell them that Cincinnati is my favorite place I have ever lived. I am able to live so much better here for so much less.

Beard Better
Beard Better
5 years ago

I’ve never understood the obsession with equity in a home. While owning your residence does have some advantages, it seems silly to me to treat it like any other investment. To me a house should be treated like a product; you don’t want to pay too much, and you also don’t want to deal with poor quality by spending too little. Then, even if you lose equity on paper, it’s not really a big deal; you still have a place to live as long as you can keep making the mortgage payments. If you later sell the house for a… Read more »

Marsha
Marsha
5 years ago
Reply to  Beard Better

I agree with you on not treating your home as a regular investment. However, the $208.33 in your last paragraph isn’t including all the interest you’ve paid over the 10 years if you have a mortage, or the opportunity cost of having money tied up in a house that could have been invested otherwise. Depending on rental costs in your area, it is possible that you still could come out ahead even considering these costs.

Beard Better
Beard Better
5 years ago
Reply to  Marsha

For the sake of keeping the numbers simple I stipulated that the house was initially bought with cash, so there was no mortgage involved. I didn’t consider opportunity cost because then the problem would become too open-ended; to come to the best decision possible, you would need to consider the opportunity costs associated with all available investment options. That could certainly be estimated (or simulated) with enough time, but my point was just to quickly show that equity in a house that is one’s main residence, especially when we’re only talking paper gains or losses, isn’t necessarily that important.

lmoot
lmoot
5 years ago

I don’t really like the approach of buying personal homes purely as an investment, and IMO timing the market is better advice for investors. I don’t think anyone who bought their home at the top of the market made a “mistake” or anyone who didn’t buy low in the market lost out on an opportunity. Yes you could have spent 20% less on the same house in two years, but really, what are the chances of it being the same house? Even though I got my house at a relatively good deal right after the crash, in 2009, I couldn’t… Read more »

lmoot
lmoot
5 years ago
Reply to  lmoot

Also… “The line dropping doesn’t represent prices themselves, only the rate at which home prices are rising. As long as the line is above the 0 percent mark, it shows prices are rising, not falling.” See, that’s the problem with charts like that. Folks often forget that “recession” is a relative description (relative to some future high, and not the current market). If today’s price on cookies is $3, but it shoots up to $8, then recesses to $4 (in a short enough period of time that inflation adjustment has little effect), it’s a better deal in hindsight to have… Read more »

Jennifer
Jennifer
5 years ago

To me, the purchase of a house should be done like any other investment you make…for the long term. If you think you will buy your house and sell it a few years later at a huge profit, then it’s probably not a realistic expectation. The same would be true for investing in the markets. Only do either one if you can be prepared to sit on it for a while and whether any storms that may come about. Owning your own home can be great, but you can’t think you’ll have the flexibility that you would have as a… Read more »

Anthonyk747
Anthonyk747
5 years ago

Good article, but you don’t necessarily have to wait if you’re willing to buy a foreclosed home. A recession isn’t always a bad thing, as it allows people to afford homes at much lower prices.

Dan
Dan
5 years ago

What if you need more space? We bought at the bottom of the market in our area.. and we have gained much equity since (4-5 yrs ago). We are looking at a bigger home now (have 2 kids now) and are coming to terms with a larger mortgage. All things considered, our DTI is extremely low (7% / 12%) and after our purchase (20% down) we would be at 11% / 15%. How do I get more space, with good schools without taking on more debt? Also- this is all calculated on my income alone – wife does not work.… Read more »

William @ Drop Dead Money
William @ Drop Dead Money
5 years ago

If you need more space, and you can wait, the best time to get it is when prices are at their lowest, because that’s when the price difference between what you get for your old home and what you pay for the new one is at its smallest.

If you can’t wait, then you just have bite the bullet and make the change. But this is one of those cases where patience can pay big…

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