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To Buy or Not To Buy…What’s Your Advice for This AFM Reader?

By JLP | January 7, 2009

I received the following email the other day from an AFM reader (summarized from several emails):

JLP,

Greetings! Yours is an awesome website, and it has proved to be very helpful ministry to me as of late. I had a quick question for you.

My wife and I are in our 20′s. We have no kids, but I have recently curiously contemplated maybe buying a new, bigger, more expensive home in order to take advantage of the current real estate situation. The house is in the best school district in the state, and nicely situated close enough to some nice restaurants and shops, etc.

In 2006, when the neighborhood broke ground (it’s in the Birmingham, Alabama area), the houses were listed for pre-sale at $689,000 or so. I know for a fact that one of the residents in that neighborhood with a similar house to the one that I want paid taxes on $707,000 last time around. This particular house has been listed for 13 months, with the price slowly falling. The home currently says $569,000. I asked the sales agent / realtor about her coming down and she told me that they are very negotiable, of course. I can get in the low 500′s, I’m pretty sure. It is a very impressive home.

The down payment of $450,000 is nearly all of my net worth. It is a large inheritance, and it will cover about 80% of the purchase price of the home. Besides that, I would have my cars, possessions and a $15 or $20 thousand savings portfolio. I would, however, be debt free. So, I guess a major part of my question is, is a luxury home a good investment vehicle in these troubled times? I’d look to sell in 10 or 15 years, hopefully making a good bit of money on the house.

I do not have a retirement account or anything along those lines. My “career” will officially start when I finish law school and pass the bar, one year from now.

My question: Is it time to move, or wait for the market to drop even more, or stay put? If I don’t buy this house, the money will probably just be sitting in a CD of some sort.

All the best,

-SM

Wow! Lots of things to think about. Unlike lots of people, I look at a house as an investment—afterall, it IS an asset. So, I would look at this from an investing point of view. You have to decide for yourself whether or not you want to allocate your entire net worth (at least right now it would be your entire net worth) to one asset. Lack of diversification is something to think about.

It could be years before housing prices start to recover so I wouldn’t plan on any more than a 3% to 3.5% appreciation rate on the house over the next five to ten years. Based on that, you could expect the house to be worth somewhere in the neighborhood of $700,000 – $740,000 in ten years. Keep in mind that there are no guarantees that housing prices will move up. If things don’t turn around in this country soon, we could be facing a long-term recession. That would not help housing prices.

Personally, I don’t think the worst is over for housing prices. There are more foreclosures looming out there and they are only going to put downward pressure on housing prices. Sure, some areas will be hit harder than others but how bad it will get is anybody’s guess.

In addition to the purchase price, you’ll also have to pay more property taxes and the upkeep on a larger home will naturally be higher. Will you be able to afford those expenses? I know in my town, a $500,000 house probably has a $12,000 per year tax bill.

If it were my money, I think I would hold off on buying the house. I would keep an eye on housing prices and if you think they are turning around, you could jump then. You have one huge advantage over most people in that you have a hunk of cash sitting around waiting to be used. Other people don’t have that luxury.

Since you have plans for using the money for the purchase of a house, I would keep it fairly liquid. Shop around for CD rates but be careful.

That’s my opinion. You can take it for what it’s worth.

Now I’d like to open it up to AFM readers and see what they think.

Topics: Asset Allocation, Housing Market | 20 Comments »


20 Responses to “To Buy or Not To Buy…What’s Your Advice for This AFM Reader?”

  1. Lance Says:
    January 8th, 2009 at 12:14 am

    SM would also have to factor in that the value of the house will likely continue to drop even after the purchase. If you look at the house in Zillow.com (I know its not the best estimate) but look at the trend, I’ll bet it is downward and if I were SM I wouldn’t invest in real estate till he starts seeing the trend bend upward. My prediction on the housing market is: America has learned their lesson, if you think the real estate market is gonna fly high think again, the market is going to give you very low ROI for many many years. People won’t get excited about Real Estate till this recession is long forgotten.

    If I had that kind of money though I’d look into commercial real estate or better yet rental properties with decent rental rates then you’ll get a decent return.

    Lance

  2. JLP Says:
    January 8th, 2009 at 12:21 am

    Lance,

    Rental properties might not be a bad idea but that’s a whole different ballgame.

  3. Preston Says:
    January 8th, 2009 at 2:52 am

    Zillow isn’t worth the bandwidth it takes to load…stay away (far worse than just not “the best estimate”)

    Load up your county records and do a public records search for comparable sales. If your area doesn’t offer that service free online, pay the $ to look it up for a few homes in the neighborhood if you’re serious.

    My opinion is that a house is for living. Even if you want a luxury house, enjoy your stay. When you move, if you make money, great. Otherwise, look at it as money well spent. If “losing” money on a house isn’t money well spent for you, then DO NOT purchase it in the first place.

    :)

  4. Bianca Says:
    January 8th, 2009 at 7:37 am

    There’s an interesting website http://www.housingpredictor.com offering independent real estate market forecasts.
    They predict that the housing slowdown will still have an impact on the Birmingham market in 2009 with a deflation of home prices at a rate of over 12% through the year.
    Regarding to that forecast I would still watch the market and the price trends before investing too early.
    Bianca

  5. Stacey Says:
    January 8th, 2009 at 7:41 am

    Like men and buses, there will always be another one (“dream” house)…So IMHO, there’s no hurry to do anything. Enjoy the peace of mind that your large inheritance brings each night when you fall asleep. Who knows how long it will take to land a job after law school, if starting your family will take expensive medical intervention, etc. Not buying an expensive house right now has less downside than buying an expensive one. And not that tax-planning should rule the day, but if you have a minimal mortgage balance, when you are making the big bucks as an attorney, you’ll wish you had some write-off!

    And yes, utilites/fixed costs are MUCH higher on a larger home…I’m living proof!

  6. Eric J. Nisall Says:
    January 8th, 2009 at 7:56 am

    Not knowing the market for where plans SM to buy, I could not speak of the housing conditions there. What I do know is that there is still going to be debt since he states that the down payment he has is $450K, while the house can be had for the low $550′s. That still leaves a small mortgage to be acquired, and with that comes closing costs. JLP already mentioned the issues regarding taxes and upkeep, but I am also wondering if there are any homeowners association fees involved. In more upscale areas these fees can also be substantial. Not to mention the increased cost of utilities moving into a larger house.

    Personally, I would not recommend to anyone that they spend almost everything they have on a home, regardless of whether they view it as an investment or not. In this case, in particular, it would be unwise, since SM stated that he is in law school and hasn’t started his career. He doesn’t even mention if they have a significant stream of income right now. In addition, that savings he mentioned would be all the back-up savings he has since cars and possessions can’t be relied upon in times of trouble.

  7. tom Says:
    January 8th, 2009 at 8:28 am

    I assume he will have no law school debt due to this inheritance.

    I would NOT buy that house or any house until you are 95% certain you are staying put for the next 3+ years. I’m 25 and since I graduated college, I’ve moved a couple times, each location being thousands of miles apart. I’ll probably be moving again in the next 3-5 years.

    Also, you forget that a huge luxury home needs to be decorated and furnished. I know from experience (with a small home) that it’s extremely difficult to fight the urge to splurge on furnishings and decorations, and the costs add up fast.

    So here is my very humble opinion of what you should do:

    ~At least wait to buy until you graduate and get/start a job and know that Birmingham is where you want to stay for the next 3+ years
    ~Pay off all student loans
    ~Use that money to max out IRA (and maybe 401k) contributions
    ~Put the money in MULTIPLE high-yield savings accounts (never know when banks will fail)

  8. No Debt Plan Says:
    January 8th, 2009 at 9:01 am

    Living in the Birmingham, AL area I can think of one or two places this home might be located. I disagree with JPM about looking at the home as an investment for appreciation purposes. I do agree when you talk about diversification.

    It’s the old problem of putting all of your eggs in one basket. Dropping $450k into something that is completely illiquid seems like trouble to me for multiple reasons:

    a.) There is no guarantee home prices will go up. Look at the home as something to live in, not something to make money on.

    b.) What happens if you need the money all of a sudden? Or a piece of the money? You would have to get a home equity loan or something like that. I would much prefer to take advantage of low mortgage rates, put a reasonable down payment down, and keep the cash more liquid. If the money is liquid it can be used for various issues that pop up.

    I would also ask why you need to move into a gigantic house in a luxury neighborhood. Do you “need” the feeling of being rich? That $300k could buy you a really nice house just about anywhere in Birmingham.

    As others have mentioned you will have higher property taxes, possibly higher homeowners association fees, etc. to go along with your luxury home.

    Also — under normal circumstances (no inheritance) could you afford to put 20% down on the home and cover the mortgage payments? If not that is a serious red flag to me that you are trying to jump into an area that you can’t truly afford.

  9. dogatemyfinances Says:
    January 8th, 2009 at 9:05 am

    Why would you tie yourself down to such a beast of a house with NO JOB? Jobs are tight out there for lawyers, and he might have to move to get a job. He can buy in a couple years.

  10. AED Says:
    January 8th, 2009 at 9:51 am

    Why are you avoiding the stock market? If your time horizon is 10-15 years, why not put some of the money in the stock market? I believe the real deals right now are in the market.

    You could invest a portion of the money in the market and a portion in a CD in anticipation of real estate prices falling even lower.

    In 10-15 years I believe the stock market will offer a far better return than real estate.

  11. Mia Says:
    January 8th, 2009 at 10:01 am

    I’m sure that there will always be a small niche market for luxury homes, but I, and many real estate experts, predict that the long term trend will be towards smaller, less ‘in your face’ homes. Excess, and the bling that goes along with it, are becoming socially unacceptable: large homes usually aren’t ‘green’, and owners of luxury homes are being viewed as wasteful, greedy show-offs.

    Do a google search for “building trends” and you’ll find plenty of information.

  12. Spokane Al Says:
    January 8th, 2009 at 10:20 am

    I strongly agree with many of the points previously made. It sounds like the writer views a fancy home as a measurement of success. A house is first off a home, and second, over the long run, one hopes that its value will increase.

    As some have previously commented, if the writer is looking for an investment that will increase in value faster that other choices, a luxury home is probably not the best move. The more expensive the home, the more exclusive the buyer.

    Just starting off in any vocation is a time to be a bit cautious. To sink virtually all of one’s net worth into a house is not the right move in my opinion.

    If the writer has the income, I would fully fund a Roth IRA for both him and his spouse. I would then put about 25% into a diversified mix of mutual funds (Vanguard is my first choice).

    I would ladder the remainder in CDs of terms of one to five years.

    I would take my wife out to a nice dinner celebrating our lives together and the excitement of the future.

    I would evaluate my need for big houses and lots of stuff – that does not drive happiness.

    I would then get back to hitting the books, passing the bar and working overtime to find a decent place to practice, learn and grow, and fully fund a 401(k).

    Once I was settled into a solid firm (if that is the writer’s direction) I would consider homes on a much smaller scale.

    And I would continue with a diversified investment plan.

  13. JC Says:
    January 8th, 2009 at 10:51 am

    just to play devil’s advocate here, but why can’t the OP put a sizeable down payment (30-40%), take out a mortgage at these historically LOW rates (get the tax advantages thereof), and still have a large stash of cash to draw from to bridge him to the end of law school and his first job? he then gets the home he wants (assuming he can live there for at least 5-10 years), and when he feels he has a stable income to work with, he can use the sizeable stash to pay of the mortgage if that’s what he wants to do…i see this as a way to hedge his bets a little by getting the real estate as well as having a cash cushion to work with to deal with the uncertain short term future.

  14. zed Says:
    January 8th, 2009 at 12:35 pm

    SM,

    My $.02. It would be foolish to have that much of your net worth tied up in a personal residence. Why do I say that? Because that’s exactly where I am right now.

    My wife and I built our dream home (Seattle area) back in ’96 for $400k. For the last year now we’ve owned it free and clear. Being without debt is a wonderful feeling but the other side of the coin is that we’re now sitting on an asset worth $1mil/$900k/$800k – pick a number. Okay maybe that’s such a bad problem to have but does it really make sense to have that much of your net worth tied up in one asset?

    Taking into consideration where you are at this point in your life and career I would strongly suggest that you educate yourself on good personal finance and investing habits.

    Charlie “Tremendous” Jones was credited with saying: “You’ll be the same person you are today, five years from now, except for the books you read and the people you meet”.

    Recommended reading list:
    “The Millionaire Next Door”, Thomas Stanley
    “Financial Peace”, Dave Ramsey
    Titles found here by Jack Bogle/Bill Bernstein/Larry Swedroe/Rick Ferri
    http://www.successfulinvestingradio.com/reading.php
    Note: The Podcasts found on this sit are also worth listening to (click on Archive.)
    Note: I’m not plugging these advisors. I’ve never talked with them. Judge for yourself.

    The message I’m trying to convey is: live frugally and well within your means, save, diversify your investments and ALWAYS be in control of your money.

    Oh and above all – Enjoy your life.

    zed

  15. SM Says:
    January 8th, 2009 at 12:55 pm

    Wow, thanks JLP and crew, keep it coming. It may not be what my wife and I want to hear, but you guys are making sense… I’m simply looking for the best investment vehicle for this large a sum of money… and a nice house seemed like the best thing. But it seems that I was wrong. Thanks again you guys, ya’ll are great.

  16. Joe Says:
    January 8th, 2009 at 2:10 pm

    Considering the legal world is being restructured and you may not be able to make big dollars as an attorney (as opposed the world in 1998) you can’t count on what your income will be. You didn’t mentioned law school loans, but if you have those you can’t possibly get rid of $450,000 unless those loans are paid off.

  17. Gerard Says:
    January 8th, 2009 at 4:46 pm

    SM,
    As with all things financial, it depends on your motives for the money. Personally, I agree with most of the commentators here. I do not think a house is the best investment unless you intend to live in it for the next 10 years. Even with the depressed house prices, I still think you will be able to make your money work harder in the stock market (especially given the beating they’ve taken). That said, this is based purely on the assumption that you do not intend to use the money in the near future. Further, I would keep an emergency fund using a CD ladder / online savings accounts regardless of which path you go down.
    Good luck!

  18. thomas Says:
    January 8th, 2009 at 10:26 pm

    Probably way too much to throw all your money into one house. Property taxes would be a pain and you have no way to offset the costs if you were paying interest.
    You would be better off buying forclosed homes, fixing them up, and sitting on them till the market turns. Not only are house prices down, but so are labor costs, supplies, etc. The true money makers are the ones that have the capital to take advantage of the down times.

    Just my thoughts. Good luck in your decision.

  19. Meg Says:
    January 9th, 2009 at 4:20 pm

    So you are married, in your 20′s, in law school, and have about $465K in marketable securities of some kind. That’s awesome! And it sounds like you already own a home since you want a “new, bigger” one.

    If you know you want to stay in the Birmingham area for 10-15 years, then I WOULD condider buying a home right now, one that you can see yourself living in for that duration. But I would NOT put more than 15% of my net worth in it (25% MAX). You need to diversify if the whole point is to make money, and you need to retain liquidity during this transitional period of your life. What if you get a great job offer in Mobile when you graduate? Or what if you can’t find a good job, or realize you hate practicing law? What if your wife gets pregnant or you total your car? You’re telling me you’d be comfortable with $15,000 in the bank?

    PS – Make sure you can afford the mortgage and taxes and insurance without living off your inheritance. If you would otherwise be living off your assets during law school, make sure those costs don’t exceed what you’d otherwise be taking out to pay rent.

    PPS – If your main goal is appreciation, houses closest to the median home value appreciate the fastest. Very expensive homes and very cheap homes relative to that typically appreciate at lower rates.

    OK, so what to do with your $375K – $465K that’s leftover? Keep at least one year of expenses in cash. Or maybe even one year of your expected salary once you graduate. Then max out Roth IRAs for you and your wife, assuming you have $5K of income for the year. Then put the rest in a moderately conservative fund such as the Vanguard LifeStrategy fund.

    If all you want to do is keep this money safe and grow it as much as possible in the meanwhile, real estate isn’t your best bet. It’s NOT as safe as it seems, even though a big house seems more tangible than a stock fund. The transaction costs and taxes and upkeep are extremelly prohibitive to good returns even when it’s NOT the worst real estate market we’ve seen in decades.

  20. SM Says:
    January 10th, 2009 at 3:20 pm

    Thanks again guys! After reading all of this, I’m happy to report that we will be passing on the new house. Thanks for the guidance! -SM

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