By: Ryan Dolan
The housing market. Everyone’s talking about it. The anecdotes are unavoidable - you’ve heard them. I heard one recently: a local family sold their home in one day at a not unusual 30% premium to an already ambitious asking price. All cash, no contingencies, multiple bidders. Made over a million dollars in 5 years. Pulling up stakes and moving to Idaho.
Prices have surged so far for so long that homeowners feel justified dumping incredible amounts of money into extensive home improvements. The remodel frenzy has gotten so bad that people are hoarding the names of good contractors, much like prized tutors. In the odd event you can get a contractor to return your calls and bid on a project (not a given), prepare to pick your jaw off the floor at their pricing. Everyday the streets of my Bay Area town are besieged by armies of contractors, realtors and homebuyers. Main street over the years has less shops and restaurants and more realtors, interior decorators and architects offices.
Perhaps this is attributable to the extended period of robust price appreciation. With the exception of the sharp markdown in prices in the financial crisis, real estate has been on a tear for two or three decades. The historic recent surge in pricing over the last couple years has made people’s house purchases in say 2019, which seemed a bit toppy at the time, now look downright brilliant.
Asset prices, whether stocks or houses, are driven in part by narratives. Whether people explicitly say it or not, this long surge in house prices has created a widespread belief that housing is a can’t lose investment. I moved to California in 1998, and the state has been in varying states of real estate obsession and FOMO almost the entire time. And just as things tend to start in California and then spread to the rest of the country, the cult of housing has become an unequivocal national phenomenon. Lest you think the insanity is limited to the Golden State, take a peek at what’s going on in California-exodus destinations like Boise, Austin, Nashville and Miami. In what has become a very divided country, Americans, irrespective of wealth, race, gender or political affiliation are united in their conviction that their house is a high-returning asset.
The family home is a loaded topic that combines all sorts of emotional, personal, financial and interpersonal dynamics in a unique and sometimes volatile stew. As an advisor, I understand that the family home represents a unique mixture of part consumption, part personal asset and part investment. And yet in boom times, belief in the investment merits of homes tends to dominate all other considerations. and help justify all sorts of poor financial decisions.
It’s important to note that the investment merits of homes tend to be overstated, primarily by an industry incentivized to overstate them. In reality, a home comes with high transaction costs and lumpy and often understated operating and maintenance costs. This is made worse by the fact that house prices tend to barely keep pace with inflation over the long-term. Robert Shiller of Yale has pointed out that, “From 1890 to 1990, real inflation-corrected home prices were virtually unchanged.” Think about that: in a century the real return on your home was flat. And that doesn’t include the negative cash flow over that period.
The period since 1990 has seen historically aberrant price acceleration. This serves to magnify the financial impact of big house related decisions (buying/selling, large remodels). Adding to this is the increasing degree of cyclical volatility in the housing market. Take the current full cycle of 2006 to today (prior peak to current peak). According to Shiller’s numbers, national house prices fell 36% from 2006-2012 only to pivot and surge 71% from 2012 to today. It’s important to note that these are inflation-adjusted numbers.
So with home prices taking a bigger and bigger portion of the affluent American’s balance sheet, and the recent trend of heightened cyclical volatility, it behooves people to make sure they are running their big home decisions through a structured and thoughtful process to help them make the best-informed decision they can.
I have several clients at very different stages in their lives, who are pondering a big house-related decision. NOw more than ever, you want to make sure you have a framework and the support to make the best financial and personal decision you can. Here are a couple of the scenarios and outcomes.
Young family: when to buy the first home?
I could feel the tension as soon as the clients walked in the room. The couple (mid 30s, 2 young kids) had been discussing buying their first home for over a year. Given their current financial situation and my future projections, we had reached a consensus that the financial risk was simply too high from them to buy a house prior to 2024-2025. This created tension as the spouses weren’t united in what they prioritized. The husband prized financial flexibility and prudence while the wife focused primarily on putting down roots and raising their kids in a home of their own.
The spousal tension had escalated as local prices continued to surge and the prospect of getting priced out of the market increased. This was made worse by seeing friends around them minting big money on their homes.
Finally, I highlighted a scenario where they continued renting, and worked at building a really robust house fund on the back of a high savings rate for an eventual 2024 purchase. Even if housing increased 25% overall, they would be in far better shape financially to absorb that purchase. The couple left the meeting in better spirits, though some tension remained between them.
A couple months later, as is often the case, patience and deferred gratification was rewarded. The couple informed me that, quite unexpectedly, they were able to rent a far larger home at a considerably lower rent then their current place. A family member was relocating. They are now in a far more sustainable situation, everyone’s happy, and that eventual house purchase, regardless of what the market does, will be made on a far stronger financial footing.
Almost empty-nesters: stay or downsize?
This mid 50s couple had very high financial concentration in their home when I started working with them. Despite very high and rising income, savings rates were low. After some analysis, it became clear that housing costs were a considerable part of the issue: a huge mortgage payment, high property taxes, relentless repairs and maintenance, utility costs, etc.
There are times as an advisor when you need to withhold your opinion. There are others where you simply need to name the elephant in the room. While it was clear the couple wanted to stay in the home as long as possible, at least until their kids were in college, the need to consider downsizing the home needed to be discussed.
As always, I help frame decisions by showing different scenarios and outcomes. I first showed their current projections: put the kids through college, retire at 65, and consider downsizing the house in retirement. To make this achievable, the clients’ savings rate would need to increase dramatically from current levels-an increase which I felt was extremely unlikely.
Given that, I showed a scenario where the savings rate increased meaningfully (but realistically), retirement was pushed to 70, and the house sale date remained in retirement. The visual analysis clearly showed that while the chance of success was materially higher, it was far from a given.
In my final projection, I had savings go up a very realistic amount, pushed retirement to 67, and had a house downsize in either 2024 or 2028. What became crystal clear was the positive transformation this would have on their financial life. Their savings rate surged dramatically (due in large part to lower home costs), their bucket of higher-returning investment assets surged, their debt load shrank dramatically, and their real estate concentration dropped a ton.
I can tell the presentation had an impact. They aren’t ready to make a decision in the near-term, but they know now what they can and likely will do in the coming years.
The multi-home-owning retirees: sell one of the homes?
This constantly on the move, active, young for their age, mid-70s couple owns 4 residences (2 homes and 2 condos). In the past couple of years they’ve used one of the condos less and less. The running costs of this condo are the highest of any of their properties, with very high condo fees and property taxes.
The husband, wanting to start slimming down their real estate exposure, and pessimistic on future real estate values-was considering selling. The wife was very attached to this property, and clearly wanted to hold on. She mentioned that should her husband pass first, she likely would spend far more time at this property and still had lots of friends there.
In reviewing their financials and future projections, it was very apparent that their exposure to real estate in relation to their income and net worth, was extremely conservative. All of the properties were paid off, and the couple had considerable investment income. We analyzed the travel expenses to this property, and estimated the future annual costs associated with keeping it. We also ran different projections on future real estate returns on the property, from a sharp contraction to continued strong growth.
What became clear across all the scenarios was that the decision to sell or keep the property was largely a financial non-event for them. The differences in outcomes simply weren’t all that material. Their personal needs and wants should trump any financial considerations. When presented with the 10 and 20 year projections, they agreed to simply keep it. Thought they may readdress the decision in 5 or 10 years, the math made their decision an easy one.
The family home. It’s a loaded topic, at the best of times. With the national residential market on steroids make sure you have the people and process around you to make the best informed decisions you can.