November 1, 2014

Mail Bag: I’m Thinking of Buying a House in Florida. What Should I Consider?

Mail Bag

When looking at home purchases, it is best to compare median household income to median home price for a local economy, then factor in a few other projections.  Though not perfect, it improves your odds of avoiding serious trouble.  There are also a few other things that are worthy of consideration, including future interest rates, local employment projections, your own personal opportunity cost, and expectations for the supply and demand of housing units to households.

Joshua,

Hi again.  Do you have any resources for watching the housing market/assessment values history for the last couple decades?

I’m researching properties in Sarasota, and I’m quite shocked at how much the market has swung in the last decade.

For instance: one home I’m looking at in a condo complex:

  • 2000 sold for $70,000 and assessed at $69,708.
  • 2005 sold for $166,000 and assessed at $174,600 (constant rise)
  • 2007 sold for $219,000 and assessed at $173,700
  • 2008 assessed for $147,300
  • 2009 assessed for $103,500
  • 2010 assessed for $93,700
  • 2011 assessed for $69,800 and is on the market for $54,900

Obviously, the person who bought it for $219,000 bust and was seriously underwater, and probably the bank foreclosed.

This kind of swing is new to me – I’m not use to looking at these kinds of values.

I’m seriously considering buying a house instead of renting because, quite frankly, it’s cheaper, and I’m building equity.

But can I expect to see these kinds of assessment values ever again?

If you can point me to some good articles to make me think, I’d appreciate it!

Thanks again!

JC

I have no idea if home prices will be up, down, or sideways next year.  No one does.  Any time you make a financial commitment, there is a degree of risk that you must be willing to bear.  Even not making a financial decision is, in and of itself, a decision with consequences.  That is the nature of the world.  All I can do is tell you some of the things that would be on my mind, and desk, before I acquired any sort of real estate investment.

The interesting thing about housing is that you must live somewhere.  Unless you are a tiny minority of the nation that inherited a home, you must make a decision about where you live, whether that is renting an apartment, buying a condo, renting space a motel, or constructing a log cabin by hand on your own piece of property in the wilderness.  As long as you live, housing costs are a necessary part of your life, even if you own a property outright and are just covering the utility bills and property taxes.

With that in mind, the first questions I would ask if I were in this situation are:

  • What percentage of the comparable home price sales consist of bank-­owned foreclosed properties? These can drive down market values as banks sell as fast as they can.
  • What is the backlog of foreclosed properties not yet on the market relative to the average houses sold in the area?
  • What is the local unemployment rate relative to the national unemployment rate?
  • What are the local employment prospects?  Does the town rely heavily on one or two employers or is the local economy more diversified?
  • What is the local median-home-value-to-median-household-income metric? How does it compare to the national average?
  • Do I prefer the convenience and relative of freedom of renting more than the knowledge that I own a property and can modify or do with it whatever I desire?
  • How long so I plan on staying in the community?

The Starting Point Would Be Median Household Income to Median Home Price

Though there is no perfect measure of valuation for a home, especially once you consider the utility different locations and features have for different people at different times in their lives, the best financial measure is probably median household income to median home price.  In simple terms, it tells you how many years it would take for a median family to pay off a median home in the community if they could put every penny of their income before taxes toward the purchase price.  For the past few decades, the historical norm for this metric has been between 3.25x and 3.50x.

Median Household Income to Median Home Price

Median Household Income to Median Home Price from the National Association of Realtors

A quick search for 2010 from CNNMoney shows that the median home value for Sarasota was $100,000 and the median household income was $52,324, a ratio of 1.91-to-1.  Job growth for the community was -11.86%.  Five years ago, Sarasota had a median household income of $49,484 compared to a median home price of $241,680, a ratio of 4.88-to-1.  

Thus, this particular community appears to have gone from way over the historical ratio to considerably under the historical ratio in terms of valuation.  This is where the employment analysis comes into the picture.  If the local economy continues to lose jobs and families move elsewhere, or, alternatively, there is an enormous overhang of excess real estate relative to the population base, the valuation ratio should fall.  It’s a basic law of supply and demand.  If the local economy picks up steam, hiring starts, and the excess inventory is absorbed, housing prices should rise.  Again, it’s basic supply and demand.

Then, you get into the complexity of interest rate increases lowering real estate values versus nominal increases in the quoted value of a property due to inflation, which can be beneficial if you borrowed fixed-rate debt against the property because, for all intents and purposes, the United States Government is paying off the money you owe through its reckless spending habits.  In many ways, above average inflation might be beneficial to a property owner who would get to pay back fixed debt with depreciated currency.

You Need to Compare the Opportunity Cost of Renting with the Opportunity Cost of Buying

Then again, you also have to consider the fact you’re looking at a property listed at $54,900.  I’d venture to guess you could get it at $50,000.  With a 20% down payment, or $10,000, using a traditional loan, a 30-year mortgage would require a mortgage payment of $195.  Renting a decent apartment in the area costs $600 to $900.  In that sense, even if housing prices fell by 50%, causing you to lose $25,000, it would only take between 3 to 6 years to be in the same economic situation you would have been renting if you compare the higher rent to the lower mortgage payment backing out the property value loss.  

Median Household Income and Median Home Prices Analysis - Image © ThinkstockFrom a financial analysis, that is an interesting proposition if you planned on living and working in the community for 3 to 6 years.  In that case, you could own the property and if the market stays stable or increases, you make money.  If the market decreases, even by another 50%, you’d be at effective break-even with renting when you looked at the various costs involved.  That isn’t a lot of downside if you can come up with the relatively small $10,000 down payment and plan on being in the community for long enough to take advantage of that math.

People don’t think that way, though.  If the market fell by another 50%, they would see a $25,000 loss on paper and freak out, not realizing they were only then in the exact same situation they would have been by renting for 3 to 6 years.  

Then, there is the convenience factor.  If you only plan on being in the community for, say, 1 or 2 years, it would probably be better to just rent and go with a nicer place, managed amenities, and the ability to walk away with short notice.  

Oh, and one final thing: If you are looking at a condo or property in a community, make sure there aren’t outstanding assessments against the individual unit or entire structure.  That is, you don’t want to buy then discover there are so many foreclosures in the development that you and the handful of other people living there have to come up with $7,000 each to cover a new parking lot or something.  

Those are a few of the things that would be on my mind if I were in your situation.  It should also give you enough keyword terms to start researching more and educating yourself on the topic.  I hope you find it helpful.

  • Connelly Barnes

    Thanks for these articles Joshua! My wife and I are looking at houses and they are super useful.

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