Friday, September 01, 2006

How to value a property during market downturn?

Housing market continues to slump. Now we can calculate true value of a property easily. As price decline, we don't need to guess and factor in the potential price appreciation while calculating home value. Without the guesswork, figures are more accurate.

Let's use following example:

Today, a typical 15 years old, two bedrooms condo/townhouse is priced around $500,000 and $550,000 in Sunnyvale, California. Rent for similar condo/townhouse is $2000/month.

If you are a home owner, $2,000/month in rent means $20,000 a year in profit ($24,000 per year in rent, minus $4,000 maintenance costs). A $20,000 income is equilevant of owning $400,000 bonds or CDs, because current yield of 30 Years U.S. treasuries are 5% (5% of $400,000 is $20,000). Bank CDs have similiar yields.

In our example, the two bedrooms condo/townhouse is 20% to 25% overpriced. They should be priced at $400,000.

It is interesting to note that if we redo the calculation from buyer's perspective instead of seller's perspective, the figures are even more shocking.

Mortgage payment consists of two parts: mortgage interests and mortgage principal. The interests portion is similar to rent. If you pay interest, it disappears and doesn't add equity to the property. To fully simulate characteristics of renting, we assume buyer will apply for a zero down, interest-only loan.

It turns out that rent of $2000/month is equivelant to mortgage payment of a $340,000 loan at 7.0% APR. And comparing $340,000 loan to $500,000 or $550,000 price tag, from buyer's view, the two bedrooms condo/townhouse is 30% to 35% overpriced.

One may ask, why is there a discrepancy between two perspectives of the buyer and owner?

The discrepancy is a result of 2% differences in interest rate that buyer borrow comparing to yields of bonds and CDs that owners would get. We understand that buyer would always pay more. That is the premium of buying to own. However, looking from home owner's perspective, current housing market is probably 20% to 25% overpriced. We recommand investors to wait for a better entry point.

Thursday, August 31, 2006

Rent vs. Buy as Housing Market Continues to Slump

As housing market slump, it is easier to calculate "Rent vs. Buy" scenario. Because "appreciation" is no longer a factor.

Mortgage payment consists of two parts: interests and principal. Interests are like rent, which doesn't add to the equity to your house. It simply disappear as your pay it.

If interests portion of the mortgage payment is roughly equal to rent of equivalent property, then it is a decent buy.

For example, let's buy a $500,000 condo with 0% down and apply interests only loan (just like renting a place). Mortgage payment would be $3250/month. It is a bad buy, because you can enjoy same property for $2000/month.

Please note that I assume the tax benefits from home cancel out fees from home association and property tax. For more accurate calculation, consult with your CPA or accountant. But NOT your realtor, whom will say anything to get the deal to go through.

And again, if you like a particular property, then paying more may be reasonable. You are the only person who can decide how much more premium you are willing to pay.

Monday, August 28, 2006

Real estates agents, time to learn new tricks!

In the past few years, real estate agents learned and accumulated a bag of tricks, coercing buyers to shell out extra cash to fulfill hungry appetites of builders and home owners. It is interesting to note that even as marketing is undergoing a slump, they continue to play these hands one by one.

The following conversation is real and took place on Auguest 27th of 2006. It is a conversation between two friends, one a potential buyer, another is a real estate agent.
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"I can't buy, because monthly mortgage payment is too high.", said the buyer.

"Apply for adjustable loans", replied the agent without thinking.

"But, that would only save me 0.25% after fee. Short term rates raised siganificantly in the past 2 years", buyer said.

"Then don't put 20% down, you can get loans with 10% or nothing down", suggested the agent with a big smile.

"That would increase monthly payment which I already can't afford", the buyer reminded the agent.

"Then cash out your 401K, that is the best option", said the agent.

"Why? I don't want IRS knocking on my door for tax and panalties for early termination of 401K", said the buyer. He is annoyed, "And if I borrow against my 401K, I would be paying back pre-tax dollar with after tax money. It doesn't make any sense".

The agent insisted, "401K is the only option".

"What about asking seller to lower their asking price?", asked the buyer.

A pause, "...... hmmm...., that would work too. 5% is common these days", the agent said proudly.

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Similar conversation took place at least two other times for me. This is simply annonying. Real estate agents are so stuck on the past that they can't think differently. Time to wake up! Time to learn new sales tricks.