Decision Time
When to invest in real estate
Is it time to buy a house? Students, fellow faculty, Oxford residents and the media frequently ask me this question. I suspect that the national media’s coverage of the recent declines in the value of U.S. residential real estate is driving the increasing interest in housing. Also, since a house generally is one’s largest investment, the home-buying decision is a critical determinant of wealth building, which is likely another reason for the renewed interest in housing.
The residential real estate industry has cited low interest rates and a nationwide cheapening in the housing stock as evidence that now is a good time to purchase a home. The former clearly is true as mortgage rates are near historical lows. At the time of this writing, individuals with strong credit histories can borrow at rates less than 4 percent and 5 percent for 15- and 30-year mortgages, respectively. There is also no disputing that homes are now substantially cheaper than during the peak of the housing bubble (circa 2006-07), as evidenced by monthly announcements from the Case-Shiller home price index. Still, I caution individuals from purchasing a home solely based on this information. One reason is that prices have more room to fall: A comparison of prices relative to the pre-bubble period (prior to 2003) shows that values are still significantly higher than they were 11 years ago. Further, the housing market still has a supply of homes that exceeds historical norms. Continued price reductions associated with excess supply will be further exacerbated by the shadow inventory of homes, which are houses that are in the process of foreclosure but not yet listed for sale. Indeed, most housing economists suspect further price decreases are on the horizon.
A nontechnical determinant of the housing purchase decision that I wish more buyers would employ involves the simple establishment of the length of time that one expects to reside in the home. On average, it takes five to seven years of owning a home to break even on the purchase, as compared to renting a similar home. Thus, those expecting to live in one place for less than five years should rent, unless they are not averse to earning a negative return from the purchase. Furthermore, individuals seeking to retain their mobility should avoid the housing market. I hope that one of the positive externalities of the busted housing market is a reduction in the stigma associated with renting.
