When You Should Not Buy Real Estate

Okay, I did an article called Why Renting Really Is For Suckers (And What To Do About It). Fairness demands that I do a companion article on situations where buying is not a good idea.

There actually are some. First off, the math just plain works against it for less than about three years. If you know you're going to have to relocate in less than three years, chances are you shouldn't buy. This is not to say that professional speculators are stupid, just that they are playing with different assumptions than most of is. If one victim isn't desperate enough to sell for thirty percent under the general market, they'll go find someone who is. But they don't buy for a place to live. They're buying with a professional eye towards making a profit, and quite often, they don't. If your situation is that you're looking for a home to live in, and you're going to have to sell it instead of renting it out after less than three years, chances are you shouldn't buy. In this instance, it's not the idea of being a property owner in general that is the major factor in the decision, it's how long you're going to own that property.

This is not to say that nobody has ever made money buying for less than three years. The just concluded seller's market right here in California is the counterexample to that contention. But real estate appreciation happens when it happens, and you never know until afterward what it was. If people could predict the market with that much certainty, then it would make sense to try and time the market. They can't, and it doesn't, at least not for the ordinary person.

You shouldn't buy if you can't get a sustainable loan that you can afford. If you don't have at least three years of a fixed rate on an amortizing loan you can afford, you should probably not buy. The market returns 5 to 7 percent per year on average. That is a very different thing than five to seven percent every year. Some years are plus twenty. Other years, like this one is likely to end up, are minus twenty. If you have a sustainable, affordable loan, you'll pay some principal down and you should be able to refinance when the adjustment hits. This doesn't apply with negative amortization, interest only, or shorter term loans. Particularly if there's a prepayment penalty, you'll likely eat up all the principal payments you made with that prepayment penalty. Now suppose you got caught in a twenty percent down year? Over longer periods of time, things even out, trending towards the average return of 5 to 7 percent per year. But that's no comfort whatsoever to those people who bought into unsustainable loans on overinflated properties in the last two years and are now facing huge problems because they can't sell for what they owe, and they can't refinance into a payment they can make. I didn't do it to anyone; I could have made a lot more money if I was so willing. But that doesn't mean there aren't a lot of them out there.

The market is unpredictable. All I can tell you for sure is that it's still declining right now and the next upturn might not come for several years. The only time the value of your property is important is when you sell or when you refinance, but if you haven't got a stable loan, you're looking at a mandatory time when your value is important. If you can't last until then, the eventual market upswing will be of no comfort. Eventually, I'm confident you'll make a better profit than you could anywhere else. But eventually can be quite a while, and if your time constraints don't stretch far enough, that's a problem. A big problem.

Third group of people who shouldn't buy is those without a sufficiently stable income, particularly if their available cash isn't enough to smooth out the bumps. If you need $6000 per month, and you make $24,000 in one whack about every four months, that might appear to be enough, but consider what happens if for some reason it is six months between paychecks? Once you're a couple of months behind and your credit score is toast, it doesn't make that go away if your next check after that is only two more months.

I think I've been clear enough on the evils of buying too much house for your income. People should not overstretch financially to buy a home, but the majority do. You get a month behind on rent, and it is a problem, but if you get a month behind on your mortgage, that's part of your credit score for ten years, and puts you in a whole different class of borrower for two. Plus you're likely to be behind on your next month, and the one after that. This is a lot less of a black mark for renters than it is for owners with a mortgage. Then when you're ready and can otherwise really afford a mortgage, you can't get one or you can only get one on prohibitive terms. So save up enough to smooth out the bumps, and it certainly doesn't hurt to have a down payment also, as that will make the hurdles you have to get over with irregular paychecks that much lower.

That's basically it. If you think you have another one, I'm interested in it, but those are the only three I can think of. The mathematics and economics do generally favor home ownership, even without that generous tax allowance given for the interest deduction and state property taxes, but there are cases where the general rules get overridden. Contrary to what many people were saying not too long ago, you can lose money in real estate, as the fact that property values locally are down about 20 percent from peak should attest. You can also become financially crippled for years. Nonetheless, if you take care to keep it within the realm of what you can afford, and what you can afford to make payments on indefinitely, then the worst that is likely to happen is that you'll owe more than the property is theoretically worth for a while. If you don't need to refinance or sell during that period, that's just unimportant. In cycles stretching back hundreds of years, real estate has always come back to higher prices than before, even accounting for inflation. The critical thing is to make certain you can wait it out.

Caveat Emptor