Is It Too Late To Buy Real Estate?

Who knows? No one really knows. Not even your real estate broker otherwise they will be rich by now. No one can predict the future. Not even The Oracle of Omaha. Without a doubt, he is the most brilliant investor of all time, yet he did not take advantage of the internet boom. What do we know? Well, risk and reward go hand in hand. The bigger the risk, the better the reward. We also know what goes up must comes down just like the stock market. So is it time to buy? Ask you father and he'll say buy now, so you don't have to live with him. Ask you uncle and he'll say "you should've bought it three years ago when I told you to." Ask you friend and they're as confused as you are. Everyone has their own opinion.

Looking into the real estate market. You kick yourself for not buying that apartment you like a few years ago. Now that same apartment is too expensive. But wait, that's what you said back then? The market is not slowing down and you know it. Last year Fortunue magazine said there is a housing bubble and it's going to burst. Fat chance. The real estate market is unstoppable. During the good years of the Clinton's Administration, the RE market steadily climbed. Despite a slumping economy, corporate scandals, highest unemployment rate in decades, war in Iraq and the terrorist attack, the RE market continued to steam roll them all. So what are we waiting for? Is the bubble ready to burst? If so, you could be stuck with a huge mortgage. If not, you could be stuck living with you parents or stuck renting possibly forever.

Ok, so you're young and brave and want to invest in real estate now. Not so fast. Lets considered the interest rate factor. This is Alan Greenspan's weapon of choice. This could be the thing that can slay the beast. Lets analyze how this work. We have seen studio going from $100k to $200k with a few years. Will it double to $400k within the next few years? If you think like the Oracle of Omaha, aka Warren Buffet, you doubt it. The reason he didn't buy into the stock market back then is because the P/E ratio of those stocks where well above 100. There is no justification for such prices. Meanwhile in real estate market, there is some justication for the recent increase, but the end is here if the interest rate goes higher.

The price of a house represents how much a person makes. Well duh. Let me connect some more dots. How much a person makes will determine how much they can afford. Their affordability is what determine their bank loan which in turns allow them to bid. Now lets say when the interest rate was at 8%, a couple can afford to bid 400k for a house since they can afford a $3000 monthly payment. They got the house and a few years later that same couple decided to move and sell their house. The 2nd couple came along and could also afford $3000, saw it and bid $500k. The first couple made out with $100K. However at a 5.5% rate the mortgage payment is only $2838 for the 2nd couple vs $2935 for the 1st couple!! This is the main reason (not the only) why people think real estate is going up. It's really the interest rate that is making the house more affordable. When the 2nd couple decide to sell their house down the road when the rate is back at 8%, they will only break even at 500k if the 3rd couple can afford $3668 a month. If they want to sell at 600K, the 3rd couple will have to be able to afford $4400!! Here you can say someone rich will come along and buy it. Well, all the rich people will have to buy up the entire neighborhood because when the appraiser/bank comes by to appraise the house, he'll say this house doesn't worth 600K. It'll worth as much as the other 100 neighboring houses. So unless everyone's income jump drastically, which is possible if there is another internet boom which is unlikely, most couples income will remain the same at $3000. At an 8% interest rate, they can only afford to bid $400k for the same exact place.

That is how RE works. As we all know, everything that goes up, must comes down. People's income will increase overtime, but ultimately the RE market is dependent on the people's income and combine with interest rate will determine their affordability. Essentially the RE market can only go up as fast as the raises their company gives them. So how was the jump from a $100k studio to $200k studio possible? Since the price is relatively low compare to a house, I can assure that the buyer at 100k income to debt ratio is higher than the one who purchased it at 200k. During the internet boom, the economy was good, a lot of people were making a lot of money through their job, business, stock market and were able to raise the RE market. Most people no longer have money in the market now, i.e. NASDAQ went from 5000 to 2000, and those savings were probably used to fund the real estate market. However, as reported by various sources, many home buyer's are stretching their income thin. Many people income to debt ratio is about 3:1. So the the same house that the sample couples bought which jumped $100k, the 2nd couple actually pay less per month then the first couple. In that example the real estate for that house didn't actually go up in value. It is the interest rate that allow the 2nd couple to afford a bigger loan, but have the same mortgage payment as the first couple.

So it is too late to buy real estate? It's never too late to buy since owning is still alot better than renting or living with your parents. Is it too late to invest in real estate hoping to get the same kind of gain you're used to seeing? If the interest rate moves upward, yes. The fed has cut interested numerous times these last few years and they're ready to increase it as the economy is picking back up.