The interesting thing about commerce is that it is pretty simple. The value of anything is what someone is willing to pay for it. Whether it’s a baseball team, a bitcoin, or a stock, this is just the way it is. Some things may have more intrinsic value because they produce an income stream — a business or a dividend paying stock, for example. Some things may have more expected value because you may be able to grow that income stream, for example a vacant shopping center. But the price for stocks and businesses are still set by buyers.
So let’s take feelings out of our decisions, and for a moment, look at a decision that may need to be more pragmatic. The value of your home is what someone is willing to pay for it. In the fake science of home buying, you can look at comparable home sales, replacement costs, average time to sell or any other measurement you want. These statistics may hold some value, but the bottom line is that the person who wants your home may have a price in mind that doesn’t match the one you might want or need.
I think this is going to be a more important time to be pragmatic because there are going to be a couple of factors that are going to shrink the home buying pool across virtually all sectors: the new tax law and potentially rising interest rates.
People who are home buyers are looking at things that they can afford. They may reach, but everyone has their limits. The new tax law has reduced what people can afford, although they may not realize it yet. Taxes influence behavior because we can be steered into doing things because of perceived tax benefits. Now that the standard deduction has been increased for those who itemize their deductions, the value of the mortgage deduction has been reduced. Property tax limitations also have made ownership more costly. Lower tax rates also serve to decrease the value of tax deductions. In other words, the government has made a decision to reduce its support for homeownership by limiting the tax breaks. Disregard whether you think this is good or bad policy, just understand that this policy will have consequences.
Rising interest rates have a secondary impact because as the cost of borrowing goes up, the amount of a mortgage that we feel comfortable servicing drops. Simple math. If interest rates go up by 1 percent, our interest costs on a $200,000 mortgage go up by $2,000 a year. It doesn’t mean that our payment goes up, because banks and mortgage companies can help you be creative with loans. But the costs are the costs.
Reducing tax advantages and increasing borrowing costs don’t guarantee that home prices are going to fall, they just make it more likely that they will do so. Buyers will eventually adjust to these higher costs by substituting renting, remodeling, inertia, or lower-cost housing. This means that people who need to sell their homes because of relocation or life changes, or because they bought using an adjustable-rate mortgage and can’t meet the new higher costs, will naturally set a lower price for their place so they can sell the home. People who sort of want to sell but don’t have to do so may maintain their price for a while, which creates a false sense of price stability. Price drops are generally not a fast process. People are anchored on what they feel their homes are worth and don’t adjust their price expectations downward as quickly as they do upward when markets are strong. I’m not predicting a housing collapse, just a general softness and downward drift.
There are some conditions that create exceptions. Scarcity is one. If your home is unique because of location, desirable features, or price, then you may get your offer. A booming economy may be another. If a bunch of jobs are created and there is a shortage of living spaces, you may be in a microclimate for housing. Maybe a stock market that continues to rally will create a wealth effect making consumers wiling to pay more for homes.
But if those conditions are not present, then I would have a plan. Here are some things to consider:
If you are pretty sure you want to sell your home and either rent or move to another city, now is the time. The markets are slow to react to react to these pricing forces, so you have a little bit of a cushion on your side.
If you are likely to be moving in the next three or four years and you don’t own, don’t buy. Time can heal buying misfortunes, but if you don’t have time, then you need to get things too right for buying to make sense.
Understand how the tax laws impact your real cost of homeownership. Be sure you understand the real after-tax costs of owning (the only benefits are those that are above the standard deduction). Also, understand the other costs of ownership — maintenance, insurance, etc.
Remember that a home is like a car, not a stock. It may not appreciate, but it can give you psychological benefits that outweigh the financial ones. If those are what matter the most to you and you can afford it, then don’t be disheartened by what happens to your balance sheet and thoroughly enjoy what you have.
Ross Levin is the chief executive and founder of Accredited Investors Wealth Management in Edina.