Why It Makes Financial Sense to Buy Now

A BUYER’S STRATEGY FOR “TIMING” THE CURRENT

ESTATE MARKET

By: William Peterseim, CFP, CMFC

CEO of Big Apple International Realty

Most of my adult life has been devoted to assisting people in buying or selling some form of property. This has included their personal residences and all forms of investments in my various capacities as real estate agent, broker, licensed Securities Rep, stock broker, and Certified Financial Planner. I have performed these functions in good, GREAT, and really bad markets. Through it all, I have seen many common “threads” in the rationale employed by Buyers in making these decisions and I have helped explode many myths related thereto.

I believe the 2008 real estate market is ripe for sharing this considerable experience with potential Buyers to assist them in making the most prudent decisions on such a major purchase (and life changing investment) as their personal residence or investment property. So, let’s begin.

In the next few pages, I’m going to summarize for you the root causes of the current real estate market, the trend, and my forecast. Then I’m going to explain market issues not generally known or discussed by the media that can help you best “time” this market for buying. I will explain the multiple benefits of ownership and for buying now and conclude with my recommendations based on these facts and likelihoods. In doing so, I hope to assist you in making the best, most profitable decisions in acquiring real estate, over the long term. It is up to you to put what you learn into action. Good reading.

As stated, these will be summaries. Should you wish to learn more about how they were developed, at the end you will be given a means of accessing the complete article detailing events and backgrounds of all that has developed in different industries and economic sectors to get us to this point. Now, for the summary.

1. It is important to note that while every Buyer strives to purchase at the absolute bottom, he or she is no more successful in that endeavor than every Seller who seeks to sell at the absolute top. Both are on a largely unattainable quest. Some will hit it, but only by accident, and won’t know that they have for some time.

2. The reason for that is that the absolute tops and bottoms of any market are historical facts. That means that they are only proven to be the tops or bottoms by events occurring both before and after, so they are not known to be those extremes at the time “the trigger is pulled” on the purchase or sale. Therefore, neither Buyers nor Sellers should get overly focused on hitting these marks. Those that do will often pay a price for waiting too long.

3. It is of little actual importance in the long run as to whether a Buyer or Seller hit their low or high. What really matters is how they do in the long term, or with the particular transaction. Were they profitable or, in a bad market, timed poorly, can they get out with a minimal loss?

4. In cyclical markets, where we do look for directional change in trends, just “getting close” to the bottom or top is what counts and what you should shoot for. This is our current market.

5. In a prolonged market making “a run” you will not be entering or looking for the bottom, for it has long since passed. That’s not the issue. You are purchasing on a “momentum play”. A lot of money can be made if you don’t wait too long to enter that run and if there are no signs of the trend ending or stalling or reversing any time soon. This is the market we had from 2002-late 2005. The warning signs developed in mid-2005 signaling a time to back off any buying and sell any property having been purchased for short-term speculation. This is not our current market.

6. There are two major factors that go into the long-term cost of ownership of real property. They are the price paid and the finance terms, particularly the interest rate. An additional, though somewhat minor factor, are the tax benefits of ownership. Of the three factors, by far the most important is the interest rate. In the current market, ironically though, it is getting the least attention by prospective Buyers. This, I believe, is a serious oversight and error.

7. Most recent Buyers and prospective Buyers have little or no knowledge of the historical swings in interest rates. Few know, for instance, that until the past decade, most of the preceding 3 decades mortgage rates were over 9.0%, roughly 50% higher than today’s rates. For several years in the mid-1980’s, mortgage rates ranged from highs of nearly 20% gradually trending down to 12%. These are rates 2-3 times current rates.

8. The only prior periods where real estate prices fell were accompanied and actually triggered by record high interest rates. You can easily understand why a Buyer wouldn’t buy at 18-19% when the interest alone on a $ 200,000 property would cost $ 2,000/month more than today.

9. Interest rates are determined by The Federal Reserve and, since 1979 their motivation to change rates follows two guidelines. They usually raise interest rates to cool the economy when they become concerned over even the threat of rising inflation. They decrease interest rates when they don’t consider inflation a factor and the economy is showing signs of weakness or perhaps falling into or already in a Recession. This is done to stimulate the economy. Although The Fed targets short-term overnight rates that banks charge other banks, the ripple effect alters long-term mortgage interest rates as well in nearly every case. And that impacts both new Buyers and those holding Variable Rate loans. To help the economy, The Fed has cut rates 7 times since August 2007. Overnight rates are at 2.0%, a rate not seen since 2004. Prime is 5.0%. However, The Fed decided in their just concluded June meeting to halt further rate cuts over inflation concerns, signaling their next move will be an increase. Therefore, we are NOW likely at the bottom of this rate cycle marking an great entry point for buying real estate.

10. The economy is gradually weakening today, but nowhere near the pace or degree as a politically biased news media has been telling the American public for over a year. In fact, until fall 2007, our economy was running at a near record unsustainably high pace while certain candidates and the media that likes them told the public just the opposite. Gradually, they put fear into enough consumers that the Consumer Confidence Index maintained by The University of Michigan began declining. As the media gleefully reported this (having directly contributed to it) more consumers became pessimistic and fearful and both stopped buying and drove the Index lower. This is important because our economy is 2/3 driven by the consumer. So, the economic decline has been largely brought about by candidates seeking office and the media trying to help them. This violates what “news” is supposed to be and do. It is to report the news, without bias, not make the news by influence. On June 24^th the Index hit its lowest point in 16 years.

11. We have been told by these same people for about 9 months that we are IN RECESSION. The fact is we are not. The classic definition of Recession is: Two consecutive quarters of LOSSES in the GDP (Gross Domestic Product) the international measure of a nation’s output. To date, in late June, we have yet to have even ONE negative quarter. In fact, a report released moments ago shows an actual increase in GDP growth for the first quarter of 2008 and stronger than projected. The 4^th quarter of 2007 showed growth at a mere 0.6%. First quarter growth had been forecast to be 0.9% but actually hit 1.0%.

12. Still, these factors are important as they have led The Fed to repeatedly reduce interest rates 7 times since August 2007 until now to help keep the economy from going into Recession and, should we, to moderate the depth and length of that Recession. That is why you have currently great, relatively low mortgage interest rates, fairly close to historic lows.

13. However, dramatically soaring oil and gas prices are taking their toll everywhere. They are contributing, more than any other factor, to the slowing economy and may yet spawn a Recession. Consumers are pinched and curtailing other normal spending to accommodate the drain on their disposable income due to paying often more than $ 50/week more for gasoline. The pinch will increase when we enter the fall heating season. We’ve cut back on travel, dining out, and other non-essential spending, all of which hurts the economy and costs jobs.

14. Inflation is rapidly becoming a serious factor with some near-record increases particularly on food essentials, again, due to oil prices. The average food item on your plate traveled 1200 miles to get there and with diesel at $ 4.79/gal and higher, your food costs are soaring. Removing the volatile energy and food components, “core inflation” still grew at a 2.8% annualized rate higher than their 2.0% “target” and helping justify future rate hikes.

15. So, The Federal Reserve is concerned. As previously stated, they left interest rates alone at the June meeting, but will likely start raising rates shortly to combat inflation. That’s their “model”. Sadly, I feel it doesn’t apply in this instance because, despite political rhetoric, we are NOT controlling the price of oil. That’s an international supply/demand issue complicated in the short term by speculators. So, we shouldn’t be punished by higher interest rates designed to curtail inflation when the inflation is caused by external factors beyond our control.

16. The only things Congress COULD do to drive oil prices down they refuse. The same party that blames the current Administration for high oil prices took control of both houses of Congress 17 months ago with the promise they would cut gasoline prices from $ 2.00/gal to $ 1.00-$ 1.25. Instead they have overseen the doubling of prices to over $ 4.00 in a record short time. But, no one seems inclined to hold them to their promise or vote them out of office or recall them.

17. What Congress can do, and you should contact your Congressman and Senators and tell them to do it, is to pass the new Energy Development Bill and allow the U.S. to develop and process billions of tons of shale oil out west; and to be able to resume drilling offshore; and to open Anwar in Alaska, as was provided in the Bill that created the Alaskan Wilderness Preserve in 1959. Presently over 90% of our areas off shore are forbidden by Congress to drill, yet the communist Chinese are now drilling less than 75 miles off our shore with leases through Cuba. If we are permitted to develop our own resources, the U.S. can once again become self sufficient on oil and stop sending our money to anti-American dictatorships in Venezuela and The Middle East. This, in turn, will relieve the most egregious cause for inflation and enable The Federal Reserve to hold down long-term mortgage interest rates thus lowering the cost of home ownership and help contribute to another boom in both real estate and the stock market.

18. It is important to know what “triggered” the current market pull-back. A “speculative bubble” formed in real estate due to euphoric, unprecedented price increases in the market from 2002 to late 2005. This was caused by the bursting of the “speculative bubble” in internet stocks in the stock market in March of 2000 that lasted 3 years. When investors realized it wasn’t just another short-term “Correction” (a relatively short-duration market decline of 10%) they began exiting the stock market. Many investors looked at real estate as the next place for their money since real estate and gold are the two historic “safe havens” in times of panic. Gold has experienced a strong run-up due to that move and has seen it sustained as the Dollar has fallen to near-record lows. Again, in the current currency devaluation, historically money would be flowing more into real estate than into gold, but it is not, due to the concerns over the Sub-Prime lending and a currently descending real estate market.

19. So, it is also important to realize that the 3 year nightmare in the stock market wiped out more wealth than the entire National Debt at the time, over $ 7 Trillion. The money that subsequently poured into real estate came in unprecedented amounts and within a short time frame. This spawned rapidly-rising prices and a strong Seller’s Market and led to increased speculation in real estate and “flipping” properties. It worked for a while as did the run up in Tech Stocks. Eventually all markets stop to catch their breath and consolidate after long upward runs. Nothing goes up indefinitely. So, real estate has been coming down to adjust to more realistic pricing. Just as then Fed Chairman Alan Greenspan’s remarks about the stock market’s “Irrational Exuberance” triggered that collapse, so did the FNMA decision to “head off” a real estate speculative bubble by instructing the 5 companies that sell Private Mortgage Insurance to place strict limits on what owners could sell their property for if they attempted to do so within certain time frames FNMA established. This was enacted in late September 2005 and converted a strong Seller’s Market into a strong Buyer’s Market in record time. In typical government fashion, FNMA had waited far too long to take action and then took action highly unfair to the unwary who had just purchased with one set of rules only to “have the rules changed in the middle of the game”. The speculative bubble they sought to avoid had already clearly formed and all they did was bust it, thereby accomplishing the very thing they sought to avoid. Great job, fellas!

20. What has further occurred to hurt both the housing market and the stock market has been the revelations a year ago of the abuses by some mortgage brokers in the use of Sub-Prime loans and in falsifying other standard mortgage applications. Their actions resulted in many truly unqualified Buyers (Borrowers) obtaining loans, often at high interest rates and poor structures that could not be properly maintained by those Borrowers over time. This, in turn, has led to record foreclosures the likes of which have not been seen since The Great Depression of the 1930s. In fact, some of the same factors that produced those foreclosures have led to the current round. So, as to structuring loans you need to consider the following:

21. Variable Rate Loans were created to help Buyers get into loans they might not qualify for at current HIGH rates, but which would become increasingly easy to maintain as interest rates DECLINED. They were instituted back in the 1980s when interest rates were around 12% for a Fixed Rate 30-year Mortgage. Going with a Variable in that market might get a Borrower in at 11.5% in a market that was definitely declining. Over the next several years, most of those Borrowers saw their interest rates decline to as low at 6%, nearly half of their entry point. THAT MAKES SENSE and is the wise thing to do in those markets.

22. The people who are losing their homes today got into Variable Rate Loans for the wrong reasons in an entirely wrong market. Sure they got maybe ¼% to ½% lower initial rate, but that was at historic, or near historic interest rate LOWS. The only direction those rates were going was UP. They tried to base their ability for maintaining those higher payments on getting big raises at work, never a “smart move”. Early this year, many of their rates started north, some by several percent and many have seen their monthly payments increase by $ 300 - $ 500. With the value of their home declining (due in large part to these loans triggering foreclosures) they too have walked away and been foreclosed or sold via a “short sale”. So, in addition to screwing up their own credit for perhaps 7 years, they have led to some institution failures and a descending real estate market. Perhaps it was ignorance or greed on their part as Borrowers, but much of the blame goes to the mortgage person that guided them in their decisions.

23. Never finance via a “Negative Amortization Loan”. I advised against this as soon as they were introduced. Here the payment is set initially artificially so low that even the interest isn’t covered so every month you go deeper into debt. Borrowers were told not to worry as the home price was going up so fast they would still build equity. YOU CAN NEVER GUARANTEE a rising price for real estate no matter how compelling the market stats look, any more than a stock broker can guarantee a stock or mutual fund’s performance in a bull market. Negative Amortization Loans gradually increase required payments and do so to higher ultimate levels than a fixed rate would generate. This is because by the time you have to cover everything and commence real amortization, you will have to pay off a considerably higher than original balance in perhaps 5 fewer years than originally. (An amortized loan makes payments against the mortgage balance with each monthly payment, eventually retiring the entire original loan by the end of its term). Amortized loans were developed in the aftermath of The Great Depression and following all of the foreclosures attending that period. Negative Amortization Loans are a recipe for disaster.

24. Except in rare exceptions on investment lots, do NOT finance your home purchase with an INTEREST-ONLY loan either. This is the only type of loan in existence when The Great Depression hit and the reason so many homes and farms were foreclosed. They were short-term, interest -only with Balloon Payments for the entire unpaid balance due at the end of the term. Most people couldn’t cover the balloon and lost the property. Many of today’s foreclosures are on interest-only loans.

25. Should they still be permitted, DO NOT finance a property with a Sub-Prime Loan. It’s just not sound thinking or finance. These loans are made to people with poor credit who have poor credit because they haven’t learned life’s lessons on how to properly manage the “trust” issue that comes with borrowing other people’s money. So, as a favor to yourself, change your thinking, if you have poor credit. Act responsibly. Impose self-restraint and self-discipline on both your spending and on the servicing of any current debt you have. Honor your commitments and you will be recognized for that and rewarded with better credit. Then you can qualify for a “normal” mortgage loan at prevalent interest rates. Doesn’t that make a whole lot more sense than finding someone who will wink, look the other way, and take your money and give you an interest rate TWICE that of the market, because you are a demonstrated BAD RISK? In most cases, if you didn’t demonstrate an ability to properly pay ON TIME a house payment based on a 6.0% loan, why should you or anyone think you will be able to make on-time payments on a loan at 12.0%? That defies logic. So, clean up your act, if need be, so you clean up your credit and qualify for the best and avoid the traps that can only hurt you.

26. Along these same lines, probably the best financing you can obtain in the short-term is FHA. Here your credit score is more important than your down payment. Also, qualifying for the loan is paramount, over the down payment. So, as a strategy looking ahead to buying and financing a home you need to first focus on making all of your payments on time. Next, avoid all but absolutely essential new purchases while you focus on paying off your existing debts. This is so you can qualify by meeting the Income to Debt Ratios for any type of financing. Once you have accomplished these tasks, getting the 2.5-3.0% down payment is relatively easy AND there is a new program available that will permit SOMEONE ELSE TO MAKE YOUR DOWN PAYMENT FOR YOU. But, you still have to have good credit and ratios, so there’s your game plan.

27. It is important for your understanding of the premise of this whole “timing” issue to also understand the other driving force affecting interest rates. Demand. Right now, demand is slack. Relatively few people are buying. The real estate Market WILL recover. That’s a given. The only questions are: Where is the “bottom” and how soon the recovery? In fact, it was announced today that sales of Existing homes increased 2.0%. So, it is important for you to understand that the recovery, when it comes, will also be a driving force raising interest rates. This is one reason why Donald Trump, considered by many as perhaps one of the wisest real estate investors, maintains that “The time to buy is when everyone else is selling”. This concept has been embraced by most successful investors in ALL markets, whether stocks, bonds, real estate, or commodities. The very reason so many people are in trouble today with their real estate and the reason the market has been as weak as it is, is because they violated this rule. They got caught up in the “hype” where EVERYONE is making BIG money and NO ONE wants to be LEFT OUT so they buy and buy. So, it should be no surprise to you that when that situation develops….when everyone is buying at a frenzied pace….the end (the top) is near, and the fall from that peak may prove precipitous. You DON’T want to be selling AFTER the peak, as so many discovered by the summer of 2006. They were listing their property based on old numbers and couldn’t or wouldn’t reduce their prices fast enough to keep pace with the free-fall of market prices. They would’ve received a lot more in most cases selling AHEAD of the peak into a buying, not selling, frenzy. Again, that’s when the Trumps of the world were unloading their holdings.

28. Now, here’s another important factor to understand. In my opening remarks I stated that everyone wants to hit the absolute bottom on both price and interest rates when purchasing and financing. So, you need to understand this in light of everything you’ve learned up to now: The price bottom will rarely if ever coincide with the mortgage bottom and, again, neither are known until AFTER THE FACT. Since the interest rates have a greater impact on the “carrying costs of mortgage financing” than does price, it’s more important to “get it right” with the finance terms.

29. I believe the market has not hit the bottom price-wise. But, I also believe in many markets, we are close. Time-wise, I believe we will bottom and turn around and start seeing prices increase pretty much across the board about this time next year. When that occurs, prices won’t “soar” because once owners see the market improving, more of them will become Sellers and doing so will retard the acceleration of prices. So, I believe we will return to the current price levels within about two (2) years. For the next concept, it is important to note this major difference: When we again hit current prices, the price TREND LINE will be positive, that is prices increasing as opposed to the current negative Trend Line with prices gradually declining.

30. Because of that, the overall improving real estate market will be moving back to normalcy. That, in turn, will drive the economy strongly, reversing any softness therein that may still exist, though it is unlikely the economy will still be soft or in Recession in two years. (NOTE: For three decades I have taught that “Real Estate is the vehicle that drives our economy and interest rates are the power-steering of that vehicle”). Based upon what I’ve written thus far, you should know that any impetus for The Fed to further stimulate the economy will be gone and their concern will have shifted to curtailing abnormal growth so as to control inflation. And, DEMAND for real estate financing will also pressure rates, so interest rates will likely be moving substantially higher. In fact, we may NOW be seeing the last of the really low mortgage interest rates.

31. Related directly to the two different markets: today and two years from now, we need to consider another major factor. Today’s market remains a strong Buyer’s Market. Two years from now as the market returns to normalcy, it will no longer be such. It will either be a weak Seller’s Market or a relatively neutral one in which neither party holds any real advantage over the other and both need each other, but not desperately. That is more the likely scenario.

32. As a result, today many Sellers are more than willing to help any potential Buyer secure their property. The Buyer TODAY is still king, but only for a while longer. Therefore, it is NOT an opportunity to be missed. The Sellers TODAY really HAVE TO SELL or they have withdrawn their homes from the Market to wait for better times. As such, they are HIGHLY MOTIVATED. Do you remember Sellers in 2005 in that strong Seller’s Market? Not fun people to deal with. They were arrogant and immovable. Some would get 10-20 offers in two days but hold off a week to get 30 or more to “entertain” taking only the gold-plated one offering $ 5,000 over Asking Price, all cash, 15 day Escrow, and no concessions. Is THAT the market you miss or long for in which to be buying? I trust not. Today, show the interest and be qualified and many Sellers will help you in unexpected ways to make it happen. Many will bend the already low price a lot lower. They might pay all or most of your Closing Costs, if permitted. And, the list goes on. My point is: THAT’S TODAY. When next we meet these prices you won’t have that same Seller mentality. A “normal market” will be one with limited negotiation, few real concessions, and everyone expected to cover their own costs. So, having a home’s ASKING PRICE the same as today may bear little resemblance to the end cost at Closing. You could be thousands of dollars ahead buying today verses then, and that’s before factoring for much more favorable financing.

33. Then we have the tax implications. As a CFP® I know that most taxpayers who do not own property with a substantial mortgage do NOT qualify to Itemize Deductions on their Federal Tax Return. Granted, the gradually increasing Standard Deduction does not mean you will see a dollar for dollar increase in your deductions from income for taxation by itemizing, but you should see a substantial increase. So, as you can deduct from your taxable income your mortgage interest and property taxes, there is a tax benefit to home ownership tenants do not receive. If you give to church or charity, those contributions are not deductible when using the Standard Deduction but are when you itemize. So, buying NOW instead of waiting two years would give you two years of income tax savings you will not obtain as a renter. Depending upon your tax bracket, the Federal Government is essentially helping subsidize your purchase and financing of a home or other real property.

34. Being an amortized loan, buying now will set you two years down the road toward pay off of your mortgage and will build some equity with each payment, again not obtained as a tenant. The argument that the home may continue to decline somewhat in value for the next year is really only relevant should you plan on moving within the next two years. If you do plan to move within that time frame, I do NOT recommend that you buy any home now but wait until after your move is accomplished or no longer a consideration. If you buy now and experience some short term decline in value, again, I expect the current prices to be revisited within two years, so any short-term decline would be reversed by then, making it a non-issue and you would still have the equity build up from your loan payments.

35. For those owner-occupying there is also the possibility that a lower purchase price today coupled with a short-term down trend could yield a Property Tax bill lower than one acquired by purchase of a comparable Asking Priced home two years from now, and that rate could be secured by Homestead Exemption with upside potential limited by provisions of that bill.

So, there you have it. 35 points to study as to why it may pay you to purchase your home or rental property TODAY in the current market, rather than waiting two years, or for things to noticeably improve. All of these points apply to someone looking to purchase investment property as well. For them, however, there is the added incentive to purchase now in that the rental market is strong, and they will likely capture two more years of rental income buying now, rather than waiting.

Please note that the rental market is strong as it is mostly because the vast majority of tenants do not know anything about the 35 points I just explained above and because the people losing their homes need a place to live. Now that you know, you have “a leg up” on the others. Feel free to share this information with others. Most importantly, though, you need to take action on your own.

This still doesn’t mean that buying anything now or even later is necessarily the best thing for you to do. This article should give you a greater understanding of everything related and therefore help you in that important decision. But, it is vitally important for you to check things out thoroughly and apply all you know to your personal situation. To that end, I highly recommend you call the good people at Big Apple International Realty and come in to talk about your personal situation and the market to try to better determine if the time is right for you. Ask for Greg or Peter. You can be assured of the very best treatment and information and never any pressure. They also have excellent contacts with some of the best, trusted mortgage people in the business who can further guide and assist you.

PLEASE NOTE: There is a new program available that enables Borrowers with good credit to dramatically accelerate both the buildup of Equity and the pay-off of their mortgage WITHOUT the need to refinance or make added mortgage payments “out of pocket”. This program can accelerate a 30-year mortgage to as little as 8-11 years. Two years from now, had you purchased now and put that program to work, you could have a lot of equity and as little as 6 years remaining to pay on your mortgage.

In closing, I will now summarize by bullet points, the entire article so you will have a ready reference. Thank you for taking the time to read this valuable information. Best to you. –I’m Bill Peterseim, CEO

SUMMARY

So, the major points determining the value of purchasing today are:

While there is still some price decline in the immediate future, most of the decline has already taken place, so that future decline will be fairly minimal;
It is an exercise in futility to think you will catch the absolute bottom of price or interest rates;
It is far more important financially in the long term to just be relatively close to a bottom. Prices in late June 2008 have just descended to prices last seen August 2004 and those prices are not much beyond “normalcy”;
It is far more important financially to be closer to the bottom of interest rates than to price;
By the time we next see the current prices in roughly two years, the market will have bottomed and be in recovery placing you on a rising, not descending, price trend;
By the next time we see these prices, that recovery and other external factors such as concerns of inflation will have driven mortgage interest rates higher than present, perhaps considerably higher;
By that time the market will have shifted from the current strong BUYER’S Market to a neutral to slightly Seller’s Market and your ability to negotiate optimal terms, price, Seller-Pays and other concessions will have largely vanished;
As the market recovers, inventory will shrink, and your selection will diminish;
Buying now will give you two years of equity build up from loan amortization; Any erosion of equity due to the intervening decline in price will be erased as prices return to current levels and you will have avoided two years of lost rent payments;
Buying now will give you two years of savings on your Federal Income Tax as you can finally justify Itemizing Deductions and can deduct most of the cost of ownership such as your mortgage interest and property taxes which comprise, for most Buyers, over 90% of the monthly mortgage payment;
There are attractive programs now available that can enable a Borrower to accelerate their 30-year mortgage loan to as little as 8 years without making additional direct out-of-pocket payments on that mortgage. Buying now, in 2 years you might only have 6 years remaining on your mortgage loan and have built a huge amount of equity;
Buying now and utilizing the Homestead Exemption may result in a lower long-term Property Tax on your owner-occupied Principal Residence.