If you’re considering buying a home, it’s important to be aware of the current challenges:
- Soaring Home Prices
- High Interest Rates
- Low Inventory
Unfortunately, these issues aren’t likely to improve soon. However, with the right strategies, you can still successfully purchase a home. Here’s how.
Understanding the Current Market
Home prices have skyrocketed, with a 17% increase on average from 2020 to 2021 and an additional 5% growth each year thereafter. Over the last 12 years, home values have climbed steadily, particularly during the zero-interest-rate-policy era (ZIRP), when mortgage rates were historically low, fueling this rise.
Why are prices so high? The answer lies in simple economics: supply and demand. As reported by Freddie Mac, the U.S. faces a significant housing shortage due to various factors.
The construction boom pre-2008 faltered after the Great Recession, leading to stricter lending standards and legislative limitations on new developments. Thus, new construction significantly decreased from 2010 to 2020, culminating in a housing deficit.
The pandemic further exacerbated this issue, causing supply chain disruptions that increased material costs, particularly lumber, making new builds less feasible. At the same time, the work-from-home trend skyrocketed demand in specific markets, worsening the supply issue.
Inflation, which peaked at 9.1% in June 2022, has also inflated the cost of building homes, affecting both materials and labor, leading builders to hesitate.
Rising Interest Rates
In response to inflation, the Federal Reserve raised interest rates 11 times, setting the benchmark rate between 5.25% and 5.5% as of July 2023. These high rates, coupled with a majority of homeowners locking in rates below 4%, have led to a lock-in effect, causing the inventory of both new and existing homes to plummet.
What Can You Do?
Step One: Assess Renting vs. Owning
Determine if it’s more beneficial for you to rent or buy by calculating the price-to-rent (P/R) ratio for your area. This is done by dividing the home price by the annual rent. Here’s a breakdown:
- A P/R ratio of 15 or less indicates a great purchase opportunity.
- 16-20 falls in a grey zone.
- 21-25 is less attractive.
- 25 or more suggests renting is a better choice.
Examples:
- Slam-Dunk Purchase: A duplex priced at $300,000 renting for $1,500 per unit gives a P/R ratio of 8.33—an ideal ownership scenario.
- Grey Zone: The same duplex renting for $750 per unit results in a P/R ratio of 16.6, suggesting a more nuanced decision based on your circumstances.
- Avoid This Purchase: If the duplex rents for $500 per unit, the P/R ratio jumps to 25, indicating it’s better to rent.
Step Two: Make Your Choice
- If renting is better: Keep renting, but consider investing in rental properties elsewhere to diversify your portfolio.
- If owning is preferable: Focus on saving for a down payment. If saving takes longer than expected, consider house hacking by purchasing a multi-unit property to offset costs by renting out additional units.
- In grey zones or high-rent areas: House hacking can also be a strategic way to gain home ownership while keeping costs manageable.
Act Quickly
If you’re serious about buying, doing so sooner rather than later is advisable. Lock in a property at its current price because it’s likely that home prices will continue to rise by 5-6% over the next year.
Consider Mortgage Options:
- Fixed-Rate Mortgage with One Free Refi: This allows you to potentially refinance at a lower rate later.
- Adjustable-Rate Mortgage: Initially offers a lower rate, adjusting after a set time.
In summary, while the real estate market presents challenges, being informed and strategic can help you successfully navigate these hurdles and secure your home.
Feel free to ask for any further modifications or details!