|Spring Real Estate 2005
Publication Date: Wednesday, July 20, 2005
Buying/selling in a bubble?
by J. Robert Taylor, J.D.
First of all let me assure you that this article is not any attempt to determine from some esoteric economic theory whether or not the current real estate market is in a bubble. Let's make the assumption that whether you are buying or selling that the tide is going to turn against you.
If you are a buyer assume this is a bubble, that is, that there is a likelihood that the market value of the property you purchase may drop at some future date. If you are a seller assume it is not a bubble, that is, that the value of your property will continue to appreciate.
Why the bubble should not matter to a buyer
1) Buyers should be buying real estate with a long-term objective of holding and living in that investment for many years.
2) Buyers should be locking in long-term, low interest rates. A failure to do this could lead to a forced sale of an asset you want to retain should interest rates increase significantly.
3) Buyers want their own home for intangible reasons of security, control, family and long-term appreciation. Those reasons don't change just because of a short-term fluctuation in the value of your home.
4) The current tax code provides significant tax incentives to own and mortgage a personal residence, including deductibility of mortgage interest, property taxes and relief from long-term capital gains tax on up to $250,000 of taxable gain per owner.
5) Buyers should only be buying if they can safely afford to retain their house for the foreseeable future no matter what part of the real estate cycle they purchased in.
6) Buyers should have at least 20-percent equity in their home. Buying with more leverage is OK as long as you have a plan for paying down the loans within a fairly short period of time so that you have at least a 20-percent equity position.
7) If you want to own a stock you can buy and sell it anytime you wish; however if you want to own a particular piece of real estate that opportunity may only come around once in your lifetime.
8) Real estate is an investment, one of the few things in the Bay Area that has in the long term always appreciated, thus making it an attractive option for diversification of your financial investments. We know from history that most of our personal property and cash declines in value over time. It makes sense to own something we can use that over time actually increases in value.
Exception: If you are a desperate buyer and are tempted to purchase a fixer-upper home in secondary location, think twice. Why would you want to make a huge investment in a location that most people would not even consider in a more balanced market?
Why the bubble should not matter to the seller
1) The need to sell is generally driven by forces that are somewhat out of our control. These are: death, divorce, job transfer, the need for a larger home, the need to move to achieve a family goal, disability, financial needs, and the like.
2) You don't have a crystal ball. If you are selling today in hopes that the market will later collapse and allow you to repurchase at a discount, where was your crystal ball in 1990 and 2000?
3) You should not sell unless there is a need that the cash from your home will resolve and that need is greater than the need to invest in real estate.
4) Based on history you will at some point look back and be surprised at how much the property you sold has gone up in value no matter when you sell.
Exception: If you own a property that you haven't maintained and is in a poor location then this is the perfect time to sell and do a tax-deferred exchange into real estate in a better location. <@endbullet>n<@$p>
J. Robert Taylor, J. D., a real estate attorney and broker for more than 20 years, is Palo Alto Realtor of the Year for 2004-05. He has served as an expert witness and mediator and is on the judicial arbitration panel for Santa Clara County Superior Court. Send questions to Taylor c/o Palo Alto Weekly, P.O. Box 1610, Palo Alto, CA, or via e-mail at firstname.lastname@example.org.