Wednesday, October 15, 2008

Is it the wrong time to buy a house right now?

We've been looking to buy a house for some time. Already, being in Bay area, we were expecting to pay a huge premium for what we get. With the financial meltdowns, it now seems probably the worst time than ever to buy.

I was trying to assess where housing prices will go in the next year. Will the next year be a better time to buy than now? There are a few things to think about that cautioned against it:

1. US Dollar might weaken as confidence of foreign investors plunges. If lending and credit freezes up, as it has, and doesn't start flowing again, it is going to take a while for the economy to rebound. If the dollar weakens, if the houses are really worth what their price tag indicates, then the prices should rise.

2. If the funds in the bank are going to be either not covered by insurance, or are going to go less distance, maybe it's worth it to invest them in something more tangible, as in land or gold.

On the other hand, if the dollar does weaken, then affordability would suffer in general. Any large loans that people would have taken out would become increasingly difficult to pay.

I tried looking for some historical data for how house prices changed over the years in comparison to how the economy was doing. I couldn't find much yet, but there was one interesting data point -- how housing prices varied as a ratio to median household income. Here is a spreadsheet detailing the trend from 1980 to 2007. Historically, in the bay area, the ratio has been stable around 4 to 5. In the last few years, it has risen to a 9.8!

Based on the experience from the downturn in 2001, incomes won't go up in the next year or two. This is true now as well -- investors are sending out warnings and asking companies to tighten belts. In our company too, we have reduced our head count and decided to take pay cuts.

If I look at the years following 1980, the housing prices ratio to incomes should have probably gone up if the income was lower and there was any inflation. It was indeed so in 1981, but then the ratio dropped every year until 1985 when it reached 4.2.

In any case high housing prices outpaced the economy, and with the downturn in full swing now, the income levels aren't going to climb up any time soon. This means, the housing prices should be up for continued correction for the next few years, until incomes actually start to go up.

In conclusion, if the economy and dollar will be weak, affordability will suffer. Incomes aren't going up. House prices as compared to income levels are still inflated in the Bay area, and therefore will come down. If not, then poor affordability in this economy will anyway make it harder to afford these high prices. Therefore, it is probably not a good time to buy a house for us right now.


Subbu Subramanian said...

Yeah I would wait and watch. Prices are coming down, but I suspect will fall even more next year.

Ed said...

Location, location, location. I don't think my house has ever lost a dollar in 30 years. Financing is another matter.

Siddharth said...

Historically, the Case-Shiller index has had a slight negative correlation with the stock and bond market. But then again, correlation is not causation and this downturn could be different from the rest.