How to take advantage of the next dip in the housing market

[IrishMustacian]

I live in a high cost of living area. I have not yet reached this conclusion, but for the sake of this discussion suppose I would like to buy a house here at some point in the next 10 years, but that I am fairly flexible on exactly when I buy it within that period. I would ideally like to wait until the housing market, which is currently extremely expensive and has been increasing around 10% a year for quite a long time, drops significantly. My question is, how should I prepare to be in a position to take advantage of a big drop in the housing market, given that I have no idea when it will happen?

My main dilemma comes from the fact that I would need to have a significant down-payment - I guess it would be on the order of 100k even after a big drop in the housing market. Currently almost all of my savings are invested, and if there was a big drop in the housing market I would expect a similar drop in the stock market, making it far from optimal to sell 100k worth of stock for a house down-payment. I could alternatively just stop putting money into the stock market in taxable accounts during the downturn until I have the 100k for a down-payment, but then I would be missing out on buying stock for cheap, and maybe the downturn would not last long enough for me to save up the 100k (it would take me around a year). Lastly, I could just keep 100k out of the market at all times, but then I would be losing out on the potential gains on that money for up to 10 years - which seems like the worst option.

All of this assumes that I would keep my job in a downturn, which is a pretty big assumption, but lets just assume I don't get let go for simplicity.

[cl_noll]

Posting to follow mostly, since I have little experience in the matter and I'm in a similar situation, except more mcol city with a below-average income.

My strategy thus far is to allocate about 20% of my savings into bonds, where it's "safe".  At which point liquidation during a recession doesn't come with the psychological baggage of selling low. But, maybe I'm doing it wrong?

The other logical scenario is to not try to keep up with the Jonses, retire earlier with your big-city earnings and then move to a medium/lower cost area.

[YttriumNitrate]

Well, in 2009/2010 how much of a drop was there in your housing market?

I was rather surprised how sticky housing prices can be in a declining market.

[IrishMustacian]

The other logical scenario is to not try to keep up with the Jonses, retire earlier with your big-city earnings and then move to a medium/lower cost area.

This is possible, but I am more of a FI but not RE kind of a person (I have what I consider to be a dream job in research), so provided I can keep the job I have (which essentially means that my area of research continues to be looked upon favorably by industry) I can see myself wanting to stay in this HCOL area.

Well, in 2009/2010 how much of a drop was there in your housing market?

I was rather surprised how sticky housing prices can be in a declining market.

This is true - it looks like median house prices in my area dropped after 2008 by around 25%, but they are currently a lot more than they were at the peak in 2008 (in 2008 peak the median price was 420k, now it is 700k). This is all according to the first source I found when searching which may or may not be accurate.

[frugaliknowit]

There's no way of knowing when and if a price drop will occur.  You should estimate what your down payment will be and put it aside in a separate conservative level of risk fund, such as a balanced fund.  That way, if you NEVER buy a house, the funds should grow ~5 or 6 percent.  When the stock market cycles down, the balanced fund probably won't drop more than 20%.   

If you go this route, you would either save up the 100K in the new account over time or transfer funds out of higher risk funds.  If you are pretty sure a purchase is imminent in the next 2 years or so, you might want to go more conservative than 50/50 bond/stock.

[Slee_stack]

Don't try to time anything.  I mean you COULD get lucky.  Are you feeling lucky?

You say you may never wish to RE.  If that's true, why would you need to time any real estate decision.

Invest slowly and steadily and diversify.  Buy at the time it makes most sense for YOU to buy.  Maybe that's if/when its cheaper than renting?

Ten years is plenty of time for a bust or a further bubble...or multiples of either.

[Scortius]

Housing prices generally don't decline much in HCOL areas as their prices are strongly propped up by limited supply. They are somewhat insulated from a short-term dip in demand.  Housing prices will drop precipitously in areas with an overabundance of cheap manufactured houses (think outskirts of Phoenix) as those markets are determined more by the need to sell a high volume of cheap houses quickly as many extended housing projects are highly leveraged.

[mm1970]

Housing prices generally don't decline much in HCOL areas as their prices are strongly propped up by limited supply. They are somewhat insulated from a short-term dip in demand.  Housing prices will drop precipitously in areas with an overabundance of cheap manufactured houses (think outskirts of Phoenix) as those markets are determined more by the need to sell a high volume of cheap houses quickly as many extended housing projects are highly leveraged.

This depends greatly on the market and the supply of people who can buy houses.

The last housing crash hit Santa Barbara pretty hard.   "Starter homes" 2BR 1BA in a bad school district - on my street, for example, a house that is dated and may need a little work but not a teardown:
- Peak 2006: $859k (house next door)
- Trough 2011: $490-500k (other house next door)
- Right now: $875-900k (based on recent sales/ listings - one recently sold for $930k down the street, but it had been remodeled.  950 square feet.)

Peak to trough was a 42% drop.

"It will never drop like that again".

maybe not, but if it does, I'm buying another house.  If it hits ~$600k mark.

[mozar]

What I did was when the housing prices went down I diverted my paycheck savings from investments for a few months to cash for a downpayment. I'm assuming that you have a very high salary if you are considering buying a house where 100k is 20%.

I bought my house for 118k and the previous owner bought it for 190k. But I ended up buying in a different area than I was originally thinking because even though houses were "on sale" every other investor knew that as well and I kept being beat out by all cash offers.

[affordablehousing]

I think you are asking two questions-
1. Where to hold your investments such that they are completely uncorrelated to housing prices in your area?
2. How to identify the trough?

As for 1. we saw with the last crash that things are more correlated than folks imagined. I think if you diversify, that's your best bet. Start holding more cash say when you get within 8 months of wanting to buy.

As for 2. so hard to identify it. I think it's really important to consider when and why you really want to buy a house. It's SOOOO much easier to invest through REIT's, hard money lending, equity funds, etc. Buying a home for your family is an emotional purchase and you live with it longer. Way easier for the casual investor to buy a house based on when they need to live somewhere.

Logic is tough. Interest rates have risen 1%, and yet in the bay area housing prices also have risen over the past 6 months. Go figure.

[haflander]

PTF. I am in a very similar situation and have thought about posting this very ? before; OP worded it better than I would have. My area is more MCOL but the rising of home prices is similar, as well as the madness of buying homes. ie, I've never been in the market but hear from everyone else that they are constantly outbid by those offering above asking price and all cash.

I'm not yet in the position to save for a DP (new and young Mustachian), but previously I was of the mindset that I would save for a DP in the highest guaranteed rate bond I could find, maybe I bonds. However, as I'm learning more about funds and investments, it sounds like the balanced fund as mentioned by @frugaliknowit would be the smarter option. I wouldn't have guessed that it would only dip 20% in a recession...that would make it a no-brainer. I'm guessing that a good example would be VBINX.