Case Study--Rent vs. Buy Help Needed

[Mrs. Healthywealth]

I've been through a short sale a while back.  Our credit is back to excellent, my wife work's per diem, and I plan to semi-retire by 45 (woohoo!). I'm so jaded from the last time I bought a house in California, this time I decided to see run it by the Mustachian's. Here it goes:

Market Value: $555K
Original Purchase price: $550K
Original Mortgage Amount: $495k
Interest Rate: 4%
Mortgage Term: 30 yrs
Term remaining: 30
Amount remaining on mortgage: 495k
Gross Rents: 2300-2500
Mortgage: 2100
PMI: about 250/mos
Property Tax: 600/mos
HOA costs: None

Some personal facts:

36year old married;
Current net income is $6300 per month
Current expenses: $3539 (this is us living it up);  Expenses w/ new mortgage: $4839
Debt: none;
-Currently we max out 457 and both Roth's, plus 10k/yr in spouse's 401k, $3600/yr in a 529
---Current rent: $1650.

We live in California, and home prices are increasing approx. 5-8% per mortgage broker.  Realtor told us that even though there is PMI right now, we can increase the interest rate to save $$ in long run, And since the house will go up in the next couple years, we can re-fi and knock out the PMI as a result. 

Questions: So is it worth us buying vs. renting in California.  I feel like the math doesn't add up, but each rent vs. buy calc I use is in favor of buying (I do 4-5% appreciation for the house, and 4-8% return on investments.)

Please help me figure out what I'm missing..thanks! You may say to wait till we get 20% down, which is what I was originally planning to do, only reason i'm even having this discussion is because realtor said how my 550k hm will become a 600k home in a yr, so it defeats the purpose.  I feel like i'm chasing after a moving target. Either interest rates will go up, or price of the home. Is it worth waiting for?

[JLee]

I've yet to see a realtor say "prices will go down" - they're selling you a house, so of course they're going to say values will go up. Your expenses will go up by $15,600 *net* annually, excluding any unanticipated repairs you may need. I don't think I would be buying.

[Mrs. Healthywealth]

I've yet to see a realtor say "prices will go down"

I don't trust anyone who is selling me a home, or working on a loan with me b/c in the end this is their bread in butter.  What's crazy is 550-600k is on the low end in Los Angeles County which makes me wonder, even if housing were to go down, would it fall like crazy in this area where we are so wonderfully densely populated?

So what's up with these rent vs. buy calculators...how is it that putting 40k into investments will not make me as much as in this California housing market, according to the numbers?

[Another Reader]

You have a short memory.  Prices fell last time and you went through a short sale.  If the overseas buyers pull out, the Los Angeles area market may drop again.  For $550k, you would likely be buying a long commute or the house has issues.

Your wife's work is per diem.  Not guaranteed if the market for her work changes.

If you can rent a nice house for $1,650, and it costs you $2,950 a month to own, that's your answer right there.  In your shoes, I would continue to rent, max out the retirement plans available to you, and continue to save a better down payment for a more favorable time to buy.

[Mrs. Healthywealth]

You have a short memory.  Prices fell last time and you went through a short sale.  If the overseas buyers pull out, the Los Angeles area market may drop again.  For $550k, you would likely be buying a long commute or the house has issues.

Your wife's work is per diem.  Not guaranteed if the market for her work changes.

If you can rent a nice house for $1,650, and it costs you $2,950 a month to own, that's your answer right there.  In your shoes, I would continue to rent, max out the retirement plans available to you, and continue to save a better down payment for a more favorable time to buy.

Haha, if I had a short memory, I would have already bought the house, upgraded my 9y/o car for leased BMW, and not asked others, outside of the people who were to profit from me, about it.  I'm in no rush, this is more me testing the waters.  I agree with you, her job is per diem, and she can lose it.  At this point, she doesn't have to work, but if we bought a $2950/mos house, the stress would creep in.  I appreciate your advise, I shared it with my wife.  I enjoy having a big cash cushion, I don't want the stess, and I like the flexibility of renting.  Buying a house for us, at this time, is unnecessary stress.  Even though we may be walking away from the $117k or more that we could potentially make in housing, the peace of mind is much more worth it to me. 

Also, I ran the numbers myself, and I only see housing winning if I make 6% or more off of it, which is possible in this market. But, I'm ok with potentially having over 300k in investments if I were to invest the $$ instead.

Thanks again, i'm sure my friends will think i'm crazy for still renting--which helps me know i'm headed in the right direction.

[Another Reader]

Real estate, even California real estate, is cyclical.  We have had a huge run up in prices, fueled by low interest rates and foreign buyers.  I don't see where the additional $117k in appreciation is coming from.  Folks that live in your market and work are already maxed out.   Financing is getting more difficult, not easier. 

I live in Silicon Valley and things are already slowing down here.  In your shoes, I would build up your cash down payment and reserves plus your other investments.  Wait until the market is soft and buy a house that's close to work and provides you with the location and other amenities you need or want. 

[Mrs. Healthywealth]

Real estate, even California real estate, is cyclical.  We have had a huge run up in prices, fueled by low interest rates and foreign buyers.  I don't see where the additional $117k in appreciation is coming from.  Folks that live in your market and work are already maxed out.   Financing is getting more difficult, not easier. 

I live in Silicon Valley and things are already slowing down here.  In your shoes, I would build up your cash down payment and reserves plus your other investments.  Wait until the market is soft and buy a house that's close to work and provides you with the location and other amenities you need or want.

Good to hear what's happening in Silicon Valley, and your overall perspective.  The 117k is what most of the calculators give me if the house appreciates 4-5% over the next 10yrs, minus all the expenses.

I spoke to the loan broker today, and he said that we qualified for a home up to 600k, but could qualify for more if my wife went back to work full time. I basically told him, I don't want my wife to ever feel like she "has to" go back to work, and i don't want to buy a 600k home that will be a fixer upper.  Next suggestion was to move further from the area--nope, i'm fairly close to my job. It's just too much $$ that i rather not spend.  I'm glad i mulled it over.  will return to happily renting, building a larger downpayment, and investing.

[Another Reader]

The math is clear.  It's the basis of the $117k increase that is missing.  Add $117,000 to today's price (better yet gross it up by adding back the expenses), bump the interest rate up a percent or two from the current mortgage interest rates, and calculate the mortgage payment on this house.  The income needed to qualify under that scenario is going to knock a lot of buyers out of the market, even after 10 years.  Cut out the cash buyers and you will have a completely different market. 

Prices don't increase forever.  The economy deteriorates, employment drops, interest rates rise, foreign governments restrict capital outflows.  Whatever the cause, the music stops, and a lot of sellers have no chair to occupy.  It's not "different this time."

In your shoes, I would do what you have decided to do.  Rent and bide your time.

[ShoulderThingThatGoesUp]

foreign governments restrict capital outflows.

Probably especially relevant to the California real estate market given recent Chinese wobbles and their willingness to try any terrible idea to keep a lid on things.

[Mrs. Healthywealth]

The math is clear.  It's the basis of the $117k increase that is missing.  Add $117,000 to today's price (better yet gross it up by adding back the expenses), bump the interest rate up a percent or two from the current mortgage interest rates, and calculate the mortgage payment on this house.  The income needed to qualify under that scenario is going to knock a lot of buyers out of the market, even after 10 years.  Cut out the cash buyers and you will have a completely different market.

I'm patting myself on the back that I actually understand this:)  It's so true.  When I was doing the math, in 10 yrs the gross equity would make a 550k home, that's a fixer upper, into a home that is close to 1million which is crazy

Prices don't increase forever.  The economy deteriorates, employment drops, interest rates rise, foreign governments restrict capital outflows.  Whatever the cause, the music stops, and a lot of sellers have no chair to occupy.  It's not "different this time."

This explains a lot.  You peeked my interest in economic cycles related to the housing market--linear vs. cyclical.  This was a great article I found on it, and it discusses CA and the boom/bust cycle it repeats. Here's the link:

 
http://www.noradarealestate.com/blog/linear-and-cyclical-real-estate-markets/

[Mrs. Healthywealth]

Probably especially relevant to the California real estate market given recent Chinese wobbles and their willingness to try any terrible idea to keep a lid on things.

Good food for thought.  Thanks for the input.

[cchrissyy]

You can't count on being able to refi in a couple years to get rid of PMI.  Of course your loan person is saying it, because they get paid now if you buy, and may be paid again later if you refi.

but the fact is
- rates could be higher then, making it a bad move
- appraised value may not rise fast enough to help you on this
- your personal finances may not qualify you for the refi at that point in time


I actually DID do this, I'm in northern CA and had put 10% down, refinancing 18 months later to get rid of PMI and a slightly lower rate. But I was lucky the timing worked out right and the value had risen enough while rates had not.  And qualifying for it very nearly didn't work, due to divorce and becoming single income soon after the refi.

[clarkfan1979]

If you can rent for 1650, keep renting. Its a no-brainer.

[Mrs. Healthywealth]

I was looking at http://portfoliocharts.com/ and playing with the portfolio calculator.  It seems if I added REIT's to my allocation it will increase my sustainable withdrawal rate. 

Given that we are going to rent, at this point who knows how long, would you recommend just keeping the money in a savings account for potentially 3-8 yrs, or would you allocate it to REIT's, or stock market? 

I'm thinking I know theanswer, but since you have various perspectives, I would like to know what you guys do.