The Home Buyer’s Dilemma: Buy Now or Wait?

If you are considering buying a home you are probably wondering, “Should I buy now or wait?” This could be a difficult decision to make and may depend on many factors both economic and personal. This article focuses on the economic factors rather than the personal; however potential home buyers would be wise to take a holistic approach in their decision to buy a home. Here I am only interested in analyzing numeric information for the purpose of creating a hypothetical range for the optimum point of entry.

By holistic I mean considering all the personal and financial ramifications specific to a buyer’s own circumstances, i.e. the needs of their family, their financial situation, and their personal tolerance for risk, as well as any other personal financial planning considerations.

So where might be the optimum point of entry?

I think most of us would agree that (assuming we were in the market to buy a home today) we would buy a property right now if we could buy it for what it would have sold for 10 years ago.

So let me pose this question, In most instances excluding some extraneous extraordinary circumstances, would you buy a property right now if you could buy it for the same price it would have sold for 10 years ago?.  If your answer to this question is “yes” than you would probably agree with the following statement, “The optimum point of entry in purchasing a property in the current real estate market would be between what it sold for 10 years ago and what it would have sold for at the peak of the market”.

Let us create a numeric example.  We have a home in a typical uneventful suburban real estate market that would have sold for $250,000 10 years ago and at the peak of the market would have sold for $500,000, an increase of 100.00%. Since the peak of the market the house has declined 10% in value and can currently be purchased for $450,000.

Let us assume the following: 1) $500,000 (price at peak) to be the hypothetical ceiling price for the property and 2) $250,000 (price 10 years ago) to be the hypothetical floor price for the property. In an attempt to narrow the range let us consider the rise in the cost of construction over the last 10 years. Assume that the same house would have cost $150,000 to build 10 years ago and that the same house would cost $300,000 to build today.  Let us further assume that the estimated land value 10 years ago would have been the market value of $250,000 less the cost to build at that time of $150,000. Hence the estimated land value 10 years ago would have been $100,000.

Here is a summary of our example.

10 Years Ago
Increase (%)
Price $450,000 $250,000 80.00%
Cost To Build $300,000 $150,000 100.00%
Land Value $150,000 $100,000 50.00%

So let me pose the next question, "If you could buy a property for the cost to build today plus the estimated land value of 10 years ago, would you buy it?".  I think most people would answer “yes” to this question, hence we have deduced a new hypothetical floor price of $400,000 (the $300,000 cost to build today plus the $100,000 estimated land value of 10 years ago.)

Here is an updated summary of what we have deduced so far.

Price at Peak $500,000  
Today’s Price
Hypothetical Floor

Now we are $50,000 below the high and $50,000 above our hypothetical floor price. 

Can we assume that the value of the property would never fall below our hypothetical floor price? The answer is “no”.  In fact during the early 1990’s there where many instances where housing values dropped below their replacement cost (cost to build).  However this may be the only way to evaluate resistance at that level.  The cost to build a home does not create an absolute floor price for any home’s falling market value but hypothetically may create some resistance at that level over the long term.  In addition you must consider the condition of the structure and the potential obsolescence of the home.  A small ranch with small rooms may have no value at all in a neighborhood where larger homes are now being constructed.

Now let us analyze interest rates and their potential effect on housing. Assume that 30 year fixed mortgage rates were 8.75% 10 years ago. Assume that 30 year fixed mortgage rates are now 5.75%. Assume that the annual real estate taxes of the property have increased from $5,000 10 years ago to $10,000 today. Assume that any buyer intending to acquire the property would place a down payment of 20% and borrow with a 30 year fixed mortgage.

Here is a summary of our assumptions.

10 Years Ago
Increase (%)
Price $450,000 $250,000 80.00%  
Cost To Build   $300,000    $150,000  100.00%  
Land Value $150,000  $100,000  50.00%  
Down Payment  $90,000     $50,000     80.00%  
Mortgage Amount $360,000        $200,000 80.00%  
Mortgage Rate 5.75%   8.75%     
Extrapolating the above:        
10 Years Ago
Increase (%)
Mortgage Payment  $2,101   $1,573   33.56%  
Monthly Taxes     $834 $417 100.00%  
Total Monthly Payment $2,935 $1,990 47.49%  

Declining mortgage rates create economic value for the buyer/borrower. In our example 30 year mortgage rates have declined 300 basis points. If 30 year mortgage rates rise from 5.75% back to 8.75%, the value of a $360,000 (5.75% fixed rate) loan issued today would fall from $360,000 to approximately $267,047 (using the NPV method). This translates into a gain/loss of $92,953 assuming the loan is held until maturity. Keep in mind that when you borrow to finance your home, you are the seller of the loan and the lender is the buyer. A fixed mortgage contains an embedded call feature (call option) allowing you the borrower to call the loan or pay it off early. Hence if mortgage rates fall you can call the loan and/or refinance it at a lower rate, and if mortgage rates rise you can hold the loan until maturity.

Observe that the total monthly payment has increased by 47.49%. This is an interesting piece of information because it allows us to observe how much the proposed monthly payment has increased in relation to the price of the home after taking into effect the decline in 30 year mortgage rates and any increase in real estate taxes.

As a buyer what do you do?  Much of this decision making will depend on individual circumstances.  A buyer that intends to live in the home for only a short period of time may be advised to wait out the current uncertainty in the market.  A buyer that intends to live in the home for ten years or more may be inclined to lock up the current circumstances. It all depends on your personal tolerance for risk, your personal needs, and your ability to sustain losses. It would be difficult to time the bottom of the market, but at the same time no one could afford to buy a house today and sell it in a year if prices continue to fall.

Please note this article was written for information purposes only and should not be relied on to make material financial decisions. Speak to your lawyer, financial advisor and your tax specialist for professional advice in purchasing a home.

By Using This Website You Agree That You Have Read and Understand Our Disclaimer!
Analytical Finances, Inc. Contents © 2005 - 2007
Real Estate Models / Mortgage Calculators / Real Estate Calculators / Business Calculators / Mortgage Interest Rates / Contact Us