Timing your trade-up

Rona,
Thank you! Your insight helps ease some of the nervousness I've been feeling about possibly putting our place on the market to buy a bigger place. I can see how "trading up" in this market could be a good decision based on your example and suggestions. Greatly appreciated.
Thanks again!

I think you forgot to add the disclosure:

"Does not apply to anyone who bought post-2003. Unless you are filling to take a loss on the property."

Hey Globe Guest,
This applies to all trade-ups. Those who bought later may sell short, but they will buy lower than they would have a year ago.
That's why trade-up is better than trade-down in the current market.

Fees to consider (when selling)...

You left out repairs/credits.

Something always turns up during the inspection that the buyer wants the seller to address, by either fixing the problem or crediting the buyer at closing.

Antigravity makes a good point; repair costs could be added to the seller's end.
I didn't think of it because I generally tell my buyers not to ask the seller to do the work, but instead give a credit. This is better for the buyer, so he/she can do the work to his/her own standard. So, I add the cost of repair onto the buying end, with price being negotiated accordingly. Antigravity is right; either way, it does cost the seller.

Another thought: The seller should do the work if it is seasonal (like clearing gutters before the winter freeze) or if the property could be damaged before closing (like a cracked tree limb or active leak.)

Someone who buys a condo with 20% down in a 5% declining market can now no longer afford a 10% down payment on anything over $600k! Nice of you to point out that fact in your article. I hope you're included in the lawsuits that will follow this credit mess...

Joe M. says someone with 20% down on a condo that depreciated 5% cannot afford a $600,000 house.
Actually, Joe, you have it backward. The traders that have big down payments are in much better shape than those who have small amounts of equity.

Let’s look at the numbers:
Suppose the condo is worth $400,000 today, $420 last year. 20% down was $84,000.
The trade up home costs $650,000 today, $682,500 last year. 10% down would be $65,000.

The trade this year still costs $250,000 instead of $262,500. In Joe’s scenario, there is plenty of money for the next down payment out of the liquidated deposit on the condo sale (about $64,000.). The trader has to be able to cover the fees, out of pocket.

It is the traders that are short on equity who could get too over-leveraged. Many of them can't do the trade-up for lack of cash.

Any trader needs to know the fees before setting out on this venture, so they don't get caught short. I am sure this entry convinced some to trade-up and convinced others to stay put.

Joe, I would be happier to hear from you if you could hold the personal threats. Thanks.

If someone is upside down on a sale, they usually have to bring money to the table don't they? If they can finance what they are upside down and the down payment needed on the new place aren't they really just circumventing the whole concept of a down payment? Meaning, if someone bought a couple years ago and is slated to take a loss, they have no equity for a down payment right? So, is it possible that someone can save $30k cash over a couple of years to cover the 5% down payment on a $600k home and another $20k to cover the loss on their own home? Further, someone who bought two years ago got a much better interest rate, so they would be walking away from a lower cost of capital. Oh, and didn't you forget that the person selling for a $20k loss is also going to also shell out another $20k for realtor fees? And maybe another $5k of closing costs?

So let's take this from the top:

Loss of equity $20k
Loss from transaction costs $25k
Savings needed for down payment $30k
Potential risk of having 2 mortgage payments $12k
Interest rate premium due to higher cost of capital : $80 per month

Your rationale: priceless :)

You are enjoying yourself at my expense...I can take it.
I have been pretty clear that trading-up isn’t for everyone. My piece is about why the math is in favor of buyers right now (so little is!) People who have been waiting to get into a house find this useful. Obviously, you don’t.

I didn’t forget the fees. I delineated them.
If you are losing money on your condo and you have low equity, what are you doing buying a bigger house? That’s nuts and I have said so.

Now let’s look at your math:

Loss of equity $20k -- Right. But the same 5% loss is $32.5K in the $650K house.

Loss from transaction costs $25k – Close enough

Savings needed for down payment $30k -- NO!
“Joe” said the buyer had 20% down on a $420,000 condo. The down payment for the next place comes from those funds when they are liquidated at the sale of the condo. The condo sells for $400K, there’s a $336K loan on it, plus your hypothetical $25K, leaves just under $40K toward a down payment. ($64K before the fees.)

Potential risk of having 2 mortgage payments $12k – In most cases, traders need to sell first. They can either “double close” or rent temporarily (another expense). It is foolish to risk carrying both in a buyer’s market. Most also need the equity from their sale to make ends meet.

Interest rate premium due to higher cost of capital: $80 per month – close enough and a good point. I should have added that to my expense list.

Rona, in your example won’t waiting another year be even better?
Suppose both markets decline another 5%, your condo is now worth $380,000 and your next house $617,500. Now the transaction only costs $237,500 next year. Another way to look at it, IF we get another 5% decline staying put only costs $20,000 but trading up now costs $32,500 plus transaction costs.

Umm so in a falling market I should leverage myself even further to increase my losses, makes sense, thanks Rona!.....

The same thing that makes trading up a better deal after a market decline works against that buyer if the market continues down. In that case, the further X% you would lose on either property would translate into more money lost on the more expensive property than on the original one.

If you trade up before the decline has reached the half way point, you lose more money on the trade up.

I get that realtors want transactions so they can get their fees; whether they're beating up sellers or buyers, it doesn't matter, just churning transactions....

Transactions cost money. If someone trades too much they'll end up paying much, much more in the long run unless they are complete sharks and rip off a lot of folks along the way.

This couple would be better off saving and putting down a bigger down payment. They start with a 20% down payment on their smaller place, and they trade to just over 5% down payment on a bigger place? I get that they can transfer the down payment portion, but you don't get wealthy paying interest, you get it by getting interest. If you trade too much you never get to the point where you're biting into principal and you end up always paying interest.

The other thing to keep in mind is that this market is not uniform across the price points. Why would someone sell a $650k house? If trading up is so much better, why would someone want to trade down and loose out? Certainly, the person who owns a $650k house most likely bought many years ago and their mortgage might be in and around what the $420k is paying and most likely their cost of capital is much better.

The other couple trading up just went from a traditional conforming mortgage under the jumbo amount. What would you think the cost of capital delta would be?

I'm just kidding and I know you said it wasn't for everyone.

One last question: Based on your scenario, why wouldn't a couple just rent to get the 5% down payment for the $650k house to begin with; they pretty much threw everything they gained on the first place and may as well have been renting. The banks got their interest and the realtors got their fees, but if the couple rented they'd have much more for a down payment if they let their original 20% down payment grow....

Thanks, everyone, for the comments. (even John P.)

The million-dollar question still remains:

How do you time the real estate market to get the home-life you want?
Real estate is different than the stock market; it's an investment that is used while it appreciates and depreciates. It's the same in that lots of people benefit from buy-and-hold philosophies while others benefit from careful trading. Suggestions like, “sell the condo, then rent for a year” may work economically, but at what cost emotionally and physically?

Veterans of the last recession, what's your advice for the next generation? What happened then? Will it happen again?

Hi Rona,
I have a real life scenario and I am definitely a real estate veteran. In 1987 my wife and I bought a condo for $89,900 at the height of the market. By 1992 you could buy a similar condo in this complex at auction for $28,000. We had a fixed rate mortgage and by the early 90's that mortgage payment became a smaller percentage of our income because our income had gone up. Therefore, we were able to bank 75% of one of our incomes. We were able to save a downpayment for another property. In 1994 at the bottom of the last downturn we bought a fixer upper cape for $116,500 and started to rent the condo. This year we sold the condo for $145,000. Over the 12 years we were able to depreciate the condo for tax purposes which created a tax loss on our tax return but a positive cash flow of money. The tenants paid down the mortgage with the rent so we had a nice profit after paying the capital gains tax. The house we are in now is worth in the low $300K range.

The house we are in is losing value but when we upgrade to a bigger home we will make it up on the next one as you explained. Those people who bought post 2003, if they don't have to sell, their loss is only a paper loss just like ours was.

You have to look at real estate as a long term investment.

Sorry Rona, there are lots of angry people who can't afford houses right now and like to take it out on you for giving advice to people who can. We traded up recently but have the double mortgage while we wait to sell our other house. We have many people interested in our other house (which is an awesome deal by the way) but they have to sell their houses first.
We love our new location and regret the lost money each month, but life goes on. The kids love the new neighborhood and the schools are really great.
Our motto is "can't take it with you!" ..(hey I'm a 2 year cancer survivor so my perspectives have changed alot)....

Rona,
Sorry that this posting seemed to cause so much controversy. I can see from a specific situation it may not be a good move, but if financially one has the 20% to put down on a new place, even if there current place has depreciated in value - it can still be a good thing.
I do appreciate your insight!