Will you have the buying power to move up? Ask James
Kudos to James in Cambridge for his great analysis of the bleak outlook confronting homeowners with dreams of moving up to bigger spreads.
Basically, given the likelihood at best of anemic price increases over the next five years, hoping to cash in on your current home in order to pay for the next one could be a pipe dream.
"If you want to "move up the housing ladder," you're going to have to earn more money. Your house won't do it for you," James notes.
Great point. The other option, I'd add, is playing the old location game, taking on a longer commute for a larger house. Given ever more clogged roadways and the decrepit state of our public transportation system, that's an option you should think long and hard about before moving out to East Nowhereville.
For those who missed it or passed it over, here is James' comment on my post earlier this week on moving up.
From 1970 to 2000, a typical buyer in boston saw his house increase in price by 40% in the first 5 years he owned it. This allowed him to cash out for a huge multiple of his down payment, and put a much larger down payment on his next house (even relative to the increased market prices, and "move up the housing ladder." Basically, the whole idea of a "housing ladder" was a giant get-rich-quick scheme. Getting on the first rung of the ladder didn't just allow you to climb to the next rung, it would slingshot you financially upward, using the financial magic of leverage.
But as anyone who's ever played with a slingshot knows, a small change in the input has a huge change in the output. The most optimistic economists' estimate (+18%) would only translate to increased buying power of 22%. A 22% higher down payment is nice, but it's hardly the kind of "move up from a starter home" bump we were accustomed to seeing in the boom years.
And that's the most optimistic economist estimate. Smaller market increases will actually leave a move-up seller with less buying power on his second home than on his first. For example, if the market increases by 10%, and transaction costs are 8%, that leaves the seller with a 6% profit on his down payment. ( ((110%*92%)-80%)/20% = 1.06 ) But the move-up seller now has only 6% more cash in a market that's increased by 10%, so his effective buying power would actually go down.
Assuming 20% down and 8% transaction costs, and treating the down payment as the driving factor in buying power:
market change -> change in buying power
0% -> -40%
+5% -> -21%
+10% -> -4%
+15% -> +12%
+18% -> +22%
+20% -> +27%
+25% -> +40%
+30% -> +52%
+40% -> +74%
+50% -> +93%
+60% -> +110%
Granted, there are other factors involved in changes in buying power besides down payments. And this doesn't take into account increased savings, or the amount of the mortgage that's paid down in the first 5 years. But houses simply being worth more in 5 years isn't enough for traditional "move up" dynamics to take hold. If you want to "move up the housing ladder," you're going to have to earn more money. Your house won't do it for you.
