A Thought Experiment From A Naive Capitalist -- October 23, 2023

Locator: 45802MORTGAGES.

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Flashback

Back on November 23, 2022 -- almost exactly one year ago I wrote, as a "thought experiment from a naive capitalist." Not one person challenged me on this this entire past year. Here's what I wrote:

On buying a house, these are my observations for folks in my socioeconomic demographic:

• the price of the house is of little importance (don't take that out of context):
• the house bought is based on the monthly outlay (principal, interest, insurance, property taxes, etc)

With "free money" or interest rates at zero percent:

• folks will buy a $400,000 house for $600,000;

With "expensive money" or interest rates at twelve percent:

• folks will buy a $600,000 house for $400,000.

Experts / realtors will tell folks to buy the "most" house they can afford

• that they can afford = monthly cash outflow

Monthly cash outflow:

• if folks think they can afford $3,000 / month, the realtor will convince the buyers they can come up with $4,000 / month
• buyers will come up with $3,600 / month on their "back-of-the-envelope" budget
  
• if they were able to budget $3,000 / month, they will do whatever it takes to come up with that extra $600 / month
• buying a home becomes a way to force one to save

$600 / month =

• $6 / day at Starbucks, five days a week, 20 days a month = $120
• four nights / month out for dinner for a family of four, $100 x 4 = $400

The first two years will be incredibly tough, very painful for the family.

At the end of the first two years, the family will become used to meeting the monthly mortgage.

By the third year, the family may, in fact, have more disposable income than they did two years earlier

• (pay raise; wife returns to work; second job; more overtime; bonuses; inheritance; family help; tax breaks with a big house)

Interest rates tend to cycle, fluctuate, change (not always, granted). 

If the family buys the $600,000-house for $400,000 with "expensive money" they will be in a very different place two years after they buy the house than if the family buys a $400,000-house for $600,000 with "free money.

Now, break, break. Where would you rather be two years from now: in a $400K house you bought for $600K with "free money" or in a $600K house you bought for $400K with "expensive money."

We're going to stop here and come back to this tomorrow. 

My thoughts may be very naive, but playing devil's advocate this is where I am right now in this thought experiment. 

I thought about this on November 5, 2022, just three weeks ago, and I posted a short note on the blog at the time.

Investing: best years of investing in front of us.

Consider the source, a goldbug, but I can't disagree. 

"Expect five years more of problematic inflation."

Two points:

• the gap between investors and savers will widen immensely;
• this year and next will be the best two years to buy a new house.

My thoughts have not changed. I think I'm right on this. It works in an interest rate environment between 0% and 6%. I'm not sure if it would work in a 14-percent environment like we had under the Carter administration.

This "thought experiment" came up again today with the release of the University of Michigan's monthly "Surveys of Consumers.

But for now, ask yourself where you would rather be in 2026:

• owning a $400,000-house bought for $600,000 with "free money" in 2020 or,
• owning a $600,000-house bought for $400,000 with "expensive money" in 2023 (or 2024)? 

If the "$400,000-house" and the "$600,000-house" analogy is confusing or doesn't make sense, substitute the phrase "the most house you can afford" for the dollar figure. 

And this whole thought experiment might not make any sense to anyone but me, but I'll come back to it tomorrow to see where my thinking is faulty. 

It should be fun. 

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Now, An Update

Link here.

Contrary to what many are saying, it might not be a bad time to buy a house.

That's because buyers waiting for rates to drop may be waiting a long time.

When mortgage rates do go down, competition and demand are set to come roaring back.

By many metrics, the US housing market has never been more unaffordable, and all of the prevailing wisdom right now says buyers should wait it out, either for mortgage rates to drop or prices to come down.

And yet, there's an argument to be made for getting in now if you can find something, even amid 20-year high mortgage rates and stubbornly high prices.

Mortgage rates at 8% have sidelined a good portion of the competition. While it might not seem like it, the current landscape might be more of a buyer's market than in recent years, particularly compared with the height of the pandemic when sellers could demand any contingencies be waived, and buyers were snapping up homes sight unseen.

More importantly, though, the lack of competition now means that when borrowing costs do ease, buyers can expect a flood of pent-up demand to wash over the market. "The days of the 2%-3% interest rates are never going to come back. Forget about that. But they will come down," the "Shark Tank" investor and real-estate mogul Barbara Corcoran said in a post on Instagram this week.

"The minute they drop and come to anything with a five in front of it, the whole world's going to jump back in the market. There's going to be no houses around, and prices are going to go up by 10% or even 15%. So don't get out of the market. This is the very best time," she said.

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Bottom Line

Ask yourself where you would rather be in 2026:

• owning a $400,000-house bought for $600,000 with "free money" in 2020 or,
• owning a $600,000-house bought for $400,000 with "expensive money" in 2023 (or 2024)?

Hint: there's no correct answer. 

But don't expect to see 2% mortgages any time soon. And when you do, you're going to need a lot of cash to outbid your competitor who is looking to buy the new house.