My House Price is Inflated – Should I Sell?

Average U.S. national house prices have increased to record levels.  Homeowners may view the current market as an excellent opportunity to sell.  While the market is high, there are also indications that a correction may occur within the next few years.  Selling near peak and waiting out a correction to buy at a lower price is a potentially profitable option.  In pursuing such action, it is important to distinguish assumptions from facts in decision-making.

In my last blog post, “Real Estate and the First Time Buyer,” I provided an assessment of how the housing market arrived at its present state and explored possible outcomes in the market in the coming two years.  It was written for the benefit of the first-time buyer.   This post builds upon that analysis and explores options for the high equity owner thinking of selling.

There are many reasons to consider selling in the current market.   For example, one’s financial portfolio may be disproportionately allocated to real estate due to the rise in prices.   Or one might be at the limit of the real estate capital gain tax exclusion ($250,000 single or $500,00 couple).   Selling now would restart the two-year exemption timeline on the next house and save significant taxation.  Maybe there were already plans to downsize or retire or move to another job or make a vacation home or rental property into a permanent residence.

There are too many scenarios to assess in this limited space.   The context of people’s lives and regional housing market conditions vary considerably.  So, the remainder of this post will explore a single case study that can provide broad insight in many scenarios. 

For this analysis, assume the strategy is to sell in anticipation of a significant market decline, and to then reenter the market when a price correction occurs.   This is a market timing scenario.  To successfully accomplish this market timing strategy requires occupying temporary housing for up to two years awaiting the market correction.  In an ideal situation the seller may own a vacation home or a vacant rental property they can occupy full time for the necessary period while they extract themselves from the market.  Those without must rent and account for temporary housing costs while sitting out the market.

This strategy anticipates a significant housing market price correction will occur in the coming two years.  There is debate among experts over whether a correction will occur, when, and to what extent; however, there are increasing numbers of reports pointing in that direction.  Most do not anticipate a severe collapse such as occurred in 2008; however, there is a growing body of opinion that a significant correction may occur.  Any national correction is expected to have broad regional variation.

There is reason for concern that the U.S. economy is facing serious headwinds.  Inflation and interest rates are on the rise and many experts think the Federal Reserve is not handling these issues well.  Concerns a recession is within two years are increasing.  The Ukraine War and the Chinese Covid lockdown are exacerbating supply chain issues.  The stock market is in correction territory (down over 10%) and may potentially extend declines to Bear Market territory (down over 20%).  These conditions may influence the housing market negatively but realize that predicting the future is very risky.  Proceed with caution.   Mitigate risk by knowing your circumstance and regional market well.

Selling one’s home is a major undertaking.  It has many implications for a family.  The analysis here is financially focused, but the intangible things – disruption of lifestyle and stress – may be more important and deserve full consideration.   Ultimately, the decision will come to, “Is the potential gain of selling worth the risk and personal disruption and stress of the process.”

Moving is considered one of the most stressful events in life.  Some folks have a lot of experience with multiple home sales in their lifetime.  They have developed a knack for organizing an efficient moving cycle process.  They have reduced their inventory of “stuff” to be carted from place to place. They know how to efficiently perform renovations and improvements, and their experience in this activity has proven profitable in the past.   They view the process as a creative adventure. They enjoy new places and transforming houses.

At the other end of the spectrum are folks who have had one or two homes in the past 30 years.  They may be recent empty nesters looking toward retirement or already have retired.  Maybe their home needs updating, and they have accumulated “stuff” throughout their house, garage, and maybe even a rented storage unit.  To them, selling may seem a daunting task.  But the record market prices may represent the best opportunity in a lifetime to transition.

First, know that simply selling a home at a peak and buying another equivalent home in the same market may be a losing proposition.   That house down the street or across town is also inflated.  The transaction costs (e.g. agent fees, taxes and other closing costs) for the house you are selling may be seven percent or more of the sale price.  There will be moving, storage, and temporary housing costs.  The house you buy will have closing costs, updating, and furnishing requirements.   If financing, there will be mortgage fees and points.  These new house transaction costs may represent an additional five percent or more of the purchase price – ensuring a loss.

The remainder of this post will use a case study of a hypothetical house in Florida to analyze the financial implications.  In this case, the hypothetical house is in the Naples market.  The region has a high concentration of retirees.  Over 50% of houses are bought with cash.  Much of the housing stock is seasonal second and third home accommodation.   Despite a robust new home builder presence, inventory is not keeping pace with demand. 

A national moderation of the market can result in much broader and more severe regional impact based on circumstance and market type.  CNBC reported on CoreLogic data in 2011 that the Naples market suffered a 55% decline in prices following the 2008 housing collapse.  Is this likely again?  Probably not, but whatever national average price correction occurs - it will likely be significantly amplified in Florida – particularly if there is a recession and stock market decline.  

A conservative approach will be taken here and use three scenarios for analysis: 1) A minor moderation of prices; 2) a 10% regional average price decline; and 3) a 20% regional average price decline.

The first step is to determine accurately the Cost Basis of the house to be sold.  Knowing this number is essential to calculating capital gain tax implications.   Start with the sale price.  In this hypothetical case it is $400,000.   Then add expenses for fees and closing costs and improvements allowed by the Internal Revenue Service.  Any costs of repairs or maintenance that are necessary to keep your home in good condition but don’t add to its value or prolong its life are not allowed.  As shown in the adjacent table “House Selling Cost Basis,” the Cost Basis of the house rises to $437,000.

The second step is to estimate the return on the sale of the current home.   An agent commission of 5-6% is typical if a real estate agent is used.  According to the National Association of Realtors 89% of sales are through a realtor.  There are also closing cost fees and charges.   As indicated in the adjacent table, “House Selling Peak Sale Price Return,” in the current market the owner is expecting a $750,000 sale price.  This results in net proceeds of $707,150, a net profit of $270,150, and a return on investment of 62%.   Not bad!

The third step is to estimate the transaction costs associated with purchasing the new home.  Estimated closing costs are $7,000 and repairs and improvements are estimated at $35,000.  Rarely is a house purchased that is in perfect condition.   It will have some typical costs such as new flooring, painting, minor repairs, appliances, and decoration.   This is a basic cosmetic uplift budget.  A thorough examination of a home for additional work such as roof or replacement windows may increase those costs.

The fourth step is to estimate the moving, storage, and temporary housing costs shown in the tables below.  Again, if one owns a vacation home or vacant rental property that can be used for temporary lodging while waiting for a market correction all the better both for convenience and financial outcomes.  But many folks will need to rent an apartment or house for the waiting period.  The table reflects a two-year temporary housing period.  Shorter periods may have lower costs.

 

The fifth step is to estimate the savings that arise from selling the original home.   Operating a home can be costly - particularly if there are high property taxes in the area and if the home is part of a Homeowners Association.   The adjacent table, “House Operating Costs Saved,” provides the estimated savings for a full two years.

The sixth step is to estimate the earnings from investing the proceeds of the sale of the house during the two-year waiting period.   Given that the funds will be needed to purchase the new home within two years they will have to be invested in very conservative and liquid vehicles.  The stock market is not a good place for these funds.  It is best to deposit them in money market funds and short-term certificates of deposit.  Rates in these accounts are on the rise, but for now can only be estimated at one percent return.  Such a low return is disappointing, but the funds cannot be risked in the stock market and need to be available immediately when the market correction occurs, and a new house becomes available.

Having the detailed estimates of all costs of executing this market correction strategy it is possible to project outcomes.   To fully understand the implications of this activity it is better to look at a ten-year time horizon.  The table below shows three sale scenarios on the left-hand column and three potential market outcomes across the top row over a ten-year period.

To understand what the table, please look at the Market Slow Down column.  Under the No Sale scenario in which we take no action and keep the original house for ten years that house is projected to be worth $1,031,004.70 with low annual price increases going forward over the next ten years.  In the next scenario where the original house is sold and the seller sits out the market for six months, the projected value of the new house and any savings/earnings from invested funds over ten years is $1,060.895.90 for a gain of $29,891.20 over the period.   In the next scenario, where the original house is sold and the seller sits out the market for two years, the projected value of the new house and savings/earnings from invested funds over ten years is $1,076,207.40 for a gain of $45,202.70.

Notice the gain rises with the 10% Market Drop and 20% Market Drop.   In these scenarios the market timing has worked.  The original house was sold near peak market, a correction occurred of 10% or 20%, and a new home was purchased in that new pricing market.   The net remaining funds were invested in the stock market for the remainder of the ten-year window with a conservative return of 5%.   As can be seen, under this scenario the gain could be more than $200,000 over ten years.

What is driving these returns?

First, the model assumes that the market correction is timed right.  The seller gets the maximum price for sale of their existing home, sits out of the market to catch the correction, and reenters to buy a house up to 20% less than it was previously valued.   But even if there is just a market slow down there is still a modest gain of $29,891.20 sitting out the market for six months and $45,202.70 sitting out for two years.

Some of the gain is largely driven by capital gains tax savings.   It is very important to understand capital gains taxes on both real estate and investments.   When a house is sold, the seller is liable for capital gains taxes on the proceeds.   There is an exemption of up to $250,000 if single and $500,000 if a couple when selling real estate.   The home must be your permanent residence and you must have lived in it for two years.   In the case study, one can see that if the owner decides to stay in the house for another ten years and then sell, the gain on the house exceeds the $500,000 exemption.  Capital gains taxes will be due on that excess.  Capital gains taxes are typically 15% or 20% of the gain (see table adjacent).  By selling the house now, the gain is less than $500,000 and is fully exempt from tax.  Again, have a complete understanding of capital gains taxes if engaged in this activity.

There is also gain from the investment of the funds that remain after the discounted house is purchased.  In this case study the original house was sold for $750,000.   In the 20% correction scenario the new house is purchased for much less, leaving a balance of about $150,000 to be invested.  In this case study we estimate a 5% return on the investment annually and a 15% tax on any capital gains generated by the investment.  These returns have a positive impact over the ten years and beyond.

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Real Estate and the First Time Buyer

Home ownership is the key to wealth development in the United States.   Record high home prices are distorting the real estate market such that many first-time buyers are unable to buy a home.  A national average housing price correction of 10-20% may be in the offing, but inflation and rising interest rates will more than offset the benefit of lower prices to make housing more unaffordable.   Potential first time buyers will need to be sophisticated, agile, and disciplined to position themselves for opportunities that may arise in what will likely be a volatile market in the next few years.

Home prices are high by nearly all measures, but there is wide regional variation.  The CoreLogic Home Price Index (HPI) posted the highest year-over-year growth in its 44-year history by the end of 2021. CoreLogic last week reported 65 percent of regional U.S. housing markets are overvalued based on earnings to price ratios.   Zillow reported in February, 2022 that 481 cities nationwide have a typical home value of at least $1 million and 49 more may join the list this year.

How Did We Get Here?

A perfect storm of decreased housing supply and increased demand was underway in 2020.   The U.S. had a systemic housing supply shortfall of approximately 3 million homes caused by ten years of under production;   homeowners held their houses longer – 13.5 years in 2020, up from approximately 10 years before the housing collapse of 2008;    Millennials, the largest generation by population, entered their prime home purchasing years in that timeframe and accounted for 37% of home purchases in 2020.  At the same time, mortgage interest rates were historically low in the 4% range following the 2008 market collapse.  Enter the Covid-19 pandemic and associated governmental policies to further intensify the underlying issues of housing supply and demand.

Russia's Illegal War Upon Ukraine

 Author Note: I have been on hiatus for several months due to travel and simply being too busy in retirement with other priorities. I still intend to blog but not as frequently.  The war in Ukraine, filled with unspeakable horror and sorrow weighs on many people as they confront video of the suffering of the Ukrainian people.  Some folks have asked for my opinion on the war and its implications. I offer my thoughts here for your consideration.

A settlement of the Russia-Ukraine War will likely be agreed in the coming weeks as Russia’s military objectives move further from reach and Western solidarity and support of Ukraine intensify.  In this fourth week of battle the outcome is coming into focus.   Russian President Vladimir Putin’s original plan to quickly take control of the Ukrainian capital at Kyiv, install a puppet government, and establish a compliant Belarus-type satellite state failed.  It appears Russia is now preparing the groundwork for a best possible negotiated outcome, though Putin will likely continue to take escalatory steps to weaken Ukrainian will and intimidate its Western supporters until a final settlement is reached.

Memorial Day – what happened to the parades and walks in cemeteries?

 I vividly recall from my childhood the prominence of Memorial Day among the pantheon of holidays.  It was one of the two big civic holidays.  The other being the Fourth of July.  At a young age I could sense the difference between the two – one celebratory and one solemn.  Memorial Day is larger in my memory.  The holiday was specifically to remember the dead of war, but the event was broader in that it was also an opportunity to visit and reflect more generally on relatives and friends who had passed.  It also related to the continuation of a tradition that emerged in the mid-1800s that made cemeteries places for peaceful meditation with nature’s beauty and communing with one’s family and friends – both living and dead.  As can be said of many traditions – times have changed.

After the Civil War ended many communities began to hold spring memorial gatherings to remember the war dead.  In 1868, a Northern veteran organization, the Grand Army of the Republic, formalized and spread the growing tradition by calling for “Decoration Day” to be a national day of remembrance. Each spring communities would gather for the purpose of “strewing with flowers, or otherwise decorating the graves of comrades who died in defense of their country during the late rebellion.”  

The “Summer of 2021” – looking good

I am more optimistic than government officials about the pace and extent to which COVID-19 related deaths and hospitalizations will decline and herd immunity be achieved in the U.S.   Vaccine producers are ramping up production to meet demand; states are working out kinks in vaccine administration; the emphasis on vaccinating elders directly addresses the most vulnerable population; and up to one third of the population may already carry natural immunities from infection.  These factors combined will likely result in dramatic change in spread, hospitalization, and deaths before summer.

State Covid-19 pandemic performance update

This blog post provides relative rankings of states in four coronavirus disease (COVID-19) performance categories.  This update is published now because there was significant spread throughout the country that began in October, but is now subsiding.  It is also issued at this time because vaccines have now been distributed for more than a month and some measures of performance are now available to assess state vaccine implementation.  

The United States exceeded 25 million confirmed COVID-19 cases and over 430,000 related deaths this week.  A dramatic increase in cases and deaths began in October.  The event is subsiding as new cases and 7 day averages decrease across the country.  Daily deaths that typically lag cases by about two weeks have also begun to decline. 

Thus far, 48,386,275 vaccine doses have been distributed to states and territories and some federal departments and agencies.  26,193,682 doses have been administered, of which 4,263,056 were second doses.

Second doses of the Pfizer-BioNTech COVID-19 vaccine  and the Moderna vaccine are administered 28 and 21 days respectively after the first dose.  Second doses are an increasing portion of doses administered from state vaccine allotments.

Like so much of the pandemic response, specific vaccination priorities within states fall under the authority of governors aided by federal funding and FDA recommendations.

Where does your state rank in dealing with the COVID-19 pandemic?

This blog post ranks states in three coronavirus disease (COVID-19) response performance areas relative to other states.  It updates previous blog posts on this topic . This update is published now because there was significant spread throughout the country in the past few months that changed relative rankings for many states.  It is also done at this time because a new element has been added that will likely (and hopefully) change the disease trajectory dramatically - vaccine availability.   In a few months the relative state rankings will be examined again, but with the additional measure of vaccine implementation within states.  

The United States exceeded 17.5 million confirmed COVID-19 cases and over 300,000 related deaths this past week.  On December 16th, the single day record for deaths was set with the passing of 3,600 people and nearly 250,000 new cases.  These markers were crossed during a period of increased spread generally nationwide that began in the Summer.  As is the nature of the virus, the spread continues to shift over time from region to region.  A Summer uptick in the South shifted to the MidWest and Mountain West in early Fall. That outbreak fortunately is now subsiding.  Prevalence has now shifted to California, Tennessee, the Rust Belt, and into the NorthEast as indicated below graphic map in the New York Times Coronavirus in the U.S.: Latest Map and Case Count on December 18, 2020.