Assistant Professor of Real Estate Jeremy Gabe Offers Crucial Advice to First-Time Homebuyers on WalletHub

Thursday, July 18, 2019TOPICS: Research

USD Assistant Professor of Real Estate, Jeremy Gabe
begin quoteI’ve always advocated renting first in any market you’re personally drawn to. If you’d like to call that neighborhood your home permanently, look at a long-term rental arrangement or make the shift to homeownership when the right opportunity appears.

Should everyone aspire to become homeowners? According to our Assistant Professor of Real Estate Jeremy Gabe, not necessarily. See what advice he gave to first-time homebuyers in an 'Ask the Experts' segment on the financial advising website, WalletHub.

Excerpt below as it appears on WalletHub:

What should first-time home buyers consider when choosing a neighborhood?

There’s nothing special about how many times you’ve been a homeowner in regards to choosing a location for the family home, or even your next rental property. My advice to anyone is to think deeper about costs associated with any location; first-time homebuyers especially can be blinded by the headline home price, looking for low prices which can lead to exclusion of more affordable and more desirable locations.

How is this possible? Think about the costs you commit to when you choose a location, which includes the cost of housing (rent or loan payments), but also the cost of schooling, commuting, insurance, security and other private costs that drive away informed buyers to create a “cheap” neighborhood. In a perfect market, it shouldn’t matter where you locate because the aggregate costs of life will be equal: you can buy a cheap home and commit to spending thousands per year in commuting costs or you can pay more for your home, walk or bike to work and pay very little other everyday costs of living. Of course, other tradeoffs exist because not everyone can live in the most desirable location (for example, you’ll sacrifice space for convenience).

Location decisions are personal to each family; we all have different opinions on space, amenities, commuting, and community. I’ve always advocated renting first in any market you’re personally drawn to and if, after experiencing life there, if you’d like to call that neighborhood your home permanently, look at a long-term rental arrangement or make the shift to homeownership when the right opportunity for you appears.

How do you know that you are financially ready to buy your first home?

This is a complex decision not easily summarized. But the bottom line is that you should buy your first home only when the costs of homeownership are less than the costs of renting. Like choosing a neighborhood, think broadly about the costs of tenure. Homeownership involves a deposit, loan principal repayments, interest payments, taxes, regular maintenance, comprehensive insurance, utilities and other operating costs. With the exception of the deposit and loan principal repayments, all these cash flows are “money down the drain”, not investments in home equity. Renting costs – rent, contents insurance and utility bills – are likewise not investments, but if these costs are lower than the non-investment costs of buying, a financially disciplined household will have more cash left over to invest in a diverse portfolio as opposed to having the family savings stuck in an illiquid home equity investment.

For those concerned with “ontological security” or the idea that only homeownership provides security of place, there is nothing stopping you from signing a multi-year rental contract. Germany, Switzerland, and many European countries have very low rates of homeownership. Until the post-war shift into homeownership during the mid 20th century, the United States was also a nation dominated by renters. I’ll spare you, but not my students, a deep dive into the historical causes of the boom in homeownership 70 years ago – politics, post-war savings gluts, returning servicemen and cheap land made accessible by private cars. A lot of research has shown that unless there is a big bust in the housing market on the scale of the 2008 crash, you’re better off financially being a disciplined renter, not a first-time homebuyer.

What do you recommend as the minimum down payment for a first-time homebuyer?

A down payment is a long-term investment in the home equity of a single property. It’s illiquid. Thus, I don’t advocate maximizing your down payment with all your savings because it leaves you without any diversification.

So choosing a down payment – how much you wish to invest in your home equity – is a complex balancing act between the cost of finance (interest rates) and your financial security goals. Put too little down and the mortgage lending market sees you as a risky borrower, charges you a higher interest rate, and thus increases the amount of “money down the drain” associated with homeownership. Put everything down and your long-term financial security is entirely dependent on your investment in home equity, leaving you without diversification and your wealth tied up in an illiquid asset. Be honest in your medium-to-long-term financial planning and speak with multiple advisors as to where in this balancing act a specific down payment is a best fit for your financial goals. Have a good idea of how long you expect to live where you choose to buy, what your living expenses are likely to be over that tenure and how much you need to set aside (in liquid investments) for future expenses like home improvements and medical costs.

How can federal, state and local policymakers responsibly and effectively increase home affordability, particularly for first time home buyers?

I teach students that urban home prices are affected by (a) how responsive housing supply is to prices (i.e. how well developers add new supply as prices rise), (b) credit availability, (c) tenure subsidies (i.e. the mortgage interest tax deduction), and (d) rental tenancy rights.

Most media attention is devoted to the first of these – actions that promote new supply – but this is the slowest means of increasing home affordability. It’s also a complex issue where overseas experiences suggest a supply boom doesn’t often lead to falling prices; I’ve yet to find a good example of anywhere “building their way out” of a housing affordability crisis. Most housing advocates promote the elimination of planning restrictions to increase density and use land more efficiently. For these reasons, reviewing planning restrictions is a good idea without the issue of housing affordability to consider. But the effect of relaxing planning restrictions on housing prices is slow to appear, if anything happens at all. In 2016, Auckland, New Zealand, opened up huge areas of its geographically constrained urban area to more intense development. Three years later, it’s difficult to conclude that this had any impact on the city’s still-high housing prices or new housing development in the pipeline (lenders are hesitant to lend and developers hesitant to develop if prices are expected to fall as a result of oversupply). It may be decades before anything changes.

Another intervention has the government funding, guaranteeing or building housing supply itself, which is what the US and many of its allies did post-WWII. This guarantees increased housing output, but a recent experience in Ireland suggests it may not have much influence on short-term prices. Irish lenders correctly assumed that the state was underwriting them, and thus lent recklessly to developers and home buyers. Insane amounts of new house building in the 2000s did nothing to dampen the Dublin housing bubble that popped because credit to continue lending was cut off by the global financial crisis, not because developers oversupplied the market.

Thus, policymakers concerned with influencing short-term home prices in the service of affordability need to look at demand-side causes of high house prices. Those interested in more equitable housing markets can use Debt-to-Income limits to even out and limit access to credit; the UK currently has a limit where you can only borrow four and a half times your income for housing. In the US, a similar limit would be too effective; wealthy coastal markets typically lend up to six to seven times income, so credit markets would effectively freeze and we’d re-live the crash of 2008 with plenty of affordable housing on offer, but also the social ills associated with negative equity and nil development activity for the future. That’s not something a politician will want on her record.

So what’s my advice? For short-term actions, focus on the rental market, but don’t forget about the long-term supply issues. Increasing rental tenancy rights (NOT rent control) can make the rental tenure choice more attractive than ownership. Germany and Switzerland provide useful models for study, but the overall goal is to allow for longer rental tenures and protection from “no-cause” eviction. Market rents are important so as not to deter development; rent supplements or public housing are usually on offer for low income households. While improving rental tenancy rights, policymakers can pay for a lot of this by eliminating homeownership subsidies like the mortgage interest deduction. A healthy and more diverse rental market as wealthier residents choose to rent will increase private investment in the nation’s rental supply as well, indirectly leading to increased housing supply.

Contact:

Renata Ramirez
renataramirez@sandiego.edu
(619) 260-4658