An excerpt from the WSJ:
But Diane Saatchi, senior vice president at Saunders & Associates, a real-estate firm in Bridgehampton, N.Y., says downsizing nowadays “costs more than people have in mind.” In her area, she says, total transaction costs easily exceed 10% to sell and buy simultaneously. When you add in the possibility of capital-gains taxes and moving costs, she says, “you need a big spread to make it worth the effort, and sellers often think they’re going to get more than they can for the sale.”
Kay Carpenter, 59 years old, and her husband Robert, 58, wanted to sell their 5,900-square-foot, seven-bedroom house in Windsor, Colo., and buy a home about half that size in Denver, where Mr. Carpenter currently commutes to his job as a hospital laboratory director.
But their current home, which they purchased for $810,000 in 2003, has received only one offer, for $575,000. “It is difficult to sell because it is a large home,” Ms. Carpenter says. The couple, whose last child left the nest in 2005, are finding that they will have to spend about $450,000 for a suitable house. Throw in the transaction costs, and the financial benefit of downsizing basically disappears.
Trading down is a bit easier in some parts of the country, like the Chicago suburbs, where there is a mix of housing types and lower-tax communities co-exist with higher ones. “It’s actually very typical, a classic scenario here,” says Richard C. Gloor, a real-estate broker/owner in Oak Park, Ill. “More traditionally, people wait until the last kid is out of the house, five or 10 years. But now the last child is in college still and people say they don’t need the space and especially don’t need the taxes.”
In pricey coastal cities like New York, Washington and San Francisco, desirable lower-cost housing is often hard to find in neighborhoods of upscale homes, real-estate experts say. In many affluent neighborhoods where aspiring retirees want to be, the supply of smaller homes is limited, due to zoning restrictions and high land prices. As a result, many homeowners find they would have to move a considerable distance to reduce their housing costs significantly.
Other hurdles beyond the slumping real-estate market are getting in empty-nesters’ way, too. Many people of retirement age are still working, for example, and need to stay near their jobs, meaning out-of-state moves are out of the question. Some are in two-income households, complicating the decision to relocate even more.
What’s more, adult children are becoming more of an issue than they used to be. In the aftermath of the Great Recession, “more and more kids are moving in with parents and grandparents,” says Jim Gillespie, president and chief executive of Coldwell Banker Real Estate LLC.
Some adult children object to their parents’ selling the home they grew up in because they are afraid it will cut their inheritance, says Prof. Kotlikoff. One way to address that problem: Give the children some of the sales proceeds right away.
Other strategies for living better in retirement might include paying off the mortgage, working longer or postponing taking Social Security, or increasing taxable contributions to a Roth individual retirement account, some financial planners say.
Charlie Horne, 71, a semiretired real-estate broker, and his wife, Barbara, 61, may have to use one of those strategies now that their downsizing move has turned out to be less advantageous than they had hoped. The couple recently sold their 3,000-square-foot, three-level house in Holliston, Mass., to move into a 2,200-square-foot condominium in a nearby development restricted to people 55 and older.
Their mistake: making a down payment on the new place before selling the old one. It took 11 months for the Hornes, who had owned their house for five years, to sell it, and it fetched just $540,000, far less than the $730,000 at which it was appraised the year before. The condo cost about the same with upgrades. “We thought it would be no problem [to sell]. I’ve been a Realtor for 52 years, and I’ve seen six recessions already,” Mr. Horne says.
The couple’s mortgage is about $380,000, or $3,900 a month. That, along with common charges of $310 per month, add up to just about as much as their old first and second mortgages and taxes. On the plus side, “the taxes were higher on the house than the condo,” says Mr. Horne, who adds that he is saving money on maintenance.
Still, Mr. Horne says, if he had it to do over, he would sell the house first. “My timing was wrong,” he says.
It is difficult to sell because it is a large home
It is difficult to sell because we don’t want to get the price right.
This is exactly the situation we are in.
We want $780K for our current 2510 sqft house so we can build a new 1800 sqft house.
We were informed that our house is only worth $660K on the market.
So, we stay put.
Notice that I wrote “want” and not “need”. I know the $780K is not realistic. I accept that. But, less than $780K and the numbers don’t pencil out.
Welcome back Dave and thanks for your contributions.
If the numbers never penciled out, would you stay forever?
This is the question that baby boomers don’t like to think about now that they are in their current house, but today’s buyers should consider strongly.
You may be in the house forever, will it fit you for the duration?
“The couple’s mortgage is about $380,000, or $3,900 a month.”
How do you get a deal that bad?
“We thought it would be no problem [to sell]. I’ve been a Realtor for 52 years, and I’ve seen six recessions already,” Mr. Horne says.
I can’t get my head around the fact that he didn’t grasp the simple concept of selling before buying. It’s just common sense…
I think today’s buyers are gambling on significant inflation down the road.
One thing that I am reasonably confident of is that rents have probably hit bottom for this cycle so if you can buy something at or close to rent parity you will probably be alright as long as you can easily afford the payment.
Yeah that mortgage pmt sounds wrong for a $380k note. Buying new before selling existing is a huge risk, often a huge mistake, and rarely a good move. Huge downside, slim upside.
Downsizing still works if you are selling in a high priced locale and willing to move to a low priced area, assuming you have equity. Selling high sf and buying small sf within the same locale, not so well.
I hope my payment isn’t $4,200 per month when I’m 71 years old.
“The couple’s mortgage is about $380,000, or $3,900 a month.”
How do you get a deal that bad?
redys | June 14th, 2010 at 8:54 am
probably a 15yr, with taxes impounded.
that said, why should a 71 year old who is semi-retired be taking out a mortgage at all????
“that said, why should a 71 year old who is semi-retired be taking out a mortgage at all????
Hahaha exactly. Bank the cash and rent!
This gets to one of my favorite areas of finance. What is the upper limit on the rate of return where the property does not produce a sufficient return to hold.
Let’s take Dave Barnes data as an example. He says, “we want $780k.” What he left of is when he wants the $780k, which we can assume to be today.
Then he states the price today: “We were informed that our house is only worth $660k.”
In terms of deciding whether or not to sell, this is easy. The owners suggest they value the home at $780k, but the market will only bear $660k.
I have no idea about Dave Barnes’ personal situation, plans, future, and so on. I only cite the numbers, since they are convenient.
So now let’s start the game in motion. Moving forward, starting with $780k today, how much will Barnes be willing to sell for next month? There are three basic options: 1. He will value the property more than $780k, 2. He will value the property exactly $780k, 3. He will value the property less than $780k. It’s similar for the general market value; it could go up, down, or stay the same.
To simplify this situation, let’s assume zero currency risk (0% inflation, constant international value, etc.). Also let’s assume that the market value stays the same. In other words the market will value the place at $660k forever. Now the question is how long until the place sells?
Let’s start with Keynes:
In the long run we are all dead.
Thus we know that it’s only a question of when, and not if, Barnes will cease to occupy the property. This is important to make sure the game is finite. Once we have the date, we know the discount rate, and thus we can compute the upper limit of the rate of return.
If you’d prefer to go the other way around, start with some very negative rate of return and raise it until Barnes would hold. For example, let’s assume that Barnes seeks to sell in about five years. Now start with a low expected value in five years, such as $50k, and raise it until Barnes suggest they not longer seek to sell today. Clearly this is bounded from below at $0, where they would not sell, and bounded above at $780k, where they would sell today.
Next we have to think about if Barnes seek to sell in five years, what would happen if prices are lower in five years? What action would be taken?
Now before you suggest something like, “How could prices be lower in five years,” let me point out that there are many parts of the country were prices are definitely much lower today than five years ago, and I don’t find any guarantee that price cannot go lower in five more years. I know a few people that thought prices would be higher today than five years ago. One holds property in Vegas, which is worth 70-75% less than five years ago.
So what is the least acceptable rate of return to hold? Clearly this is different for each individual, but we can measure it based on observation of action. This is also not unique to housing.
Moving forward to Au, gold.
A friend, who finally got the “I told you so,” called in 2009. The “I told you so,” was definitely his, if you really consider it to be such. He did not like my reply, but what can I say?
The situation: My friend purchased a small amount of Au back in the late 70s, near peak pricing. Now I think he actually held it for about 29 years, but it’s close enough to 30 to just round to 30, as far as I am concerned. Now that Au has finally hit new high prices, he was able to sell, “At a profit.” Profit does not consider time. Profit is defined, loosely speaking, as Selling Price less Purchase Price, if positive. Otherwise it’s called a loss.
In any event, my friend sold his Au for slightly more than the purchase price some 30 years earlier. Yes, he is required to report the profit to the IRS and pay taxes. Yes, he suggested, “I told you so,” in that he sold for a profit.
My reply?
I’d call that, “Thirty lost years.”
He called it, “Selling at a profit,” and I called it, “Thirty lost years.” I guess in some way we are both correct, and maybe it was worth it to him to hold for so long. My personal expectation relative to time is much higher.
I didn’t finish my coffee, and I have math problems, which makes me a little sad. Something about being human, I suppose. There are also several typos. Those are unacceptable too.
Let me correct this:
“Now start with a low expected value in five years, such as $50k, and raise it until Barnes suggest they no longer seek to sell today. Clearly this is bounded from below at $0, where they would not sell, and bounded above at $780k, where they would sell today.”
I need to be clear that Barnes is selling today based on the value in five years. If the value is expected to be $50k in five years, he would definitely sell today for $660k. If the value is expected to be $660k in five years, he might sell today–this is not as clear. If the value is expected to be $780k in five years, high might sell today, if five years is too long to wait for the additional $120k ($120k return on an asset with a market value of $660k, is this enough?). If the value were expected to go sufficiently high, say $5M, then he’d very likely hold for the full five years.
Once again, I apologize for the sloppy work.
Since I have a love of this particular issue, let me present this another way. We have to get some assumptions out of the way, such as currency risk, individual property risk, and I hope I don’t have to outline these things carefully for this forum. Please allow me to assume continuity on discrete home prices, for simplicity. I will also assume an ownership position, as the rent versus buy is a topic for a different day, so in all cases here, it is assume you will buy. I will also assume the owner has a discount rate greater than zero.
The housing market prices can go one of three directions:
1. Down
2. Neither up nor down
3. up
There are no other options.
Case 1: Down
The first case is easy: If the market is going down, then you want to purchase the least costly home that suits your needs/wants, within your financial means, as always.
Non-housing example: Automobiles. Generally speaking, cars go down in value, so you buy the least expensive one that suits your needs. It’s not that you don’t buy, but rather, you consider the cost of the market value declines.
You are always negatively leveraged, since we assume a greater than zero discount rate.
Case 2: Neither up or down
This is fairly easy, since the capital investment will be recovered at the end. You invest $100k, use the asset, and in the end, you recover $100k. The cost of using the asset is the discount rate times the investment, per year. I buy an asset worth $100k today, use it for a year, and sell it for $100k. Thus the cost is the use of the $100k capital for a year. Depending on opportunity cost, this might be a great deal. Currently the spread between a risk-free investment and 0% is approximately 0% (in other words, risk-free instruments are not yielding much).
Once again, you are always negatively leveraged, since your discount rate is greater than zero.
Case 3: Market prices going up
Case 3a: Negative leverage
If prices are not going up fast enough, by less than your positive discount rate, then you are negatively leveraged. Specifically, your positive discount rate is greater than the positive increases in market value. This is similar to the above cases, but positive returns are being realized. This is the case where the guy sold his Au after 30 years. Sure the market value when up, but the return is so low that I called it 30 lost years. This is a case of negative leverage–my expectation about returns is much higher than essentially nothing over 30 years, and thus, depending on the yield spread, we could just call this an extension of Case 2 above. Let the positive return be one differential above zero, so we are very close to case 2.
Case 3b: Neither negative or positive leverage
If the prices are going up by your discount rate or cost of capital, then the cost of using the asset is approximately zero. This is not as ideal as being positively leveraged, but is much better than being negatively leveraged, as is the case in the above cases. In this case, you might borrow 100% negative amortization, and when you sell, you simply walk away, no cash one way or the other. It should be noted, however, that there is a profit on the sale, since the selling price is more than the purchase price, but the cost of the capital matches the gain. Let’s assume a owner-occupied residence where no taxes are due.
Case 3c: Positive leverage
If market prices are going up by more than the cost of the capital, then you are positively leveraged. This is the ideal case, and if the risk is sufficiently low, then take all you can get. This is what happened during the run-up in prices. Your cost of capital [=borrowing cost at ~5-6%] was below the market gains. In this case, you want to borrow as much as possible to maximize the returns of the positive yield spread. See also: Housing bubbles.
That said, we always must deal with future expectations. It does not matter what the value was yesterday, or any time before yesterday. When selling you will always sell today or in the future. And thus it’s only future expectations that matter.
Now that we have that out of the way, Case 1, where the housing market is expected to decline, then lower priced homes will be demanded to minimize the losses. In Case 3c, larger, more expensive homes will be sought to maximize yield spread profits.
Now you decide your own discount rate and expectations about the future of the housing market.
This same framework can be used for negative discount rates, but the cases shift around a bit. For example, you could be positively leveraged if you have a negative discount rate that is less negative than the market returns.
“For example, you could be positively leveraged if you have a negative discount rate that is MORE negative than the market returns.”
Even for a 15 year mortage, they’d have to be near 10% interest to pay $3,900 a month for $380K balance. If they refinanced that today to a 30 year at 4.5% like you can right now, that would be $1925. Head scratcher there considering half the difference is from the interest rate alone – assuming there wasn’t a huge typo and they were just at a super high interest rate.
@Jim,
“If the numbers never penciled out, would you stay forever?”
1. Not forever. At some point (I am 61 and my parents are healthy and living in a multi-story house at 88) I would expect to have to leave this house for health reasons. But I probably can postpone that move for 20+ years.
2. The numbers don’t pencil out today because of the goal.
Sell at $780K
Minus RE commission (6%) $47K
Minus money spent on prep $20K
Minus 1st mortgage $110.5K (We are paying this down at approx $700/month. In theory, we have 11.5 years to go.)
Minus HELOC $39K (we are paying this down at $1K/mo)
Which leaves $563K to be spent on:
Add to vacation fund: $100K
Buy scraper for $200K
Build house for $263K
3. We can always change our goals:
a. Put nothing towards vacation fund.
b. By a house for less than $463K.
4. As we pay down the 2 mortgages, the numbers become better for us even if the selling price stays at the current $660K. So, actually, every month, the numbers come closer to desired.
5. Buying a newer house in [the City & County of] Denver for less than $460K is quite easy. My problem is that I have the hots to build another [we built this one] house. Building your own is a lot more expensive because of:
a. land purchase cost
b. construction quality
6. I don’t see any trends (Denver is/was not Phoenix or Las Vegas) towards lower house prices. I also don’t see any trends towards higher prices in the near future.
To Pemeliza:
They are not gambling on inflation (gambling is what you do in a casino). What they are doing is “certaining” – ask your parents what Vietnam and LBJ did for inflation and house prices in US$ (not beer tokens). I promise you everything (with the exception of computer power) from beer,bread,potatoes,land, bricks and sticks to petrol and real estate will cost a larger amount of dollars in 2020 than it does in 2010, your mortgage amounts and payments if you are clever remain constant however.
@JP2,
I took all those finance classes years ago when I got my MBA. Your financial analysis is accurate.
But, I do not consider a house that you live in to be an investment. It is, in my mind, a place to live and change to fit your lifestyle. That is why we [share ownership with the bank] “own” a house and don’t rent.
For example:
1. We had $300K (purchase + rennovation) into our house in 1987. The CPI says that is $576K in today’s dollars. We have also put another $25K in improvements over the last 23 years. So, $600K in round numbers.
2. If we put $100K into the stock market in 1987 it would be $366K today (based upon S&P 500 and ignoring dividends).
3. This means that our house has been a terrible investment.
For the first family in the article… The ones with the large house in Windsor moving to a smaller house in Denver… Windsor is a hike from Denver – it’s almost at Ft. Collins… easily a good hour drive in good whether, assuming no snow storms. Houses are more expensive in Denver. The markets are different. They weren’t just downsizing, they were changing markets. It would be like selling a McMansion in Temecula valley and complaining you couldn’t buy a smaller house, cheap enough, in Mission Hills.
The line that really struck me from the article was this:
Some adult children object to their parents’ selling the home they grew up in because they are afraid it will cut their inheritance, says Prof. Kotlikoff. One way to address that problem: Give the children some of the sales proceeds right away.
Are there that many adult children that are THAT selfish? Wow.
Dave Barnes,
Isn’t CO a personal recourse state for a mortgage? Maybe that’s why you’re not seeing price movement (outside of the pockets of overbuild i.e. Greely)
The 3,900 mortgage probably 1) isn’t the original amount or 2) isn’t a 30 year. Some people still use 20 year (or less)….
Dave Barnes- “But, I do not consider a house that you live in to be an investment.”
If it’s not looked at as an investment, it is unclear why you’d care how much it sells for, or if it would sell for more in the future.
Sure a rational player seeks to maximize the selling price, but if the decision is not made based on finance, why would you stay if you want to move to a different place?
Andrewa,
Factor in opportunity costs, and you’ve got a thesis in waiting.
Chuck
Dave Barnes-You forgot one thing. If you didn’t buy a house in 1987, you would have had to rent for the past 23 years. You have to subtract 23 years worth of rent from your purchase price in adjusted dollars. Actually, the math would be:
Value of the house today – (Purchase price in today’s dollars + taxes paid over the years in today’s dollars + HOA fees (if any) in today’s dollars + repairs/maintenance over the years in today’s dollars – tax breaks for owning in today’s dollars – rent for a similar place for 23 years in today’s dollars). If the number is greater than the profit any investment (stock market, gold, whatever) you could have made with the same amount of money as the purchase price (both in 1987 dollars), it was a good investment.
Something like that, anyways.
In any case, the best choice of action is probably to stay put. Once you pay off the mortgage completely (in 11.5 years?), you get on the real free rent program. Not the phony I-ain’t-making-any-payments-until-the-bank-forecloses program, the real I-don’t-owe-anybody-rent program. Even if you want to build your dream house, not having a housing payment beats a perfect house, IMHO.
JP2,
If your friend held his gold for 30 years only to sell now he truly is a fool.
tj & the bear- I agree, but he got the “I told you so.”
Basically he said he would not sell it for less than he bought it for. He was right. Really I never thought he’d hold out for so long. And what’s worse, I actually forgot about the whole situation…
“I told you so.” and “I call that 30 lost years.”
Also, there is a good chance that if he were a bit older, he wouldn’t have made it, and it would have been a lost story, as I would have never remembered these things.
Re # 24 How much the free rent program you cite costs depends upon taxes and insurance. In CA its essentially a free tax program with Prop 13, but not the same elsewhere (over 65 programs possibly being excepted) And then you have insurance which costs something but depends upon where in the US you live. (In CA do you include Earthquake insurance??). So its more like the cut your rent by 75 to 80% program.
So its more like the cut your rent by 75 to 80% program.
True, but that’s nothing to sneeze at. Yes, you are still on the hook for taxes, HOA fees (if any), insurance (although in theory you could cancel this-there’s no requirement to hold insurance on a property you owe outright), and repairs. But, like you said, that’s probably only 20% of your previous payment.