Financial Samurai
Slicing Through Money's Mysteries
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If you want to upgrade your home, get excited! The perfect time to upgrade your move-up home is coming. Meanwhile, be patient and build your cash reserves.
I really can’t believe the good fortune for move-up homebuyers. The supply of homes has stayed relatively steady, but the demand for homes has been dropping since 1Q 2022 given mortgage rates have increased by ~2%.
For those of you with strong cash flow and large cash balances, you should be loving this economic environment! Not only is the Fed helping you make homes more affordable, you’re also getting a higher return on your risk-free cash.
As a parent to two little ones, I’m actively trying to accumulate more money to live in the nicest home possible. After all, the best time to own the nicest home you can afford is when you have the most number of heart beats living at home.
Once your kids leave for college, it’s unlikely you will be buying an even larger home. That would feel wasteful, lonely, and illogical. Rather, you’d probably either just keep your home or downsize. Maybe a condo by the ocean would be nice.
In 2020, I climbed up the home upgrade ladder when we bought our current home. It has the ideal floor plan for work from home parents with kids. Having an office is huge. It even has an extra room for an au pair.
However, two years have passed and there are more home deals appearing at higher price points. Even though I said that I bought our forever home, as a real estate fanatic, I’m always looking.
The perfect time to upgrade your home is in year two or three of a real estate down cycle. Historically, real estate moves in seven-to-ten year up cycles and one-to-three year down cycles.
The risk of buying after only one year of declining prices is that prices could still go down for another one to two years. And the risk of buying three years after the peak is that you might miss the bottom.
You see, it’s hard to know when the peaks and troughs are in any real estate cycle until about six months AFTER they happen. Therefore, the perfect time to upgrade your home may very well be at about 18 months after the peak. Basically, recognize when the peak was and wait 12 months.
Today, we know that 1Q 2022 was the peak in home prices. If you bought a home at the top of the cycle, not all is lost. You will just have to come to terms with your actions and enjoy the home for as long as possible. If you can hang on for 10 years, you’ll likely be fine. After all, if prices decline for three years, you’ll likely need at least three years to recover.
Based on the framework above, the best time to upgrade your home is between July 2023 through February 2024. Summers and winters are the slowest months of the year, which also make them the best times of the year to buy a home.
During the summer, people are traveling. Homebuyers will usually want to settle on where they will live before school begins. During the winter, people are also traveling and spending the holidays with family. Any seller listing in July, August, December, and January tends to be more motivated.
During a real estate down cycle, higher priced homes will usually decline more in absolute dollars. Some luxury homes might also decline more than the median-priced home declines in percentage terms as well.
During a recession, nobody needs to own a vacation property or a house with two more bedrooms than needed. Hence, they tend to be the properties that decline the most since they are the first to be listed.
As an upgrade buyer with strong cash flow, you are thrilled to see more higher-end homes with price cuts. Even if your own home is losing value, you are still gaining on a relative basis. Here are some examples.
Let’s say you live in a $500,000 home and you want to upgrade to a $1,000,000 home. Properties in your city will decline by 10% from here. As a result, your $500,000 home depreciates to $450,000 and the upgrade home depreciates to $900,000 from $1,000,000.
Thanks to equal home price percentage declines, you’ve now saved $50,000, or a net 5% off the purchase price for your upgrade home. Hooray! If you’re putting 20 percent down, you now only have to come up with a $180,000 down payment versus a $200,000 down payment.
Not only do you pay a lower price for your move-up home, your property tax bill will also be 10% lower as well. For long-term homeowners, having a permanently lower proper tax bill is very valuable.
In a scenario where higher-priced homes decline more than your home price, you’re really loving the situation. This scenario is very common if you look closely at the opportunities in a down market.
This summer, I saw a home listed at $5,800,000 that gave me some real estate FOMO. After three months, it finally lowered its price to $5,500,000. After a month of no activity, the seller delisted.
I’m confident if a buyer came in with a $5,100,000 offer with no-financing contingency today, the seller would accept. If the transaction went through, that would result in a 12 percent price decline.
We can argue whether the home was overpriced to begin with at $5,800,000. But I think it would have gotten $5,800,000 had it been listed in February of 2022.
Now let’s say you own a median-priced $1,800,000 home in San Francisco. At one point, the median price was $1,900,000. So you’ve lost $100,000 either due to real price declines or due to seasonality.
But thankfully, your company went public ten months ago and you sold a lot of your stock. You’re sitting on $3,000,000 in cash and $600,000 in home equity from your current residence. With an annual household income of $800,000 a year, you’re looking to upgrade!
You’re thrilled with the housing downturn because the house you want to buy costs $700,000 less. Meanwhile, you only lost $100,000 on your primary for a net benefit of $600,000.
But given you want to build more passive income, you don’t create economic waste by selling your primary residence. Instead, you rent it out for $6,000+ a month after you buy your upgrade home.
Sadly, there is also a chance your cheaper home declines by a greater percentage than your desired move-up home. In such a scenario, you are likely still coming out ahead if you upgrade to an expensive-enough home.
For example, let’s say your $450,000 home declines by 20% to $360,000. It was a spec house in a neighborhood an hour from city center. During boom times, builders overbuilt.
Even though you’re bummed out about a big price decline, if the $1,000,000 upgrade home in a prime neighborhood declines by only 10%, you’re still winning by $10,000. Then of course there is lower property tax and insurance bills compares to the pre-decline price as well.
To make this big leap in a very difficult economic environment, you would need conviction in your job security or cash flow. Because even though you’re saving on your big fancy home purchase price, your mortgage, property tax, insurance, and maintenance expenses will all be higher.
Although my risk assets have lost value this year, my passive income has not. Instead, my passive income has actually increased due to strong private real estate distributions and new tenants in my main rental property. After finishing my downstairs remodel, my rental home is getting rented out for $1,350 more a month.
For a while, I was deliberating on whether to be an idiot and buy a nicer home just two years after buying our forever home. To do so, I would have had to sell lots of assets and stretch like crazy to buy this nicer home. It was funny to observe how I couldn’t contain my desire for more.
But four months later my desire for a nicer home has faded. Every month that goes by, nicer homes I’m eyeing are getting a little bit cheaper. And because I understand real estate cycles take time to turn, I should have another 12 months or so to find a great deal.
While we wait for upgrade home prices to come down further, I’ll be aggressively accumulating as much cash as possible. And you know what? It feels amazing to have a new reason to save again. It also feels better to live in our home for at least three years, instead of just two.
If you’re looking for a place to park your cash, Personal Capital Cash is a high yield cash account yielding a 2.02% APY for non-clients and a 2.15% APY for clients. There are no minimum balances. Higher savings rates is the one immediate benefit of the Fed hiking the Fed Funds rate.
For trade-up buyers, the Fed is doing us a favor by hiking aggressively into a slowdown. If my read on how rich central bankers think is correct, then I expect to see at least 10% price declines in luxury property by mid-2023.
And if the Fed somehow relents by year-end with its aggressive rate hikes, our investments will likely start to appreciate in value once more. If so, due to a lag in the real estate market, we should have about a three-month window to buy our upgrade homes at discounted prices before they get out of reach again.
We may pay a higher mortgage rate. But at least we’ll get a nice purchase price discount for our home upgrade. As inflation returns to trend, then we can refinance into a 7/1 or 10/1 ARM and save even more.
The thing with personal finance enthusiasts is that we are forward-thinking. Instead of spending our money like uninformed maniacs as we head into a storm, we are increasing our saving rate.
Hence, not only will we be able to better withstand Fed-induced economic violence if it doesn’t relent, but we are also more easily able to withstand elevated inflation.
As the average person gets crushed because they don’t spend enough time reading about personal finance, we swoop in and take advantage of opportunity. This is how it’s always been and how it always will be.
Readers, are you excited about upgrading your home in this current economic cycle? Is the Federal Reserve actually hurting the majority by inducing boom bust cycles, while giving others the opportunity to take advantage?
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Filed Under: Real Estate
Author Bio: I started Financial Samurai in 2009 to help people achieve financial freedom sooner. Financial Samurai is now one of the largest independently run personal finance sites with about one million visitors a month.
I spent 13 years working at Goldman Sachs and Credit Suisse. In 1999, I earned my BA from William & Mary and in 2006, I received my MBA from UC Berkeley.
In 2012, I left banking after negotiating a severance package worth over five years of living expenses. Today, I enjoy being a stay-at-home dad to two young children, playing tennis, and writing.
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