I was recently at a focus group to test some ad concepts for a client’s Web site when one of the participants threw out a joke that got the entire room chuckling:
"Well, if you ask a Realtor, then it’s always a good time to buy."
Chalk that reaction up to some of the recent advertising efforts of real estate brokers, agents, and even the National Association of Realtors. Fact is, consumers simply don’t trust real estate professionals to tell them the truth when it comes to the critical question of whether they should buy a home or not.
And various other companies make it a point to stress how one cannot trust a Realtor when it comes to this question. This video on YouTube is a pretty good example of that message: "Don’t ask a real estate agent if you should buy a home. It’s like driving into a muffler shop and asking if you need a muffler. The answer will always be yes."
This is a widespread belief among consumers. And as long as this is a widely held perception among consumers, the notion that Realtors — especially buyer agents — are professionals who owe a fiduciary duty to the client is something that only industry insiders believe.
But I know from talking to respected Realtors that they do frequently tell buyers to wait on buying, that now is not a good time to be purchasing a home. The question I had, naturally, was when — and under what circumstances — would a Realtor tell a buyer client not to buy.
The rent vs. buy analysis
In commercial real estate, a very common analysis that is done is the lease vs. buy analysis. Commercial real estate software frequently includes a module that will allow the potential lessee to do a fairly detailed analysis on whether the company should lease the space or buy it outright. In residential real estate, however, this analysis is not often done.
So I went and did some analysis, with some help from a couple of stellar, ethical and data-loving Realtor friends: Jack Miller in Austin, Texas, and Linsey Planeta in Orange County, Calif.
I modified a worksheet from Kahn Academy with actual Excel functions for calculating payment and interest, and plugged in the actual numbers from recent sales and recent rentals from Austin and Orange County. The worksheet takes into account things like property appreciation, general inflation, maintenance costs, homeowners association costs (if any), property taxes, as well as what an after-tax return on money invested in stocks, bonds, etc., would return.
That last point is important since any rent-buy decision has to take the opportunity cost into account. I also took into account the deductions for mortgage interest payments as well as property taxes, and made some assumptions about family income for a joint-filing married couple. And I assumed that the buyer would be making a 20 percent downpayment.
The results are … surprising.
In Austin, a $230,000 single-family house would rent for approximately $1,250 per month; in Irvine, a $587,000 single-family home would rent for $2,832, on average, per month. On those numbers, renting in Austin saves $94,800 over buying that same house over a 10-year period. …CONTINUED
The present value of the benefits of owning that house in Austin is approximately $47,000 using these calculations. In Irvine, the renter saves a whopping $144,000 over a 10-year period over buying the same house; the present value of the benefit of ownership is about $142,000.
As long as the present value is positive, buying makes sense (assuming there aren’t other extenuating circumstances). In both cases, however, the assumption is that house prices will appreciate year over year at a 3 percent rate for Austin and 2 percent rate for Irvine.
The trouble is that, according to Trulia, home values for Irvine have fallen 14.1 percent over the past five years. And while home values in Austin, Texas, have appreciated a total 3.2 percent over the past five years, that is a far cry from the 3 percent annual increase in our model.
Even if we assume that Irvine’s horrid numbers were the result of the real estate bubble, and that over a 10-year period things will return to normal (after perhaps a couple more years of flat growth), 2 percent annual compounded growth year over year seems a bit optimistic.
Once we adjust to a more sober growth rate using Austin as the baseline (3.2 percent divided by 5, or 0.64 percent annual appreciation), the present value goes down dramatically.
The specifics of a rent vs. buy analysis depend on the local market conditions, of course, as well as the buyer’s situation. However, as a general rule, the truth is that the choice isn’t between renting vs. buying: the choice is between renting a property vs. renting money (the mortgage).
The question is: Are you sitting down with the buyer client and running through this worksheet with them? If not, why not?
The emotional issue
In talking through this with Realtor friends, I’m learning that most real estate agents take the approach that whether it’s a good time to buy or not is almost entirely an emotional issue. Some buyers are fulfilling a lifelong dream of homeownership; others believe that owning a home is a prerequisite to starting a family.
Whatever the drivers of homeownership are, the Realtor simply takes them as a given and works around it.
This is not enough. A professional adviser’s job is not to parrot the client’s desire, but to help refine it with additional knowledge and expertise, so that the client can make an informed decision.
If the prospective buyer says, "I want to buy because it builds equity, instead of paying rent so the landlord can build equity," the professional response to that should be, "OK, let’s sit down and take a look at the amortization schedule for mortgages, because you might not be aware that most mortgage payments are entirely interest on principal for the first 10 years or so, and it isn’t until payment No. 129 that payment to principal overtakes payment to interest."
The professional Realtor should be explaining opportunity cost, the effect of inflation, the effect of assumptions about growth and appreciation, and financial impact of having significant cash tied up in an illiquid asset (real estate).
The buyer may still decide to go ahead, but is doing so with full knowledge of what amortization is, what the financial impact of the decision is, and so on, thanks to the superior knowledge of the Realtor. …CONTINUED
If the buyer is emotionally invested in having a place of her own so she can paint it whatever color she wants, so she can hang her own curtains, etc., the professional response should be to point out the financial cost of that flexibility: $140,000 in Irvine over 10 years.
Above all, professional Realtors should be dispelling misconceptions, ensuring that the client understands the full financial picture of what they’re getting into, and providing guidance.
The professionalism angle
As long as consumers feel they cannot trust the Realtor with this question of whether it’s a good time to buy or not, Realtors cannot be seen as true professionals. If it’s always a good time to buy, then Realtors are not advisers but salespeople trying to hawk a muffler. Consumers know that Realtors get paid a commission — that they don’t get paid unless there’s a sale.
Use of financial projections, of worksheets on quantifiable benefits, helps overcome this lack of trust. It’s one thing to hear, "Oh yes, now is a great time to buy in Austin," and another thing altogether to hear, "Well, given your income level, given your cash situation, given the property in question, the prevailing rents and given these assumptions … the present value of owning that home is $2,400 over 10 years. It’s your call as to whether that’s worth the risks you’ll be taking on, but here’s what I think …"
While we’ve looked only at the purchase side of the equation, on the sale side a similar analysis should be run for the seller to inform him of the financial pros and cons of putting the home on the market now versus waiting a while. Gut feelings go a long way, but professionalism demands that conclusions be backed up with data and knowledge.
While a certain amount of facility with financial terms, and with concepts like time value of money and opportunity cost, is required, none of this is rocket science. Data has to be gathered, but most multiple listing services have that data easily available already; and other sources provide other data points you’ll need.
Tools can be created to simplify these kinds of analyses by brokerages and by vendors. Anyone whose business is advising people on such a major financial commitment should be able to run through this analysis.
And anyone who is unwilling to run through the analysis for fear of losing the sale should let the client know that she is a salesperson trying to hawk a house, not an adviser to be trusted.
Make no mistake about it, however: Consumers do not trust real estate agents to tell the truth when it comes to the question of when the time to buy is, when it comes to whether they should buy at all, and on the flipside: whether they should sell or wait. As long as that’s the case, the image of the Realtor cannot climb out of the gutter.
Robert Hahn is managing partner of 7DS Associates, a marketing, technology and strategy consultancy focusing on the real estate industry. He is also founder of The Notorious R.O.B. blog. You can reach him on Twitter at @robhahn.
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