Condo purchase?

jen

My husband (and dog) and I are currently renting a house in Ballard and are growing tired of maintaining someone else's yard and not being able to plan more than six months in advance (our landlord doesn't want to rent out the house long-term). Essentially, we're not wild about going through the expense and hassle of moving only to end up in a similar situation.

That said--now is clearly not the time to buy a condo in Ballard. Prices are still high and I can't imagine they will stay there. Right now, there's something like 20+ units on the market at Canal Station and no one's biting.

Understanding that RE is completely speculative, any thoughts on buying a condo in the Ballard/Phinney area in the next 12 months? Anyone think prices will adjust enough in that timeframe to make a purchase a reasonable decision? We would likely stay in a condo for four or so years.

My hope is that over the winter, the massive oversaturation will make sellers desperate and we could end up with a good deal. But I guess the question becomes: what is a good deal? How overvalued are condos in this area currently?

Any thoughts would be great! We could probably suck it up and rent for another couple of years, but we're not "happy renters."

Ubersalad

Occupancy level is the key in condo. Always request for HOA questionnaires, which has a list of questions/answers that will answer whether or not you should buy into this particular condo.

For example it will list out how many units in the condo, how many that are sold or under contract. How many that are rented out, how many are primary owners and if the condo is under litigation.

If the condo has over 90% occupancy level with an overwhelming majority being primary owners, I see little risk in such condo. But then again, that's tough to find nowadays.

jon

You could buy the condo now and at the same time buy put options on the Case-Shiller Index. There isn't a market for Seattle specifically, but you could use the nationwide one. That way, as housing market falls, the value of the puts will rise. The price you pay for the put is essentially the cost of the insurance. You could sell call options to offset that cost, but then you are effectively giving up all appreciation potential in your condo, but that's what renting is also.

http://www.nahb.org/generic.aspx?genericContentID=56050

prusakolep

jon wrote:

You could buy the condo now and at the same time buy put options on the Case-Shiller Index. There isn't a market for Seattle specifically, but you could use the nationwide one. That way, as housing market falls, the value of the puts will rise. The price you pay for the put is essentially the cost of the insurance. You could sell call options to offset that cost, but then you are effectively giving up all appreciation potential in your condo, but that's what renting is also.

http://www.nahb.org/generic.aspx?genericContentID=56050

It's not that simple. Case-Shiller index is not traded directly, but as futures, so you don't trade options on the index, you just trade futures contracts. And if you look at the futures chain for the national index: http://finance.yahoo.com/q/fc?s=CUSQ07.CME you will see that the quotes on the index contracts get lower with time and bottom out about Q2 2010 at a level of 186, which is about 15% lower than the current level of about 215. So according to the markets, national house prices will decline another 15% and will bottom out in 2010. As far as I know, you cannot hedge a house purchase using these futures contracts in the way you describe. You could use the futures to "lock in" the contract at its future time with the price that it is currently quoted at. So if you sell contracts dated Q2 2010, to hedge owning a house, you would be saying that you accept a 15% loss in 3 years. You could be ahead only if the prices drop more than 15%, but you lose out if they rise or drop less than that. On the other hand, you could buy the Q2 2010 contracts, making a bet that you want to buy at the bottom of the market, at 15% lower than the current prices. Of course, you would have to wait until 2010 to actually buy the house, but your price would be almost "locked in" at 15% less than you'd have to pay today. If the prices in 3 years turn out higher than predicted by the futures contract, then your contract will rise in value and if you traded the correct amount of the contract, that will offset the extra price you'd pay for the house. Likewise, if prices drop more, then you lose money on the contract, but get to buy a cheaper house.

But even that bet is not guaranteed - it will only work if prices in Seattle match the national index. If they don't, you could lose money on the contract without an equal benefit in being able to buy a cheaper house. The futures contracts work well for hedging price movements of only well defined commodities or securities - when it comes to houses, it is just an approximation. Moreover, when trading the contracts for houses, you'd have to trade an equivalent size of the contract as the price of the house you want to buy - I don't think that you could buy $600K futures contracts very easily, and you can't take a mortgage on a futures contract, like you can on a house... (I wonder if there are mechanisms to leverage futures positions - anyone know here?) So I don't think you can actually use these index contracts directly, but only as a tool to know what the markets really think about real estate prices.

jon

There are puts and calls listed here:

http://www.cme.com/daily_bulletin/Secti ... 007194.pdf
http://www.cme.com/clearing/clr/spec/co ... NG&foi=OOF

I think the interpretation of the levels of the CSI as a prediction of a falling price is incorrect. The rate of decline is instead primarily a rate of return that reflects the rental value of the property. Here's why.

Let's say you bought a bunch of properties that closely match the CSI for X dollars. You then enter into a futures contract to sell a corresponding amount of CSI futures that mature in three years at a price of Y dollars. Let's assume that in three years, your properties still match the actual CSI value at that time. You would then sell them for Y dollars via the futures contract, which because of the way CSI works would be close to the market value of the properties. In the meantime, you paid interest on the X dollars but could also rent out the properties.

So what should Y be in order for this to be a rational market? Since you are paying interest, you might think Y would be higher that X by the return you could have gotten by investing the X you paid for the properties. However, because you can earn income on the properties themselves, the Y you need to do this is actually lower than X. The amount of rent you would charge would exceed the cost of capital by the depreciation of the property (real wear and tear, not tax depreciation), plus the risk of ownership. So the properties themselves would be worth less, but you would have gotten that money out in rent in the meantime.

So I think you could use the CSI futures to offset the change in price. There probably is some small amount of loss built in as you describe because of the falling market, but I think going more than one year out that factor is small compared to the rent effect, because otherwise people would do arbitrage just as I am suggesting, because the future CSI really is the future price of houses you can buy today.

jen

Okay--this thread has officially gone way over my head.

casey1167

Jen, you complicated things by added that you and your husband own a dog.

Alan

I think the real answer is: "No one knows when, if, or how much Bellevue and downtown Kirkland will drop in price."

laxtosnoco

One of the reasons I like reading this blog is the diversity of backgrounds and opinions. Jen asked a simple (but I think unanswerable) question about whether now was a good time to buy a condo. Instead of getting a bunch of shouting back and forth with different prognostications (prices WILL hold flat, or WILL drop exactly 52.3453%), prusakolep did everything but derive Black–Scholes to provide a hedging strategy for her.

It is interesting that finance academics love to talk about efficient markets, and financial engineers are constantly thinking of new financial instruments for hedging or speculative purposes. However, they never really seem to help the individual who gets caught up in speculative markets and wants to do his/her homework without learning stochastic calculus. How many people are ready to start trading futures contracts?

Jen, it sounds like you've thought this through but are getting a little antsy renting. Four years for holding a property is not a long time frame to recoup 7%+ sales costs. I suggest you run a couple of scenarios using rent vs. buy calculators. Plug in some rosy and not so rosy sales price projections (ex. +/- 25%). If you're okay with the downside potential, then go for it. However, try not to let your increasing discomfort as a renter cloud your analysis.

Alan

I held a place in Raleigh, TX for 4 years and made 10% before sales costs.

I held a place in Austin, TX for 5 years and made 1% before sales costs.

Real estate does not always go up, but you have to pay to live somewhere. I'm currently hedging my bets by renting in this market. I have lower month to month costs and I think I have a lot less risk to losing money (although the risk of inflation seems very real right -- but then I've hedged against that in a couple of ways).

uptown

Condos prices can be more volatile than houses as you don't own the land underneath, and other factors, such as too many renters in the building, can make it very hard too sell (buyers have to get investor loan). Condo prices have been known to drop off the scale in many cities including Seattle in the past. Even after the dotcom bust, the new buildings going up in Belltown had problems selling. If the builder can't sell their units after you buy, they will rent them out, so price accordingly.
I would lean towards buying something on it's own land , even if it's small or old, before buying a condo in this market.