Buying now or waiting for the market to crash is the better strategy?
Since 2019, investment and rental property prices are facing their first real test for the first time. Mortgage rates are quickly rising, which puts downward pressure on prices. Therefore, many real estate investors are asking themselves if they should buy now before interest rates increase or whether they should wait for a likely market decline.
People who buy and sell real estate need to know this question, and we can find out for ourselves with some simple math.
The variables
Here, I’ll walk you through the differences between buying now and waiting for a “crash” to see how your returns might fluctuate. Using calculators, I will show you how to perform these statistics on your own.
Let’s put together two situations to see what happens. We’ll use home values just as an example. The first is to purchase now (mid-May 2022) when 30-year fixed-rate mortgage interest rates are about 5% and the median house price in the United States is $400,000.
After that, the normal house price will drop by 10% to $360,000, although this will not occur until the end of 2022, at which point interest rates for investors would rise to around 5.75 percent.
Timing is Everything
Please understand that I am not predicting a crash at this time. Prices will certainly begin to level out in the next months, and they may even begin to decrease at some time over the next year or two, in my perspective, rather than continue to rise. However, I do not believe that a 10 percent decline is possible.
In general, limited inventory and demographic demand will likely exert upward pressure on home prices, counteracting the impact of higher interest rates. However, we are living in unusual times, and the future path of the property market is uncertain at this point.
As shown by this blog, I’m going to model what I believe to be a real “crash” scenario – a 10 percent decrease in house prices – and see how it plays out. Though we could run an infinite number of scenarios, the “crash” scenario is the most fascinating to me since it is the one that receives the most number of queries.
The rent charges in all situations were $2800/month, with an average gain of 3 percent predicted after the acquisition. I did this because, even if prices do fall a little in the next year or two, I expect a substantial increase in real estate value over the following ten years. I understand that rent could decrease in a “crash” scenario, but I want to keep the number of variables in the study as few as possible. Therefore, I kept rent the same in both situations.
Analysis
This rental property calculator will be used to make this analysis as simple as possible, so I’ll enter my predictions here as well.
Scenario 1: Buy now
Purchase Price : $400,000
Down Payment: $100,000 (25%)
Closing Costs: $7,000 closing costs
Annual Appreciation: 3%
Loan Details: 5% interest rate, 30-year fixed rate
Rent: $2800
Assuming that I held the home for ten years, the cost of this fictional house would climb to $538,000, and I would be making more than $10k per year in cash flow after a decade of modest rent increases. In the scenario that I was to sell the home after ten years, I would make a profit of $265,000, which is a 13.28 percent annualized rate of return on my investment. Excellent profit margins!
Scenario 2: Wait for a price drop (10% price correction)
Purchase Price : $360,000
Down Payment: $90,000 (25%)
Closing Costs: $7,000 closing costs
Annual Appreciation: 3%
Loan Details: 5.5% interest rate, 30-year fixed rate
Rent: $2800
For example, in Scenario 2, if I owned the home for ten years, the worth of this fictional house would climb to $484,000, and I would generate about $11 thousand dollars in cash flow every year. Suppose you’re asking why the property’s value is lower in both situations. In that case, I’m assuming an average annual appreciation rate of 3 percent in all scenarios, which results in a lower value for the property. Our starting point for Scenario 2 was $360,000, as opposed to $400,000 for Scenario 1, which was the situation in the previous scenario.
In the event that I decided to sell the home after ten years, I would make a profit of $245,000, which is a 13.44 percent annualized rate of return, which is somewhat greater than the rate of return in Scenario 1.
Breakdown
Considering these two assessments, it is clear that the differences between these two scenarios are not very significant. Scenario 1 generates a bigger overall profit ($265,000 vs. $245,000), while Scenario 2 generates a better rate of return (13.44 percent vs. 13.28 percent). This is since you invested $90,000 down to gain $245,000 in Scenario 2, but you put $100,000 down to get $265,000 in Scenario 1.
If it seems that I manipulated the inputs to make the outcomes appear comparable (which I occasionally do for the sake of explaining), I did not do this. I devised a reasonable market collapse scenario that resulted in the following outcome, which I believe was reasonable.
To be honest, I was pleasantly surprised by how similar the outcomes of these two situations turned out, and I considered the findings reassuring. It is understandable to be concerned about the state of the marketplace and where we are headed in the next few months.
Receiving the findings of this study and discovering that “buying now or waiting for a 10% correction is roughly the same” gave me greater confidence in my investment plan.
My opinions on the current market situation
Because even though this is a perplexing marketplace, I am still aggressively seeking discounts. Here is why.
In the next year or two, I anticipate the market will continue to rise or somewhat level out in value. However, it is challenging to predict when the market will peak considerably. In addition, I believe the market will appreciate much more in the following weeks and months. Overall, I am not attempting to time the market since I have tried it previously and failed miserably every time.
According to the statement I made at the outset of this post, there are two independent variables within that equation: interest rates and real estate prices. One of these factors is up in the air, while the other looks pretty definite. My theories concerning the future of investment property prices are based on my observations of what has happened in the past, but they are only my thoughts. Investment Mortgage rates, on either hand, are virtually certain to rise shortly. The Federal Reserve is adamant about keeping inflation under control. Bond yields are increasing fast, causing mortgage rates to rise. Since the direction of interest rates is foreseeable, but the route of property value increase is not, I am attempting to make judgments based on the variable that I can more accurately predict: property value growth.
Predicting the Market
Even if the market does fall over the next year or two, I firmly believe that anything all along the lines of a 5 percent correction is more plausible than a 10 percent drop, even though a 10 percent correction is still theoretically possible. A 5 percent loss, which I will refer to as Scenario 3, results in the worst returns of all: $244,000 in profit at a 13 percent annualized return, which is the poorest return. This occurs because the fall in prices is insufficient to balance the increase in interest rates. As a result, even if the difference is tiny in the long term, purchasing now has a slight benefit over what I believe will happen most realistically in the following years, in my opinion.
These situations are preferable to what I believe alternative investments may provide in terms of returns. With inflation already eroding the purchasing power of money at an annual rate of 8 percent, I feel a great need to put my money to work. Currency is dropping in value at an alarming rate, and I do not want to see my purchasing power diminish. It is unappealing to own bonds since they pay a negative real interest rate (they do not even keep up with inflation).
Even though I invest in the stock market, I do not believe that I will achieve a 13 percent annualized return over the next 10 years in the stock market, nor do I believe that I am knowledgeable enough about cryptocurrency to allocate a significant portion of my net worth to that asset class. True, I am prejudiced in favor of real estate since I am most familiar with it. However, I think it will beat all other asset classes within the next ten years, bar none.
Research Matters
Of all, these are only my estimates and thoughts regarding the market. Individual investors are ultimately responsible for making their predictions about the market at the end of the day.
Once you feel where you believe the market is headed, it is time to do your research! As I did, use the calculators, news and related sources to evaluate whether now is a good time to invest or whether you would be better off waiting, depending on your estimates about where investment property prices and interest rates are headed shortly.
So do not let fear hold you back — crunch the figures believe in yourself and make an educated decision about your plan based on the information you gather.
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