Flag: Real Estate
Boomers on the cusp of retirement or beyond looking at soaring real estate values may realize just how sweet is home.
Capturing large home appreciation and renting, downsizing, or moving to a part of the country where living expenses are more modest may offer a way to stretch retirement dollars, advisors agree. But, they add, there are no pat answers and any discussion should cover both the financial and emotional impact on clients.
Since the first quarter of 2004 rental vacancies have ranged from 10% to 10.4%, according to the U.S. Census Bureau.
Even so, average rental costs vary nationwide and may affect the decision to sell and then rent.
Data from the Department of Housing and Urban Development appearing in late 2003, found the following rents for a two-bedroom apartment: Flagstaff, Ariz., $887; San Francisco, $1,775; Atlanta, Ga., $944; and, Chicago, $951.
“The best thing for all people, in general, is to look at it in the context of personal life needs,” says Keith Newcomb, a certified financial planner and wealth manager with Full Life Financial, LLP, Nashville, Tenn. The home is a center place of our lives, he continues, so the first question to ask is whether “current housing meets my needs.”
There is a tendency to want to “stay put,” according to Newcomb, and that may be a good thing because “speculation with a primary residence is not necessarily a good strategy. When you speculate with, what for many, is their single largest asset, it creates more risk.”
One measure of determining whether or not it is better to rent is to look at a home’s value and establish a P/E ratio, he says. And, if the P/E ratio is high, then the cost of renting needs to be compared, Newcomb says.
It is important that a client take a long-term strategy, if a decision is made to sell, he adds. Points to consider include whether equity in the house will outpace savings from the sale of a home and the eventual risk that rents will begin to catch up with the costs of maintaining a home, Newcomb says.
The issue often comes to the fore when there is a life change, he explains. Newcomb recounts a physician who sold his residence in New York City and moved to Waynesboro, Tenn. He decided to rent, according to Newcomb, because he believed that market appreciation would be “fairly stagnant” given the distance from amenities such as a movie theater. While the strategy can work if you move to an area where the cost of living is lower, if you stay in the same market, it may not work, he adds.
If someone is selling and going to buy again, Newcomb suggests that they consider the following:
==access to transportation hubs;
==a growing urban center 1-3 hours away;
==a new, growing urban center;
==commercial activity nearby (for instance, turning a farm into a shopping center.)
If a decision is made to buy rather than rent, Newcomb says, a net present value analysis has to be completed to determine whether it is better to pay in cash, take out a mortgage, decide on how long the mortgage should be, or decide on a combination of both cash and mortgage.
An advisor has to help a client determine whether it is worth paying $1 in mortgage payment to save 25-35 cents on that dollar, he adds. And, Newcomb continues, as the note amortizes, the deduction will go away. So, what might be a good plan in the first 5 years, might be a bad plan in the last 5 years of a mortgage, he continues.
And, an advisor must make sure that a client is not persuaded to take on more home than they can afford to own or to choose mortgage options that pose higher risks such as an interest only option without understanding those risks, he explains.
If a boomer is looking to downsize then it can be an opportunity to secure a client’s financial future, Newcomb says. For instance, some of the assets from the sale of a home can be redeployed to the purchase of long term care insurance, he says. This can be important, he adds, because although many boomers are freeing themselves of “ball-and-chain items” such as college costs and the cash flow looks great, 20 years down the road major health care expenses could impact cash flow.
This is a major investment that clients are making and it is important to present them with the whole picture, according to Elyse Foster, a certified financial planner with Harbor Financial Advisory, Inc., Boulder, Colo. For example, a planner should run a projection of growth rates and inflation and keep in mind that there are still pockets of very good value in the U.S. if a client is willing to relocate.
Before deciding on whether or not to sell and then rent, a client needs to decide on a time line. Will they rent while parents are still living in the area or until children finish up school? she asks.
If a client is going to remain in an area for less than 5 years, it probably will make more sense to rent than to buy because of fees and expenses related to selling and then buying another property, Foster says.
Liquidity is another consideration, she adds. “Stocks are much easier to unload. Real estate is much more expensive and cumbersome. It is a big asset.”
While appreciated real estate prices may encourage an individual to rent rather than buy after they sell a home, Foster recounts the experience of a woman in Tucson, Ar., who sold her home, rented and lost ground to inflation. “Rents ate up her reserves,” she adds. And, according to Foster, she lost control over her ability to remain in a location. She ended up moving three times, according to Foster. Her income consisted of Social Security, a small pension, and the equity she held in the home that she sold, Foster adds.
The National Association of Home Builders, Washington, says that data in fourth quarter 2004 suggests that the rental market, particularly the mid-range rental market is gaining momentum.
But if a baby boomer downsizes and relocates to a less expensive community, then they can have a reserve of cash and continue to participate in a real estate market she says on average, nationally has experienced a 6% return.
In addition to financial considerations, Foster says that there is also the psychological factor of how important it is for a client to own a home.
One of the worst things that a client can do is to buy too much home, she says. A client needs to ask, “Am I sacrificing too much to own an expensive home?”
Ricky Grunden, a certified financial planner in Dallas, says that he would start by producing a spreadsheet comparing the cost of renting with the cost of buying.
Lifestyle can be a big factor on whether to stay in a home or downsize, he notes. He says that he is working with a couple that has just downsized and loves the fact that they no longer have yard work.
And, if money is ultimately needed for either long term care or assisted living, there is an asset that could be sold, he adds.
But, when most people leave a house, it is usually because they cannot keep up with the maintenance and renting takes care of that, he says. But, rents may also escalate because the higher cost of housing has kept people out of the market, he says. Most clients find comfort in buying rather than in renting, Grunden says.
Whether a client uses the proceeds on the sale of a home to pay for a new home or assumes a mortgage really depends on the temperament of the client, according to Grunden.
If a client wants to keep money available but also guarantee that they will be able to pay off the new home, then he’ll recommend investments such as municipal bonds, a fixed annuity or laddered government bonds, he adds.
With interest rates so low, he says that a client may want to consider a 30-year fixed mortgage and let inflation eat away at the payments over time.
Michael Kitces, director of financial planning with Pinnacle Advisory Group, Columbia, Md., says that if a boomer’s geographic area is in a bubble, then it might be worth downsizing to a smaller home or to rent in order to “take equity off of the table.”
Such options can be ways for baby boomers to make the numbers that will get them to retirement, he adds. But, Kitces continues, the discussion has to be broached carefully because for many clients, a home represents safety or holds emotional ties.
And, if a decision is made to downsize and to purchase a new home, boomers may have different reactions to assuming a new mortgage rather than paying for the home with proceeds from the sale of the first residence, according to Kitces. Boomers’ parents, products of the Depression, taught them that a mortgage should be paid down, he says. So, although “boomers are more comfortable with mortgages, they did get the lesson that you should make a mortgage go away.”
He also says that advisors have to temper a boomer’s enthusiasm to buy a lot of house and end up “house rich and cash poor.”
In some areas, home prices have outpaced rents and it may be better to rent, Kitces says. But, he adds, “the reality is that people do not make decisions just on money.” So, it may be difficult for someone in their late 50s who hasn’t rented for over 25 years before they got married, to decide to rent, he says.
“Should I stay or should I go?” is the question boomers are facing