Many of my clients ask me about risk as it relates to buying and owning property in San Francisco, so I thought I would write down a few thoughts about the issue including what the relationship is between real estate risk and the time a person is willing and able to hold onto a property.
Why Does Real Estate Risk Exist?
Gains and losses in real estate are created at the time ownership transfers, at any other moment the gains and losses are theoretical unless, or course, you are trying to refinance, but that’s a different story. Keeping control of when a home is sold is what’s important. It is easy to assume that no one can take away the owner’s right to decide when to sell their home, but as the recent downturn showed this is not always the case. Real estate risk is created in relation to how susceptible an owner is to the market forces swirling around them. Specifically, will a time come when they must sell their home?
Time Creates Real Estate risk.
There are a number of ways that an owner can find themselves in a position where they must sell, and they are related to how long they plan to own a property. This brings up the idea of wanting and needing to sell a property and there is a big difference.
Owner Occupier and Real Estate Risk
There is no better way to minimize real estate risk then to buy a home with the intent of living in it for the indefinite future using a 30 year fixed mortgage. In this scenario the owner will not be overly concerned with market fluctuations and since the interest rate on their loan is fixed until the day they own the home free and clear, what interest rates do over time is of little concern.
The next rung of risk is purchasing a home with the intent of selling it in, let’s say, 5 years. In this case risk can still be minimized by making the distinction between Wanting and Needing to sell in 5 years. The difference is the owner may want to sell in 5 years, but if for what ever reason they shouldn’t they can make that choice. An owner may not have this choice if instead of purchasing a home with a 30 year fixed loan they purchased a home using an Adjustable Rate Mortgage (ARM) with a fixed period of just 5 years. If after 5 years interest rates have spiked causing their monthly payments to go up to a level they can’t afford they could easily find themselves in a position where they must sell.
Investors and Real Estate Risk
In a situation where an investor’s plan is to buy a home and then sell it in one year, as might be the case if the investor wants to “flip” a home, the risk is very high because it is impossible to know what the real estate market will be like in a year. What seemed like a great deal today could be terrible in the near future if the market hits a rough patch. There are holding costs when buying a home as an investment, costs which an owner may not be prepared to continue paying over the long term. This can lead to a time when they are no longer willing/able to cover their expenses, so not only do they Plan on owning the home for just one year, they may only Be Able to own the property for one year.
How To Control Real Estate Risk?
Buy for the long term.