How to Take Advantage of Bubble in Primary Residence Market

Question

Hi everyone,

My primary residence is in a clear bubble. I live in Louisville, CO and housing prices have skyrocketed due to very limited supply and massively high demand.

I bought the home in December 2010 for 337 and a very similar home with a less desirable layout in my neighborhood just came on the market at 435. Everything is selling at, or higher than, asking price, so I am fairly certain it will sell in that range.

I have a 30 year fixed at 4% with 253k left on the loan.

Is there any way to take advantage of what is happening in my local market right now? Or just sit back and watch my 'paper' value go up and up and up until this bubble bursts?

I have one rental property purchased last year that is performing very well so far (28% COC return) and have enough saved to buy a second property... But good deals are hard to come by.

Thanks for any advice you can offer,

Perry

Diane Bartley · Answer

@Perry - this is a very interesting question and one that I think about regularly as well. We live in Northern Virginia and bought in summer 2009 for a 12% discount off of what prices were at the peak (DC area never dropped as much in value as many other places around the country). Now that we're in recovery mode (or maybe a bubble), prices are back up to where they were previously and have even edged higher, and it definitely gets one thinking.

In order to determine what to do, if anything, I would ask what your big picture strategy/vision looks like. These are the scenarios I tend to think about:

1. If you love the area AND would be happy in your house for the foreseeable future AND don't want to downsize in order to realize the appreciation while maintaining similar payments, I would ignore the bubble and keep paying off that great low interest rate as scheduled. After all, prices rise and fall, but it doesn't necessarily mean you are in a position to take advantage of it. (In my situation, we are already living in a smaller house so downsizing is not an option, and we are locked into a very specific location due to proximity of family.)

2. If you love the area but would be fine to live in another house, maybe a duplex as you mentioned, keep trying to find something where the numbers work out. Have you run the numbers - would your current home be a profitable rental? (Mine by the way would not - it is a great to live in and the appreciation potential is very high, but it would not be a profitable rental.)

It also sounds like this extra cash wouldn't really make a big difference to your current major life/business/investment priorities. So probably best to just ignore it and soldier on. As an inspired follower of Mr. Money Mustache, I repeat his mantra of "$x assets and $x coming in from cash-flowing rental properties and a paid-off house" - and then I get to retire early and do whatever I want. :-)

Bill S. · Answer

The way to make money in an inflationary time is by borrowing as much as you can and getting out before it bursts (if it does). If you don't have the stomach for that and moving to a cheap place to live is not an option then you just ride it out and make the most of what you can.

Strategies in rapidly appreciating markets is to find short term deals where your exposure to the burst is limited. Some people have put contracts on homes under construction and then sold the house before closing at the new market price. $600K home at 20% per year leaves lots of room after the 9 month construction window is complete.

Value added deals also are a play. You find a property with some "issues" and shave the hair off and you can make a nice profit. That works in most markets but the results are compounded by appreciation.

Development and infill are also options. Find a small house in a nice area and scape it and build a big house and make big bucks.

Find raw land and subdivide and sell is another way.

A house on a large lot. Buy and sell off part of the lot is another.

Jon Holdman · Answer

Well, you could refi and get some cash out.

I agree deals are very hard to find here at the moment.

I recall an article in the Denver Post back during all the foreclosures.  It said "this poor couple is losing their house to foreclosure after 30 years, instead of burning their mortgage".  Turns out they had refi'ed and HELOC'ed the property again and again.  The money went to business ventures, vacations and what not.  When values fell and times got tough, they couldn't make the payments and couldn't see because they were so far underwater.  Guess what?  I have ZERO sympathy.  When you extract every bit of equity you're already selling the house.   What happened to these folks may well happen again.

A house you live in does end up with a lot of cash tied up in one item.  But its just an expensive doo-dad, like a boat or car.  Best, IMHO, to own liabilities, such as a residence, free and clear.  So I would urge caution before trying to extract cash from your house.  Don't put yourself in a position where you will lose your residence in the next downturn.

Bill S. · Answer

@Adrian Tilley Personally I invest for the long haul. I think that trying to time this market is a very bad idea. Right now, we don't have the liar loans and we don't have (as many) ARMs so the downside seems smaller. Also keep in mind that last time (2006) we really didn't take the dive that areas like Vegas and Phoenix did. Speculation is what drove the bubble and many of the tools of that have been removed from consumers hands.

If you are over extended there is no time like the present to pull back and invest within your means.

Denver Metro population is growing, we are adding jobs, and companies and people are moving here. If wages continue to grow so will the RE market and if RE values continue to climb wages will need to follow suit and so goes the circle. I'm sure that people tried to time the SoCal market in the early 80s and were left holding the bag after the area grew steady for a decade or more. BTW the Denver commercial RE market is considered a bargain compared to the prices paid in the Coastal markets. Think about that for a time.

Timing the market is generally considered a very bad idea.

Stay within your means and remember a rising tide lifts all ships.

Jaden Ghylin · Answer

Two options I can think of that some people used last time around.

1) Sell your house and rent.  This can be expensive to move and difficult if you have a family, but I know families in CA that did this.  Some even moved out of state to find lower cost housing.

2) Get a Home Equity Line of Credit and use it to invest in higher return projects.  Be sure you don't get caught in the bubble hype when it turns.  This is probably the easiest thing you can do, but it will be more difficult to find high return investments.  Consider looking out of state if needed.

I hope that helps!

-Jaden

Jean Bolger · Answer

Depends on what your priorities are right now. How much joy does living in Lousville give you? (I know, it's the "best small community in the country"!) How does that balance against your longterm goals? Do you have realistic means to reach those goals without selling/moving?

I made the move from hip/trendy Highlands (in Denver) out to working class Aurora, and it was a fantastic decision-- for me. But you are likely at a very different place in your life.

Perry Rosenbloom · Answer

The community here is amazing. Thank you all for such thoughtful responses. I transitioned from active to a lurker once we bought our first investment property last year, and now hopefully back to more active (I'm sure a newborn had something to do with it, too lol).

@Bill S.  - Great points. I really like the idea of finding a value added deal if we cannot find another rental.

@Adrian Tilley  - Ah, my wife would not permit the sell and move into a rental right now :) Wouldn't work with our existing lifestyle and circumstances.

@Diane Bartley  - Our current home would work as a rental, but again, not very realistic of us to move... Unless it was to a significantly better situation. And I love that mantra!

Jon Holdman · Answer

That's a great saying!

Adrian Tilley · Answer

@Perry Rosenbloom Only 2 things I can think of:

1. You can cash out and do something productive with the equity - buy properties or whatever.  If you can earn a higher rate of return than your interest rate, you're making money.

2. Sell and move - you might have to get an apartment or rent for a while until the market calms down, not a good strategy if you have kids in school, etc.  This is what I'm doing.  We found a place that is a bit below "normal" market (not this craziness we're in now) and will sell our home during this mini-boom.

Perry Rosenbloom · Answer

@Jon Holdman  - Agree whole-heartedly. While I've considered a cash out refi, I certainly don't want to over-leverage... If deals were plentiful, I might consider it more. But since I already have enough saved for when the next deal comes along, why add additional risk, right?

@Jaden G.  - Can't move out of state as my business is here (plus, I love Colorado too much!).

One option that crosses my mind very occasionally is to move into an up/down duplex with an FHA loan and rent my current primary... But in the markets we want to live in, even in the most optimal of situations we would have a significantly larger monthly payment.

How to Take Advantage of Bubble in Primary Residence Market

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