Buyers Blog Update 10/30/2020
Have an Exit Plan
Moving is highly stressful and many buyers’ goal is to buy their forever home and never have to move again. The goal is aspirational and will not occur until that last move occurs, intentional or not. A household may live in a home that fulfills every dream, yet a job change, or life change can instigate another move. The average household moves every seven years. Some basic thought and decision making ahead of time can help make a sudden move far less traumatizing even if the move is a surprise, beyond the household’s control, and/or a step backward.
Businesses and business leaders often discuss the need for an exit plan when opening a new business or financial joint venture. The same thought process can be used when purchasing a home. The exit strategy should not drive the type of home to buy, quite the contrary. The exit strategy should reflect the type of home that you do buy and your household’s current stage in life. An exit strategy may also not be immediately practical and action after the home purchase may be required. There is always a level of risk involved with buying a home that can not be prevented entirely. The goal of an exit strategy is to put the odds of success in your favor as much as feasible.
The 2008 housing crisis and 2009 recession brought some painful financial lessons for some overleveraged homeowners. Tracey and I witnessed the financial burden that some people had to contend with when they were forced to move when their home value was under water (worth less than their mortgage). Some people wrote a check at closing, some rented their home and suffered through negative cash flow for almost a decade, and others did not have the financial strength to weather the storm and executed a short sale or the lender foreclosed on the property.
Large Oahu single-family homes typically provide the poorest cash flow when renting to long-term tenants and city regulations limit most homeowners to this option if they decide to rent. Rent as a percentage of the sales price of a single-family home is lower than a small condo with low maintenance fees and the cost of maintaining a single-family home is higher. Some people hold onto single-family homes because they want to return to the home when they retire. Keep in mind, that if you are raising or had raised children on Oahu, those children will not likely be living with you when you retire. Therefore, the house may not meet your needs when you return. Another thing to consider is that the cost of living on Oahu is high and it may not be practical to return to Oahu if your children and grandchildren live on the mainland. If you are thinking about buying an Oahu single-family home, the least painful course of action is to make a substantial down payment so that you can minimize the possibility of owning a house that has an under water valuation. If a large down payment is not possible, then make extra principal payments to build equity faster. This action will also significantly reduce your mortgage interest expense over time. One extra mortgage payment per year can result in paying off a 30-year mortgage in 17 years.
Small condos with low maintenance fees are your best option to if you want to hold onto a piece of paradise when you leave. The rent on some condos will cover the maintenance fees and mortgage if you have 30% equity, versus needing over 50% equity before rent will cover the mortgage on a single-family home. Please note that these figures do not cover the cost of maintaining an investment property. The price of the condo will also track the median price of Oahu real estate over time. Therefore, if you are worried about being priced out of the market if you return to Oahu, then a small affordable condo may be the best ticket home.
When determining your exit strategy, remember the tremendous tax benefit that a household has when selling a primary residence. An individual can exempt $250,000 of capital gains and a married couple can discount $500,000 of capital gains when selling a principal residence. Once a homeowner starts renting, then that exemption gets reduced by the percentage of time the property is a rental until the time that the homeowner has not lived in the property for two of the last five years (three years after moving). At that point, the homeowner exemption disappears, and the property owner must pay capital gains taxes on the entire gain plus depreciation.
While homeownership has many benefits, pay attention to the risks involved with owning a home. You increase your odds of success if you remain in it for seven years or longer. If you are likely living on Oahu for three years or less, seriously consider renting versus rolling the dice on owning a home for less than three years. Most people did not predict the mortgage meltdown of 2008 nor did they predict the economic turmoil created by the COVID-19 pandemic. Having and executing a well thought out exit strategy can minimize the financial trauma of selling in a buyer’s market.