Buying a home? Adjust to conditions

I toured Philadelphia's Northern Liberties neighborhood recently with a friend who is house-hunting. Boy, there's a lot going on there: big condo buildings under construction, old row houses being gutted and rehabbed, funky restaurants and bars popping up ...
It made me want to get out of the bland suburbs and move to town. But is this a good time to buy -- for me, my friend or anybody?
Like any small market, this neighborhood has its own issues. There still are a lot of dilapidated properties there. This is worrisome for a house-hunter -- especially a first-timer such as my friend, who expects to be transferred out of town in four years or so.
On top of that, there's been a lot of bad news about the housing market nationally. The National Association of Realtors recently said it expects the median existing-home price to fall 0.7 percent this year compared with a 1-percent gain last year. It said new-home prices should gain a miniscule 0.4 percent this year, compared with last year's 1.8-percent gain.
For 2008, NAR projected a small 1.6-percent gain in existing-home prices and 2 percent for new homes.
Given all we've heard about the softening real estate market, the subprime mortgage meltdown, the risk of recession and rising interest rates, does it make sense to buy a home this spring?
Making it economical
Maybe -- but only if you adjust to the new conditions. Generally, it takes healthy home-price gains -- on the order of 5 percent or more a year -- for buying to be more economical than renting if you don't expect to stay put at least five or six years. When appreciation is lower than that, it takes even longer to break even.
A home is a great long-term investment but a terrible short-term one. To counter the kind of rising risks we see today, buy only if you plan to stick around seven, eight, even 10 years.
To the extent you look at a house as an investment, you need to be more demanding than with other investments such as stocks. For two reasons:
First, a house is a concentrated holding, meaning you have a lot of money tied up in one thing. If a biker gang or slob moves next door, home prices could fall and you could lose a lot of money. With stocks and other securities, it's easy to spread your money around to dilute the risk.
Second, with a house, you generally lose money the moment you get it. That's because of the real-estate agent's commission you're likely to have to pay to sell. With mutual funds, there need be no commission at all.
Consider an existing home bought today for 250,000. To sell it, you'd pay 15,000 in commissions, assuming a typical charge of 6 percent. So the home's value has to go up 15,000, or 6 percent just to break even.
But if the NAR projections are right, the price would rise only about 1 percent over the next two years, leaving you 5 percent down. Add moving costs, fix-up costs and other expenses related to selling and you'd be even deeper in the hole.
Your down payment would have lost money. Had you rented, that cash could have gone into a worry-free money-market account paying 5 percent a year.
How it pays off
Over long periods, home ownership pays off because the monthly principal and interest payments, assuming a fixed-rate mortgage, are frozen. Rent tends to go up year by year.
Also, those interest payments are deductible on your federal tax return, while rent is not. And for most people the profits made when a house is sold are tax-free, while most of us are taxed on gains in stocks and other types of investments. But it takes a while for these benefits to offset ownership costs that renters don't have.
To weigh buying versus renting, check out the Bloomberg calculator at www.bloomberg.com/invest/calculators/rentbuy.html. Note that this, like others of its type, does not account for unexpected expenses you have as an owner but not as a renter, such as a new roof or furnace. Those would make the break-even period longer.
If you're eager to buy this spring, be picky and negotiate hard, as buyers have the upper hand in today's market.
Jeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at brownj@phillynews.com.