Scott Burns

Time to Sell Your House?

That question appears on the cover of the new Forbes Investment Guide, available on newsstands. The article, titled Moving On, establishes a first for articles on residential real estate: pre-emptive selling. The article suggests that selling your house is …like selling short: You could unload your house and buy back something just like it two years from now.

The article tells the story of sales in Tampa and Manhattan. The sellers are going to rent while they wait for home prices to decline.

It may happen. It’s certain to happen somewhere in the next two years. The real question is whether it will happen where the sales are made and whether the decline will be worth the costs. Not to mention the personal wear and tear.

Those costs include:   preparing the house for sale, keeping it ready for showing, the selling commission and related fees, the cost of moving and making the new place home-like, followed by the cost of searching for the lower priced replacement home, the costs of buying and financing, the cost of moving (again), and the cost of making your new-new place home-like. Offsetting all that could require a decline of 10 to 20 percent, depending on how much your two new place makeovers cost.

In fact, a good case can be made that home prices have risen handsomely in recent years for a reason— the first $500,000 of home sale capital gain is tax-free. This change in the tax code materially changed the nature of housing as an investment. Prior to the change, you could only avoid capital gains on home sales by rolling over to a higher price home. You could also avoid a certain amount of capital gain if you sold your house after reaching age 55.

Nice. But complicated.

Changing the capital gain exclusion to $500,000, whatever your age, and allowing you to repeat it every two years if you got lucky— which is how the tax code reads today— basically made homeownership a tax-free experience. That, in turn, changed its relationship to other investments.

You can get an idea of housing returns by examining the table below. In it, I assume that you bought your house for cash and enjoy two forms of return. The first is your return in services— the tax-free imputed income you receive in shelter. You can also figure it as the difference between the total amount you pay to own your home and the presumably higher amount you would pay to rent the same home. (This return, by the way, is one of the reasons real estate economist Karl Case says that housing markets slump rather than crash— a house always provides a useful service.) The second is appreciation in the price of the home.

In moderate appreciation areas, service returns are often in the 5-6 percent range. In high appreciation areas, where rental values haven’t caught up with prices, service returns tend to be lower.

Why? Owners pay up, banking on price appreciation. Long-term, I think a good case can be made that service returns will vary from 4 to 6 percent. Historically, appreciation was 4 percent annually from the 80’s to the present. It ratchets up to 6 percent if we calculate from the inflation ridden 70’s.

Basically, that means houses have provided total returns of 8 to 12 percent— now entirely tax-free.

Putting A Range On Home Ownership Returns