A New House Decision - Essay Example

? A New House – Decision A New House – Decision A housing industry in the United s is passing through a bad patch. It is indeed an uphill task to decide whether to buy a new house right now or not. Though prices seem attractive; it is indeed difficult to make out whether there is still a scope for the prices to go downward. A lot of uncertainty prevails at the economic front and a decision of such kind requires a thorough scrutiny from many economic angles. Moreover, purchasing a house requires substantial financial involvement and a wrong decision could be catastrophic causing financial doom in many ways. In such situations, it becomes imperative to take help of economic tools available with us. It will be prudent to assess the existing economic state of the country in general and housing in particular before we embark upon making any decision to acquire a suitable dwelling. As of now, current economic state of the country can be described as per the following. 1. Unemployment rate in the month of March, 2011 has been found to be 10.0 percent hovering at the same level for last several months. In fact, it has gone slightly up indicating that economy is still not improving in real sense (U.S. Unemployment…) 2. US GDP growth rate seems to be accelerating as it showed the encouraging numbers at 3.1 percent in the in the last quarter of 2010. It is encouraging in the sense that in the year 2009 it was negative and remained like that for several quarters between 2009 and 2010. (United States GDP…) 3. The crude oil prices are ranging between $110- $120 per barrel. Historically, crude oil prices have a biggest bearing on the economy. Whenever crude oil prices are found to be ruling high, US is found to be in the grip of recession. As per the comments made by various analysts, the prices are going to remain at this level for some more time to come. Housing Inventory in United States Some other statistical data that may help us in making our decision is excess housing inventory buildup in US market. According to Berg, Bob (2010), the excess inventory at the end of 2010 is somewhere around 1.2 million units. On demand update, the pent up demand is estimated to be around 1.24 families. However, how quickly pent up demand moves into the shelter market will depend upon the employment generation through economic activities that people get in coming days. As estimated by him, the excess inventory is likely to be absorbed only by mid-2012 or so. (Berg, Bob 2010) Marginal Benefits and Marginal Cost Marginal benefit and marginal cost analysis in economics can come to our rescue for making a decision in buying a housing unit when many other economic parameters are in disarray. (Mankiw, Gregory) The best part of procuring a housing unit, in contrast to other assets, is that it occupies a prime spot in the list of our daily needs. Other assets like stocks, gold, or silver hardly have any utility value–they are neither consumed nor they can be put to any daily use, but housing serves dual purpose. It provides us a shelter which is essential for our survival and also it is an asset, which appreciates over a period of time. The point is that even if we do not buy a house for our day-to-day living still we need to have one as our shelter and only option then is to have it on rent. If we attempt to compare the rent paid per month versus the cost of the housing per month by way of mortgage, we can quickly come to a conclusion whether to go for buying a house or just have one on rent. Assuming, the cost of housing is $200,000, one needs to pay $1,000 per month on rent. Mortgage cost of the housing with the matching features can be found out considering 15 percent down payment and mortgage period of at least 20 years. This will have three possible outcomes. 1. My mortgage cost is substantially higher than $1000 per month. 2. My mortgage cost is equal to or slightly more than $1000 per month 3. My mortgage cost is less than $1000 per month. Alternative 1 indicates that marginal cost is substantially higher compared to the marginal benefits. Assuming, mortgage cost per month comes to $1500 per month or more having taken into account the opportunity cost of down payment in the calculation. Alternative 2 indicates that with a little bit of additional cost by way of mortgage, I become the owner of a housing unit. Quite clearly, marginal cost is not much against the marginal benefits; after complete payout I become the owner of the house and I will have benefit of appreciation over a period of 20 years. Alternative 3 indicates that marginal benefit is much higher with no marginal cost. Marginal benefit is becoming an owner of the property after mortgage is paid out in 20 years, which will not be the case if I rent the house. I will get the benefit of property appreciation. Rents of properties keep on fluctuating in line with economic scenario and overall buoyancy or bearishness of the housing market. While doing marginal cost benefit analysis, it is required to take into account likely aggregate cost of rentals in next 20 years. We also need to make some sound calculation for what will be the likely appreciation of the properties after 20 years. This is required to make a sound decision whether to go for property procurement or not. Based on the above matrix, the decision becomes straight forward. This is how the economic theory of marginal benefit versus marginal cost comes handy in making the crucial decision of buying a housing unit. The Principle of Demand and Supply and Equilibrium The market forces of demand and supply decides about the ruling housing price at any given time and it keeps fluctuating. In the year 2006, the median price of housing touched its peak and since then it has been falling as shown in the graph provided by US census bureau. As per the latest data, the median price is hovering around 202,100 as reported for the month of Feb, 2011–that is the lowest since the peak seen in 2006. (Median and Average…) The availability of cheap credit from the lending institutions and banks was the major reason for buoyancy during the period of 2003-2006. It was further fuelled by speculative forces. Demand of the housing units rose sharply outstripping supply. There were all sorts of buyers–call them investors, speculators, or genuine buyers. Together, they were pulling the market up. Speculators come out first as soon as they sense the weakness in the market. They book their profit fast and genuine investors keep holding because they cannot realize the game. As the downward trend accelerates, more speculative sellers bang the price dumping the stock and thus price keeps falling until an equilibrium stage reaches to match the demand and supply forces. The equilibrium oscillation continues for several months or several years and one has to constantly keep an eye on it to judge the reversal of the cycle. (Mankiw, Gregory) It is not always easy to judge when the market has reached equilibrium until the housing index shows a reversal which lasts for several months. (Median and Average…) It is required to keep an eye on housing inventory data, which can give some indication of demand supply gap. Our understanding at macro level can give us some clue but that needs to be checked at micro level relating it to demographics, area specific growth and change in local policies. Location and Strength of Economy Location is an important consideration for our making a decision whether to go for dwelling unit or not. As economy gets strength, housing demand also increases. Rental will also go up but mortgage cost will not, once the mortgage terms and conditions of the property are settled. Location is important in the sense that Economy does not progress evenly in all parts of the country. It is quite possible that aggregate demand in the country rises as economy gets strength but that may happen in certain locations or states and at many places there may not be any rise in demand because economy there is at standstill. It is important to identify the locations where economic activity is on rise; the reason could be any either local policy changes or some demographic shift. Economic activities never remain buoyant evenly across all parts of the country. It is required to monitor the same diligently. (Mankiw, Gregory) International Trade International trade is a good indication of assessing about the strength of economy. For quite some time trade balance is not in favor of United States. The increased level of exports will give a fillip to the economic activity and will help reduce the balance of trade. US economy is essentially a service and knowledge economy; if new avenues are explored, it can give a big boost to the economy thus reducing the unemployment rate. It can immensely contribute to the GDP growth rate of the country. Education, tourism and high technology areas can bring the country out of recession, which will in turn have a multiplier effect. Housing demand will certainly go up during that time and that will be a time to buy a new house. (Mankiw, Gregory) Conclusions: The above insights now can help us taking a decision as per the following. Decision based on Marginal Cost-Benefit Analysis If I have to take decision based on marginal cost and marginal benefit analysis then the things are pretty simple. Though it is not an ultimate decision but still in the absence of other parameters it is a good way of deciding for buying housing unit. It should be kept in mind that though marginal benefit is higher than marginal cost, in no way it is an indication that there will be no fall in the prices of housing after our making a decision to procure one. Simply our decision is based on long term benefits versus current cost. It also means that we are not attempting to buy at lowest possible price. If marginal cost is found to be substantially higher against marginal benefits, I will refrain from procuring a house. Decision based on Demand & Supply Principle If I have to go by demand and supply then I would keep an eye on excess inventory buildup and when it shows that residual inventory stock has exhausted, it is a first signal to think about buying a dwelling unit. This implies that either we have now reached equilibrium or there will soon be demand surpassing supply and that will be a good indication to move ahead and procure a dwelling unit. Decision Based on GDP and Employment Data If I have to take decision based on GDP, I will think of buying only when at least 4 quarters of GDP growth rate show up trend on a continuous basis coupled with unemployment rate that keeps on falling in line with GDP. The present macroeconomic factors do not give me clear green signal and do not meet with my laid down criteria of investing in a house. In the given circumstances, I would like to wait for at least a couple of quarters more and again review my decision on the above grounds. References: 1. U.S. Unemployment Rate At 10.0% In March – Gallup. Online from http://thedaleygator.wordpress.com/2011/04/01/u-s-unemployment-rate-at-10-0-in-march-gallup/ [Accessed on 4/8/2011] 2. United States GDP Growth Rate Online from http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=USD [Accessed on 4/8/2011] 3. Berg, Bob (2010). Housing Inventory Data. Online from http://www.woodbiomass.com/woodbiomass/news/North-America/Wood-Energy/RISI-VIEWPOINT-UPDATE-US-Census-fourth-quarter-2010-housing-inventory-data.html [Accessed on 4/8/2011] 4. Median and Average Sales Prices of New Houses sold in US. Online from http://www.investmenttools.com/median_and_average_sales_prices_of_houses_sold_in_the_us.htm [Accessed on 4/8/2011] 5. Mankiw, Gregory N. Principles of Economics, electronic edition, P 4-14, P 177-180. Read More