Introduction
Price of housing in the US peaked in 2007 thereafter it has been falling. The declining prices of housing are caused by two key factors that are, high unemployment rate and high housing inventories which are pushing high house prices down. This condition has been brought about by the global financial crisis which has significantly impacted on the consumers spending patterns (Federal Housing Finance Agency 1). Further, house prices do not seem to have stabilized, and it is expected that the US housing market will continue to plunge because of the large inventory of homes and aberrant mortgages. The deteriorating performance was also recorded in 2011 both in pricing and the number of units sold. As reported by Federal Housing Finance Agency (FHFA) in quarter three, the seasonally-adjusted Case-Shiller index was more negative falling by 7.42% from a year earlier and by 1.61% from the previous quarter. Further, 313,000 units of houses were sold in September 2011, this is lower by 0.9% from the previous year. Also, average prices were down in quarter three by 20.02% from quarter one in 2007 (Federal Housing Finance Agency 1). It is argued that prices are so low that the US houses now seem to be undervalued. A recent study by real estate firm Zillow Inc revealed that “the US home prices are down from their fair value in one third of nearly 130 housing markets. Undervalued markets comprise of Detroit by 25%, Modesto, California (18%) and Fort Myers, Florida (13%)” (Global Property Rights 1). The graph below shows the trend in percentage change in prices for housing since 1991 to 2011.
From the graph it is evident that both nominal and real prices have been increasing at an increasing rate from 1991 to 2005. In the period from 2006 to 2007, the percentage change in price has been declining but still positive and thereafter a negative change (2007 – 2011). This situation in the housing market necessitated the government to intervene with costly measures.
Government intervention
With the shrinking housing market, the government moved first to replace the vacuum that had been created by the mortgage crisis. Government agencies have been pumping out more housing loans through a new relief plan introduced in October 2011. The relief plan is a refurbishment of the existing Home Affordable Refinance Program (HARP). The improvement was aimed at scrapping off the previous maximum loan-to-value ratio and reducing or abolishing the 2% fees paid by some high-risk borrowers. The HARP program has been extended to December 31, 2012 (Global Property Rights 1). This has lead to reduction of transaction fees and relented on some tough conditions that had to be met before conclusion of purchase of a property was done. This program has attracted a number of investors who were cut out by the harsh requirement and high transaction cost. Critics argue that HARP program is a very expensive way to stimulate the economy and therefore it is not worthy of the government’s initiative. This is because there is a reduction in revenue, and the state has to spend a considerable amount of money on the program. That withstanding, introduction of the program has seen an increase in mortgage-to-GDP ratio to over 100%. The highest was recorded in 2007 at 103% and later felt to 95% in 2010 due to the poor economic conditions (Federal Housing Finance Agency 1).
Purpose of the paper
With the falling prices and government involvement, the current housing market is appealing to invest in. Before any outlay is injected in a project, an investor would want to know the costs associated with acquiring such investment in the prevailing market conditions. Further, an investor would want to do a cost – benefit analysis in order to define if the project is worth investing in. Also, the investor would compare long term opportunity cost of other alternatives that may be utilized, such as renting, leasing other than purchasing. This treatise looks at various facets of a new medium sized house, in terms of the price, transaction cost, insurance, mortgage, among others, with an intention of alluring a financer to inject capital. The paper will analyze the costs associate with acquiring a new medium sized house estimated to cost $110,000. It is located in Florida, Orange County, Orlando (Global Property Rights 1).
Research and facts
Insurance
Properties owners, investors and lenders prefer the method of title insurance because it eliminates the risks arising from unseen hazards such as fire, theft, terrorist attacks, and floods, among others. Insurance of title will ensure that property is safe and marketable. Further, it is mandatory for any mortgage traded in the market to be insured. In general, home owner may cover both property and liability for accidents that may happen with the home (Brueggeman and Fisher 3). This is because, in the event that a peril occurs, the home owner may want to be brought back to the state he/she was before the accident. Therefore, it is necessary to cover both the property and the items in the property. The cost of insurance usually depends on what it would cost to replace the house and valuation of the additional items to be insured. In most instances, home insurance is usually a term contract for a fixed period of time. To a larger extent, the amount of premium to be paid by a home owner depends on the risks to which the property is exposed to (Brueggeman and Fisher 4). For instance, insurance premium for a house that is located in flood, war or earthquake prone areas is likely to be high. Premiums for both liability and property are usually in one fixed amount payable every term. Insuring an asset is important because, in the event that a peril occurs, the owner of the property will be compensated or, if it doesn’t occur, the owner will be paid back the total sum assured at the lapse of the insurance term.
ISO outlines various standardized homeowners insurance forms for general use depending on what is to be insured. The forms give a home owner a basic range of items that can be insured. Home owner may consider taking one of the many policies. The medium sized house will require an insurance policy which safeguards the property and liabilities that may arise (Brueggeman and Fisher 3). Various insurance companies in the US offer different packages that may be appealing to homeowner. These policies come with different costs depending on the risks insured and the value of the property. Leading insurance companies in the US are GMAC, MetLife, Farmers, State Farm, Mercury, Nationwide, The Hartford, Allstate, among others (Global Property Rights 1). On average, the annual insurance premium is 12.5% of the sum assured. Assume the sum assured is $200,000 and comprises of cost of the property and liabilities, this will amount to $25,000 per annum.
Property taxes and other related fees
In the US and other developed nations, property taxes vary across states. The tax base may also vary from one nation to other. Conventionally, tax is levied on the market fair value of the personal property, leading to a double taxing system. This market value is made up of two components that are, the cost of improvements or constructions put up on a piece of land, and the value of land (Global Property Rights 1). Other than the property tax, there are other costs inform of lawyer’s fees, registration fees, taxes, title insurance fees, recording fees agents fees among others that have to be incurred by the buyer during and after the purchase of the property. Title search and insurance fees vary depending on the location of the property, size and value of the property, coverage and complexity of the search (Global Property Rights 1). The fee is incurred for searching title of a property in the lands registry, the output is a title report. Though not mandatory, a title report is an essential prerequisite in securing title insurance. On average, the cost may equal to 0.5% of the property value (Global Property Rights 1).
Another common transaction fee is the recording fees. They are charged by the state for keying in an official record for the change of ownership. They are in fixed amounts and very minimal, and some states in the US do not charge it (Global Property Rights 1). In addition, there are attorney’s fees. They normally fluctuate depending on location and the complexity of the transaction. Each party (seller and buyer) usually pays for its own lawyer. Some lawyers will charge a fixed rate ranging from 0.5% to 1% of the sell price, while others may charge a fixed fee or on hourly basis. The total cost of attorney’s fees will depend on the extent to which they are engaged. There are real estate transfer taxes that are to be incurred. This also depends on the location of the property. Some states such as “Mississippi, Missouri, and New Mexico, among others, do not charge the fee. In Colorado, the fee is charged at 0.01% while in Delaware it is charged at 2%” (Global Property Rights 1). Finally, the transaction of trading in a house will entail the use of an agent or a broker. Agent’s or broker’s fees have to be paid and are usually paid by the seller. The amount is typically negotiable and it is always at 6% of the sell price. This fee is also depends on the duties to be carried out by the agent. In most instances, it is always high if the carried out activities are many. Since both the buyer and the seller may not be professionals in preparing documents ensuring that all legal requirements are met, it is necessary to meet the engage professionals and therefore transaction costs have to be incurred. The table below summarizes the transaction fees (Global Property Rights 1).
Table 1.0 Summary of transaction fees
The table indicates that, on average, a buyer may incur a transaction fee of 1.05%, of the selling price of the house, on the lower side and 2.2% on the higher side.
Maintenance and repairs expenses
Ownership of a home comes with a substantial amount of responsibility not only of paying the initial cost of the home, but also keeping it in working order. Just as a car, a home comes with its own specific set of requirements and oddities. These requirements require allocation of some money to cater for the cost (Global Property Rights 1). A simple procedure may be undertaken to determine the cost of the repairs. First, inspection of the house should be done so as to come up with a listing of repairs to be undertaken. Secondly, the repairs should be prioritized before spending because some may be of more agency than others. Third, a contractor can be engaged to give estimates of the initial cost and the duration the repairs are likely to take. Finally, a decision can be made on the amount of money to spend and what repairs are to be done first. To a large extent, the cost of repairs greatly depends on the condition of the house at the time of purchase, in the sense that a house in good condition is likely to take in less in form of repairs (Global Property Rights 1). The medium sized house to be purchased is in excellent condition, therefore repairs will not cost a large sum of money. The contractor engaged estimated the cost of repairs to be approximately $1000 and will take three days to complete the repair work.
Rentals in Florida
In the United States, monthly rate vary from one state to another. Some may be as high as $1,200 while others as a low as $400. In Florida, a three bedroom house would be rented for approximately $800 (Global Property Rights 1). Assume the house is bought under a mortgage with a fixed period of 15 years with equal term installments, in fifteen years time, the cost of the house (approximately $130,000) will be less than the cumulative rent paid for those twelve years ($800*12*15 = $144,000). This implies that in the long run it would be beneficial to live in the house than living in a rental. Buying the house would be a good idea because the rents may fluctuate from time to time. Conventionally, the value of land and building are normally appreciated due to routine maintenance, and therefore the rents are likely to increase in the long run while the mortgage may be fixed for a long term and occasionally change in case of poor economic conditions (Global Property Rights 1). This may be detrimental as the cost of renting would be greater than the cost of buying the house. By and large, in the long run, the benefits of buying a house exceed the cost in the long run. In the short run, the initial investment may be high, but it can be catered for by financial institutions.
Details of the house
The medium seized home is a residential property located in Orlando in the state of Florida. It is situated close to Bus line, Cul-De-Sac. The building is relatively new as it was constructed in 1999. The living room is of a quite large size15Ă—14, while kitchen is 12Ă—12. The house has a parking for two cars which is attached to the house. The interior comprises of attic ventilator and blinds (shades). Air conditioning is centrally located in the house. Heating is in form of fuel and electric. Appliances available in the house are range and microwave. The attractive exterior construction is made of block and stucco. The exterior feature is made up of patio (balcony or deck open). Finally, the data utilities are electric. The features of the medium size house are superior enough to invest in. Also, the house is spacious enough to start and grow with (Global Property Rights 1).
Utilities
Other than the interior and exterior features, the house has a steady supply of clean water throughout the year. Further, the sewage system is in good condition and well maintained. The house has a tapped gas supply throughout the year. It also has an electric system which is in good condition (Global Property Rights 1).
Analysis of value of the property
It is essential to value a property, as the price is necessary for completion of transaction. The price can be used for various purposes, for instance, in computing insurance premiums or in other transaction fees as seen above. There are three common approaches to valuing a property that is the cost approach, sales comparison approach and income approach (Jacobus 295). At present, trends tend towards use of scientific methodology of valuing proprieties which rely on the foundation of quantitative-data, risk and geographical location of the property. When using market comparison approach, a comparison is made with assets of the same features that have been sold before. Therefore, it is important to be familiar with the physical features and amenities of the property. Then, the features are compared to the similar houses in the same locality that have been sold recently under the same market value conditions (Jacobus 296). For more similar houses, few adjustments will be made to the price of the house. It is important to compare prices for houses sold not longer than within a six months period, especially if prices are erratic. However, if prices are relatively stable, sales comparisons can be made for a period of one year. For quite unstable market conditions, six months can be a very long time. In order to apply this method, it would be necessary to collect data for date of sale, sale price, financing terms, location of the property and a description of the physical characteristics and amenities (Jacobus 297).Three to five comparables can be used in the valuation. Adjustments can thereafter be made depending on the prevailing economic conditions, difference in size of various parts of the house and other unique features that are not common to both houses (Jacobus 298). The value of the house is arrived at by comparing the market price and adjusting it to suite the amenities in the house.
Using the cost approach, also known as the summation approach, the value of a property is arrived at by adding value of land with the depreciated value of structures put up on the land. “The cost structures comprise of cost of building a house and other improvements which has the same utility possessing modern design, workmanship and materials” (Jacobus 296). This approach is most appropriate when valuing new properties. This approach also uses the concept of sales comparison approach in determining value of materials, labour and other costs that are not land costs. Depreciation value is also obtained from comparison of various sales data. Finally, income approach is another methodology which can be used in valuation especially for commercial and investment properties (Jacobus 301). Sufficient market data is necessary for this approach because it utilizes the rents paid for a given size of office space. This method of valuation is largely applicable for income producing properties such as office towers or major shopping centers. This technique involves use of market supported discount rates to projected cash flows to give present valuation of the property. For the medium sized house, the comparison approach was used to estimate the value of the property as $110,000.
Legal forms
Buying and selling a house is one of the most important transactions that people encounter. This is because the amount of money involved is enormous. When acquiring properties, various legal forms and documents have to be prepared to process and complete the transaction. Most of these documents require use of a professional to prepare and process. Further, most of the real estate forms must be notarized in order to be recorded in the lands record (Jacobus 301). In the State of Florida, some of the legal documents that is required is the letter of offer to purchase. This letter outlines the purchase price and the terms of sale. Rights of the property are transferred to the buyer if he/she accepts the terms that are stipulated in the letter. In addition, Real Estate Sales contract has to be prepared. It is a contract for sale of real estate. “It can be used for cash sale, assumption or new loan buyer” (Global Property Rights 1). Residential Disclosure Statement should be prepared. The disclosure statement is a “form that the seller of the property must complete and provide to the buyer disclosing to the buyer all defects and other information about the residential property” (Global Property Rights 1). Lead-Based Paints Disclosure statement is required, especially when selling a house that was constructed prior to 1978. This form is usually completed and signed by both the buyer and seller. When the seller is doubt about the date of construction, then he/she should include that in the disclosure statement. Besides, when the form is in use, then the seller must give to the buyer the EPA Lead-Based Paint information Pamphlet. There will be the need to prepare buyers affidavits. By signing this document, the buyer affirms that he is acquiring property for use as a residence and that sales price does not exceed a certain specified amount. This is majorly used for withholding tax (Global Property Rights 1).
Assumptions
The medium sized house is located in Florida. The selling price (Market value) of the house, amounting to $110,000, is deemed to be the valuation of the house. Further, the annual rate of insurance premium is assumed to be 12.5% of the sum assured amounting to $200,000. This amounts to $25,000 per annum. The house will be purchased through a mortgage. The down payment will be 10% of the selling price, that is, $11,000 with an annual repayment rate comprising of interest of 7.8% of the selling price. This will amount to $8,580 per annum paid up front. The mortgage will last for 15 years. Upper limits of the transaction cost are used, that is, 2.2% of the selling price. Repairs and maintenance cost are also assumed to be $1000. The table below summarizes the initial cost that will be associated with purchasing the property.
Table 1.1: Summary of initial total cost to be paid
The initial investment cost for the medium sized family house will amount to $48,000. All these will be incurred in the year of purchase. On a yearly basis, cost of insurance premium and mortgage fee will be paid totaling to $33,580.
Conclusion
Putting in money in long term investments is a hard decision to make for both individuals and businesses because large chunks of money are involved and the transactions are not easily reversible. For this reason, it is essential to convince investors beyond reasonable doubt that the benefits that will accrue from such investments will exceed cost and that thorough market survey have been conducted to establish feasibility of such project. Such thorough scrutiny of the market will help investors make a rent or lease, rent or buy, make or buy decisions among others. It is worth investing in the three bed room located in the state of Florida as the long run benefits out ways the costs.
Works Cited
Brueggeman B. William and Fisher D. Jeffrey. Real Estate Finance and Investments. New York: McGraw-Hill Irwin, 2008. Print.
Federal Housing Finance Agency. Housing price Index. 2011. Web.
Global Property Rights. Property Search Listing. 2004-2011. Web.
Jacobus Charles J. Real Estate Principles. USA: LEAP Publishing services, 2009. Print.