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An energetic young entrepreneur made lots of money in real estate during the late 1970's by buying fixer-uppers and renovating them. His strategy was to buy a tired-looking cosmetic fixer and move in to it for a couple of years while he completed the transformation. When the work was done, he'd sell for a significant profit, find his next project and repeat the process again and again.
This no-brainer plan worked wonders for years until the recession of 1980. Mortgage interest rates shot up to18 percent and home sales slowed to a virtual standstill. Not daunted by the prospect of a slower market, this entrepreneur bought a project house in 1981 before selling the home he'd just finished renovating.
After months of marketing his masterpiece, with no nibbles, he found himself in a financial bind. He was supporting two home mortgages and incurring renovation costs at the same time.
Ultimately, he was forced to put the home he'd just purchased on the market. Unfortunately, this house sold before the one he really wanted to sell. Not only did he fail to achieve his goal, he was set back financially.
Perhaps you're thinking this would never happen to you. If you're prudent and cautious, it won't. However, this situation is not all that uncommon, particularly in a transitional market like the one we're experiencing now.
A Berkeley, Calif., homeowner thought she'd cash in on the huge appreciation she'd earned on her home during the late 1980's. She decided it was time to sell the big family home, which no longer suited her current lifestyle anyway.
Her mortgage broker approved her for a swing loan so that she could buy the townhouse she desired before selling the family home that she'd owned for years.
She bought the townhouse and put her home on the market. Unfortunately, the market for her home softened, and she was unable to sell for a price that would allow her to pay off her mortgage on the big house and pay back the swing loan. She ended up putting the townhouse on the market, which sold quickly. Not only was she unable to make the move, she lost about $50,000 in the process.
REPEAT- HOME BUYER TIP:
It's risky to buy a new home before selling the old one in a softening real estate market. If prices drop between the time you buy and the time your home is ready to go on the market, you might have to dip into savings to make up the shortfall. Or you might have to sell other assets, or sell the home you just purchased, as in the examples above.
A market slowdown could mean that it will take far longer to sell your home that you'd planned. If you're paying for two mortgages and a swing, or interim, loan, this could become quite costly.
An option for some who buy before selling is to rent out the old home if it doesn't sell within a reasonable time. If your mortgage on that property is low enough, you might even generate a cash flow. But, you may jeopardize your capital gain tax exemption ($250,000 for single tax-filers and $500,000 for married couples). This exemption is available only to homeowners who resided in the property for two of the five years preceding the sale. Consult with a tax-adviser before considering this strategy.
THE CLOSING:
Another concern is that tenant-occupied property can be difficult to sell unless the tenants are cooperative. You might have to incur fix-up expenses before you re-market the property.
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