What To Do With All That Home Equity?
May 3, 2021 | By Kevin Smith
Elon is here and he brought Tesla. It seems like a new celebrity or ultra-wealthy tech investor moves to Austin every week, and I hear casual Austin references in podcasts so often I barely take note anymore. This type of growth seems different.
The quirky college town I remember from the 90s is no longer. Austin is on the short list of destinations for a seemingly endless stream of migrants fleeing the coasts and the cold for greener pastures (August here is not so green). The story is not new. We are about 10 years into a rising market, but the last year has been extraordinary.
Austin Home Values (from Zillow)
The Austin Zillow home value index shows a +18% one-year increase of the average home price. Other estimates are even higher. The reasons for this growth are debatable, but a basic argument for sustained growth is compelling. People are leaving less favorable living conditions elsewhere, and there is social momentum behind preferences for Austin. Both massive tech companies and startups are setting up shop in Austin, creating loads of high paying jobs and demand for housing.
The housing price factor receiving less attention is Austin’s disinterest in developing more dense real estate in the city limits. Far east and southeast Austin seem to be the last frontiers of development, and the only places to find a newer home under $450k. . The city embarked on a process to update the land-use code and failed twice to make substantial improvements to support density. With a surge of demand and stagnant supply, prices go up, and I can’t imagine preferences for density changing any time soon. We saw this reluctance to build more housing play out in San Francisco during a surge of demand, and it could happen here, too.
If you are trying to move to Austin, good luck! At some point in early 2021, there were only about 300 houses for sale in the whole city. Bidding wars are ending up in sale prices 15-25% above listing. If you own a home in Austin, you kind of hit the jackpot. You might be thinking about how to make the most of your sudden increase in equity. Here is a breakdown of some options Austin homeowners are considering:
This makes a lot of sense if you have a reason to move elsewhere. Selling after a massive run-up in any market is generally not a bad strategy. You can use your newfound equity to lower your monthly overhead, possibly while increasing square footage. If you are about to take a job in Detroit, you will probably find a castle to be affordable.
Selling is harder to justify if you want to continue working and living in the Austin area, unless you are ready to trade your semi-urban lifestyle for the emerging suburbs along the tollways: Buda to the south, Georgetown to the north, Manor, Hutto and Taylor to the east. Those communities compete with each other and have a lot to offer. The new Austin suburbs are more compelling than the cookie-cutter Dallas burbs I grew up in. If you can improve your quality of life by moving outside of town, you will also improve your cash flow and participate in Austin’s continued growth. I love living close to town, but I am loosening my grip on the idea.
Stay and Improve
Almost everyone in Austin has enough equity to take some cash out, either by way of refinancing or a home equity loan. If you can improve your interest rate and plan to stay a few years, it probably makes a lot of sense to refinance. If you take cash out, it is important to know how it impacts your payment, interest rate and closing costs. You should also have a plan for a productive use of the lump sum of cash suddenly appearing in your bank account.
If refinancing doesn’t make sense because you’ve done it recently and can’t improve your loan, a home equity line of credit could be a possibility. Keep in mind your interest on that loan is only deductible to the extent you use the funds to improve your home, and the interest rate is variable, meaning it can increase or decrease with the market.
What can you do with the cash? The increase in home value was driven by the demand for your land, not necessarily your slightly dated kitchen. You could use the funds to make home improvements to add value, to the extent market prices are higher than construction costs. That would be instant equity, BUT construction is currently very expensive. Labor and material shortages have driven prices up. For example, lumber costs 350% more than one year ago. General contractors have more work than they can handle, so they are bidding up prices as long as people will pay. Any new construction project runs the risk of being 25% more expensive and 50% longer to finish than anticipated. That is always a possibility, but now more than ever.
You could also invest the cash and wait. (This is probably what I will do.) How to invest depends on how soon you want to be able to use the funds and how important it is that you be able to pull the trigger quickly on a project.
Buy a Rental
Since prices have increased so dramatically, investing in Austin property has become appealing. You could tap into your equity to buy an income-producing property, which could work out great if prices continue to soar, but the market presents some challenges to this strategy.
The return on investment in real estate comes from a) cash flows from rent, and b) price increases. It is nearly impossible to buy a rental property and generate positive cash flow in this market because rent increases have not kept pace with property value increases, so the costs of owning the property will likely exceed the rental income. This means the owner will have to subsidize the property while holding it.
The big money in real estate is made on leverage, meaning that you borrow money to buy a more expensive property than you can buy with cash, and you benefit from the entire price increase. This works great when interest rates are low and property values increase. An Austin real estate investor might have to plan on paying at least $10k annually, but maybe $20-30k, to own a rental property with the hope that appreciation will more than offset those costs. This is not for everybody, and we encourage new real estate investors to at least consider other markets.
Rent your house and live somewhere else
You may not want to walk away from your Austin equity and the chance that it will continue skyrocketing, but you wouldn’t mind living somewhere else. The conditions are similar to those described in ‘Buy a Rental’. You will likely have to subsidize your rental and hope the price continues upward, but moving somewhere that substantially improves your cash flow could relieve that burden.
If your cash flow is strong, and you like your house and location, there is nothing wrong with simply enjoying the good fortune of living in Austin at the right time for price appreciation.
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