Introducing our latest video series: Turning Tenants into Buyers.

This series breaks down the core mortgage fundamentals every DRE licensee needs to master when guiding first-time buyers toward homeownership. Throughout the series, we illustrate the distinct financial advantages of purchasing a home with a 20% down payment.

In this second episode, we depict the relationship between rental value and occupancy, and illustrate the best and worst times during a business cycle to acquire property.

Watch the first episode here. 

Establishing the cost ceiling

A prospective buyer needs to understand the dollar amount of market rent a tenant will pay to occupy a property is the ceiling amount a homebuyer of the property ought to spend monthly on mortgage payments and all other costs of ownership.

For a wage-earning tenant considering homeownership to understand the consequences of taking on mortgage debt, their discussion with their agent begins with the agent explaining that a landlord, with or without a mortgage, covers all costs of ownership from rent the tenant pays.

Further, the costs incurred for owning a property, whether held out for rent or occupied by the owner, are the same. Operating expenses such as utilities are not ownership costs, but are incurred by the occupant to use the property they rent or own.

Thus, first-time homebuyers are taught a fundamental truth about ownership and how it relates to rent.

A buyer agent intervenes to stop the tenant’s cycle of paying one third of their income on rent and receiving only the right to occupy the property.

But as the owner of a mortgaged home, one third of the prospective homeowner’s income delivers both the right to occupy the home and build equity in that home.

The 20% down home equity cushion

A successful transition from renting to owning property involves an awareness of the best and worst times during a business cycle to acquire property. In other words: timing the purchase.

In a recession, which starts the business cycle and ends when a recovery is underway, the pricing of property is most advantageous for a buyer of property. But during recoveries and on into boom times, the monthly ownership costs of buying a property reach 130% to 150% of a property’s rental value. This reflects a period of sales price distortion as buyers pile in.

Again, the timing of a home purchase is best during a recession and into the initial stage of a recovery — before boom-time pricing sets in.

Property prices fluctuate dramatically over the length of a business cycle, from recession through recovery.

In this context, home equity is instantly created by a down payment of 20% or greater, an important cushion against the loss of a home. Without a 20% equity cushion in a home when values drop — as in any recession — the homebuyer will experience a few years of negative equity. While consumer prices rarely decline from year to year in a recession, prices of capital assets — homes — do drop.

An agent frames it to their buyer-clients this way: cyclical ups and downs in the economy take place regularly, and home equity protects against adverse financial impacts which strike homeowners in a recession.

Economic cycles bring home prices into range

The widening gap between renting and buying the same or comparable housing is even more pronounced with California’s current high real estate prices. But as always in California, a premium is paid for the allure of living or investing in property here, the appreciation factor used to evaluate property in California.

The appreciation factor, estimated at 1.5% annually, is in addition to the annual consumer inflation figure generally held at 2%.

Home prices always drop from peak boom-time pricing, like what occurred mid-2022, as recessions inevitably set in, allowing opportunity value to be exercised.

The only option for buyers to compensate for the ceiling placed on their borrowing capacity due to existing debt is to offset their debt-to-income ratio with:

  • large cash reserves;
  • consistent employment at the same place for more than five years;
  • high credit rating; and
  • a mortgage with a low loan-to-value ratio (LTV).

The relationship between occupancy and rental value

The down payment, together with mortgage funds, represents the capital investment a buyer-occupant makes to own and occupy property.

The buyer occupant’s return on invested capital of savings and mortgage money is called implicit rent. And implicit rent is the amount of money a homebuyer — as a tenant — would pay to rent the same or equivalent property.

For all acquisitions of property, the buyer agent and their buyer-clients review how implicit rent plus monthly equity buildup balances against:

  • current mortgage interest rates;
  • opportunity costs of lost interest on savings;
  • default insurance premiums; and
  • operation and maintenance costs of the property.

Editor’s note — Stay tuned! The remainder of this series illustrates how an agent or broker fully and effectively communicates the costs of a worthwhile mortgage-leveraged homeownership to their prospective buyers and the long-term financial security a 20% down payment provides.