Buying a house? Here's why you should consider a small town.

The housing market has been insane for my entire adult life. For example, in 1996 at age 22, I was loaned $150,000 by a bank to build a house. Except for the land, I had no money for a down payment. In fact, I had no real savings, which was not strange given I had less than a year of professional work experience. I had drawn the construction plans myself (which sounds more impressive than it was). I had no experience as a builder or even a general contractor. Yet a bank was willing to lend me more money than I would earn in nearly five years. 

That may make sense to you. It made no sense to me at the time and makes no sense to me today. Who in their right mind would do that loan? Not me! Even so, it’s not nearly the craziest housing-related financial transaction I’ve been involved in. Not by a long shot.

So, when friends ask me housing-related questions—particularly the big question: should I buy a house?—I struggle with how to answer. The most honest answer always is: here’s what I’ve done. Yet, what I’ve done seems crazy. And all the options on the table today seem crazy too. 

Anyone who buys a house today is risking a huge market correction. The Case-Shiller index, which looks at housing prices and their relation to household earnings, is far above 2007/2008 levels, which we all are willing to call a “bubble.” If that was a bubble, what is this?

And for those of you not good at graphs: this graph charts a ratio of home prices to household earnings. The two are related and, in theory, this should be a flat line (when earnings go up, home prices go up, keeping the ratio steady). The spike up shows how people are reaching way beyond their earnings to get into a house.

With earnings staying flat, for the price to earnings ratio to go from a bubble of 5.5 to what is considered a normal level of 2.5 requires a 55% decline in home prices. And a ratio of 5.5 is a national average—the hottest markets are even higher. How could I ever recommend someone buy a house in such an overvalued market?

The answer has nothing to do with market fundamentals and everything to do with the reality on the ground. The Federal Reserve, with their actions in 2008 and the years subsequent, has signaled that housing prices cannot go down. Sure, there may be a modest adjustment, but there can’t be a systematic correction. Housing prices are too important to the economy for a correction to historic valuation levels.

And that’s a reality. We talk a lot here about city budgets and how a lack of productivity in our development pattern has made local governments insolvent. Drop property values back to even 2008 bubble levels and that chronic funding squeeze becomes an acute emergency.

Not to mention what a drop in housing values would do to the financial sector, where—in a zero interest rate environment—betting on housing, and all its derivative forms, is one of the most lucrative games in town. The financial people will attest that the average credit score on a mortgage is higher now. That’s true, but so is the leverage.

So back to the question: should I buy a house? I get back to what I’ve done, which is hedge my risk by buying in a place that is less overvalued and at a price that is not going to be destructive if valuations correct. For the professional who now finds that they can work from anywhere, I’m going to make a case here for buying a home in a small town (or a severely stressed neighborhood in a larger city, although I can’t speak of this option from experience). Let’s consider two houses.

Remsen, Iowa. Image via Josh Berendes on Unsplash.

The first is a $400,000 home in a major U.S. city, something similar to what my colleague Rachel Quednau wrote about last month with regards to Madison, Wisconsin. This is a modest home in a walkable neighborhood in a desirable city. Save up enough money to put a $40,000 down payment on that house and the monthly mortgage will be $1,560, not including taxes and insurance.

The second option (of many such options) is to be my neighbor, to move into a house two blocks from mine in the small city of Brainerd, Minnesota. Perhaps the house sells for the listing price of $225,000, but I think it is more likely that it sells closer to the Zestimate of $188,000. For simplicity, let’s assume $200,000. That’s half the down payment and a monthly mortgage of only $850, excluding taxes and insurance.

If I’m nervous about a price correction, the cheaper option provides me with less downside risk (the smaller market is less inflated to begin with and a 50% correction means I’m underwater in my mortgage $100,000 instead of $200,000). It also cuts my down payment in half, leaving me $20,000 more cash in my pocket. And, it gives me an extra $8,500 per year in cash, which you can invest (I’d diversify into something other than housing) or use on vacations, going to concerts, theater, or sporting events, eating out, or other memorable experiences, all of which are very accessible from most American small towns.

This is not only what I would do, it’s what I’ve done. When I give people this advice, I typically get the same response: Why would I want to live in a small town? What is there to even do?

And then I grasp all the more clearly why housing prices in major cities are so historically overvalued, even in a work-from-home age where people can literally live anywhere.

If you’re considering buying a house, you should really visit a small town. Great walkable neighborhoods, good local restaurants, fun arts and culture, lots of outdoor activities, no traffic, no commuting, relatively safe, the ability to buy anything you can get in a major city and have it delivered the next day, all within a reasonable drive to a major city for special events or a weekend getaway.

Plus the money to take that getaway. Or literally thousands in extra savings every year. Your choice.

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