Buying Now Beats Renting

I see the Fed staying behind the curve on raising rates. Fed is not run by monetarists, and Obama is putting in people like Janet Yellen who are not inflation hawks. The public is pushing back big time on Tax increases. I see a limit to the Gov't increasing taxes. End result will be the U.S. debasing currency. I also see inflation becoming a bigger issue. So in my scenario the Fed doesn't increase rates, the market demands them.

Finally, let me make the inonada case on this.

In my segment of the market, it ain't 19.5x, it's 25x. I'm not saying that 19.5x don't exist, just not where I'm interested. That cuts the net yield to 1.0% (or 1.4%). Maybe some things happen with maintenance (doesn't scale, exit from
AMT deduction blockade on taxes) that puts it at 1.5% (or 1.9%). The big problem is that mortgage deduction only counts on the first million. Your cost of financing is no longer 3.9%, more like 5.0% or 5.5%.

So on the one side, you have an asset that yields 1.5% (or 1.9%) plus 2.5% increases, the equivalent of 4.0% or 4.4% fixed. On the other side, you put up 20% and borrow 80%, so your interest amounts to 4.0% or 4.4% of total asset value. Holy crap, the yield on my 20% down payment is 0!!!!

And this is something on which I'd want 15% to make up for the risk and illiquidity.

Lmao again. Let's see they give you $6k tax credit then take away $200k in asset price as they (Bernie/Obama) tighten credit risk and interest rates. It's like the carsalesman making you pay over list then closing the deal with rubber floor mats. Flmao.

Which is why I sold at 19x in 2005. IMO, we need to get to 10x.

I think a reasonable story could be made at 15x. At 10x, I'd be buying everything I can. When you 5-6% to unlevered yield and then lever by 5x, that's a lot of lolly. Even in the inonada example, expected return on equity would spike to 25-30%. I'm not holding my breath on that, and I doubt we'd see it with current interest rates and bubble memories. Give it a decade, maybe we'll see something.

"IMO, we need to get to 10x."

nyc10023: If I'm not mistaken, don't you own currently? Out of curiosity, if you believe NYC RE is currently that much overvalued, then why not sell now?

Investors are like a herd of animals, they all do the same thing. I suspect we'll hear the virtues of getting out all regardless of price even if the correction has already basically occurred or been factored in.

I just wanted to re-post seg's post from about a page ago that got lost in the shuffle:

"For those who say there is nothing in the current market that has a chance of providing an adequate return in excess of financing costs, here's a few units to consider. Differnt types of units, different types of buildings.

555 W 59 #31A (Element) -- Sold $2.46m, rented for $9,923 net of free month ($10,750 gross).

205 W 76 #8G (Harrison) -- Sold $1.64m, rented for $7,000

155 W 68 #31C (Dorchester Towers) -- Sold for $1.04m, rent appeard to be $6,000

2025 Bway #6CDE (Nevada Towers) -- ASKED at $1.5m (did not sell), rented for $11,000

The respective cap rates (after MM) are 3.9%, 4.0%, 4.7%, and 5.2% (on Day 1). If you add in the (much discussed) generally accepted 2-3% expected inflationary growth, then the expected returns are in the 6.0% - 7.5% range, which is in excess of today's prevailing mortgage rates. And quite significantly in excess of mortgage rates if viewed on a tax-adjusted basis.

Any thoughts here? Maybe these are outliers but the notion that there hasn't been aything close to providing an acceptable return is not quite correct, I don't believe.

And yes, my calcs ignore transaction costs. IMHO, transaction costs to buy are not going to make a big difference amortized over time. If you assume that you sell, that of course does move the needle.

http://streeteasy.com/nyc/rental/550691-condo-555-west-59th-street-lincoln-square-new-york

http://streeteasy.com/nyc/rental/629116-condo-205-west-76th-street-upper-west-side-new-york

http://streeteasy.com/nyc/rental/537663-coop-2025-broadway-lincoln-square-new-york

[it wouldn't allow the 4th link]
"

seg: 'coz I'm lazy and my partner doesn't want to. But a bunch of brokers know that if they can bring me buyers at X w/o my having to keep the place in show condition, I'm out of here.

Let me take on the most challenging one:

http://streeteasy.com/nyc/rental/537663-coop-2025-broadway-lincoln-square-new-york

Quite honestly, I am perplexed by this one. No question the asking price of $1.5M is great from a buyer's perspective. No question the unit was listed for rent with a last ask of $11K and marked as rented, maybe after one contract fell through.

What I question, however, is the $11K rent. The unit listed is a low-floor 60's coop at 2100 sq ft recently-renovated for $11K. In this same market, you could find something like this better-renovated (IMO) 4600 sq ft 43rd floor trophy apartment with sweeping river views and distant park views for $16K:

http://streeteasy.com/nyc/rental/486478-condo-200-riverside-boulevard-lincoln-square-new-york

If you're some sucker really paying $11K to rent something like that, and you will never "wise up" and continue doing so for a decade, then there is no question you should be buying. If you're an investor, and you think you can continue finding people willing to pay that high a price continually, then that's fine, but I personally wouldn't count on it. There's no margin of safety if your numbers depend on always finding a person who will over-pay by a large amount.

Seg, I'd like to run some numbers on this one as I think it'd be interesting. What do you think this place really rented for, and do you think that sort of rent is maintainable? Had there been no asking price, I would have put it at $7K for "good deal", $8K for "OK deal", and $9K for "bad deal". Given the $11K ask, if it really rented off that, I'm having a hard time coming up with a negotiation that finished at a number less than $9K. What do you think?

Inonada: the rental market for good-quality and well-situated (please exclude the Trump towers from this discussion) on this part of the UWS is tight. Maybe in some quiet months, you will get a deal at 7k. But it is just as likely you won't and if you have to live somewhere, you will pay 10kish. BTDT. BTW, it's a late 70s co-op.

inonada: I am perplexed by that one as well. My best guesses:

a. The rent. It does seem high, but I'm not sure we have a firm basis for assuming it rented for less than $9k. From the time of original listing it was on for about 3 months. If the owner wanted to get it rented, haven't we seen that pricing a unit 20% too high is not the best way to achieve that? Similarly, if the owner was really THAT delusional about the price, wouldn't it take more than 3 months to convince them? I'd guess it probably did rent for less $11k, but I'd be surprised if much less than $10k. Just a guess. And yes, that 200RSB listing is a much better property, but $16k is also a lot more money.

b. The $1.5M asking price. I have no direct knowledge of this building, but the maintenances are very high. Strangely, I think sometimes a high maintenance can be such a turn-off to buyers that the market actually over-compensates for it, as the price discount can exceed the magnitude of the incremental liability of taking on a higher maintenance. Even with the highest MM, that unit still had the highest cap rate of the four. Just a theory. And of course, if the $11k rent is far off, then we can throw all this out the window.

10023: got it. After reading some of your previous commentary on interesting hypothetical ideas (e.g., at the Dorilton, Riverdale, etc.) it didn't seem like you would choose to sell and rent. On the other hand your views on current value also seem fairly pronounced. Hence my question.

"What do you think this place really rented for, and do you think that sort of rent is maintainable?"

I didn't really address the last part of the question. At $10k, that's $57/sft. Seems a little high, but is it that high? This is a 7/8-room apartment with 3 real bedrooms. As 10023 said, there is not a huge supply of rental units of that size, in that area. The building is nowhere near new but it is very centrally located for that area.

Compare the 3BR rentals at the newer buildings -- RSB, Corner, Aire etc. One might say the unit at 2025 Bway is expensive on absolute terms, but (sadly) a pretty good deal on relative terms. Assuming you don't want to pay the huge premium for brand new + amenities.

Seg, I doubt it rented for less than $9K as well. I would think that $10K is very likely. During the same time period, I was able to negotiate 10% off asking prices of two very competitively-priced apartments. I would imagine that for something with a high ask like this, 20% is a possibility, but that's about it. My blind guess of $8K for an "OK deal" would have clearly been off, and I'm willing to bet it rented for $9K - $10K.

On your over-compensation for high maintenance, I completely agree. I'll follow up separately.

Comparing $11K rent to $1.5M purchase:

$11000 rent benefit
$ 400 saved brokers fees and moving costs
$-4450 maintenance, deduction rendered useless because of AMT
$ -200 insurance
#-1250 10% transaction costs, amortized over 10 years
$ -800 upkeep
======
$ 4700

So by my math, you're getting a 3.75% yield on day 1, plus 2.5% growth, so the equivalent of a 6.25% yield. The cost of financing here is 4.25% (blending $1M tax-deductible and $200K non-deductible) on $1.2M, so 3.4% of overall price for the 80% financed. That leaves you with a carry of 6.25% - 3.4% = 2.85% on a 20% down payment, so a 14% expected return on equity.

Does that look like a proper return given the risk and illiquidity? Hell yeah. Would I be willing to bet on an $11K rental price for that apartment? Hell no. You drop the rent to $10K, expected return on equity drops to 10%. You drop the rent to $9K, we're down to a 6% return on equity.

The thing about high maintenance is that as it goes up, it makes the rent vs. buy comparison even tougher. In the extreme, maintenance equals rent, and assuming the deduction value of AMT is rendered useless, you have a property that yields $0, which should have a value of $0.

Suppose you believe that buyers of regular- or low-maintenance property is pay too much compared to rent. As the maintenance increases more and more to match rent, the overpayment becomes more and more clear, and in the extreme, nearly all bulls would agree that it is a value-less property.

To be fully accurate, if ownership is non-recourse, there's option value in owning the property, so a maintenance-equals-rent property should be worth more than zero, but we haven't had that for a while around here.

"This is a 7/8-room apartment with 3 real bedrooms." Strike that. 6 or 7 rooms. I'm having issues with counting this morning, apparently.

So we've got they typical prime 25x place, which yields zero ROE by my calculation. We've got the typical post-war 20x coop, which yields a 6% ROE by my calculation. Then we've got seg's high-maintenance / low-price coop, which yields a 10% ROE by my calculation (I'll go with $10K over $9K to balance out for the fact that I didn't discount the $1.5M price).

IMO, this last one looks reasonable. If I were itching to buy because of personal reasons, I'd consider something like. If I were itching to make big money, I wouldn't. I.e., if a friend came to me and said that they're buying that place, I'd say "doesn't sound unreasonable".

Out of curiousity, does anyone have anything better than seg's magic place? Nice job on digging that one out, seg!

"The thing about high maintenance is that as it goes up, it makes the rent vs. buy comparison even tougher."

Would if I be laughed out of the room to suggest that, theoretically, maintenances should tend to converge over the longer term? In other words, you *should* get what you pay for. For instance:

- Tax abatements expire
- Building mortgages are paid down
- Timing of major building renovations. These should be a more comparable expense in the long term, but can be very choppy/onerous in ST.
- Badly run buildings. Do they stay badly run forever? Perhaps a weak analogy, but in a public company shareholders can throw out the board, bring in new mgmt, etc.
- Other idiosyncratic tax differences that should normalize over time?
- Exceptions to my theory would be land leases or big interest-only mortgages on the building.

So, I think it would be unwise to pay a big premium for "low maintenance" unless there is a clear, sustainable justification for it. It must also be a good idea to explore the reasons for a high maintenance. If two apartments both have $2,500/month maintenance, of which $1,000 of standard mortgage P&I, then is $2,500 simply $2,500? There are some who say yes, regardless of whether the building mortgage matures in 2011 or 2025. Lunacy.

This is a long-winded way of wondering what tends to happen when all else is equal (recognizing nothing ever is). Imagine 2 buildings, same amenities, same age, same number of units, etc. Apt A in in Bld A is $3,000/month MM. Apt B in Bld B is $2,000/month MM.

Now start growing your maintenance by 3% a year, as seems to be standard operating procedure by now. While the ratio is still the same, the $ difference between A and B has widened to $1,300/month by year 10, and will continue widening in perpetuity under this treatment.

inonada: How would you analyze this? Are A and B more likely to converge over time in MM (for the reasons above), or would you continue modeling a 2-3% increase from the starting point for both?

And yes, agreed that an apartment for which MM = Rent is worth Zero.

I am extremely well-acquainted with 2025Bway. The mtge/mtce issue is a big one, bcs their mtge is 19m+ (sponsor saddled them with it, and sponsor did NOT default). I don't think they're paying off interest but they're still enjoying low rates on that 19m, so watch out when they need to renegotiate that mtge.
OTOH, hallways, elevator, windows have been redone in last 5-8 years.

Ouch Nevada is one special story. Poor construction, high maintenance and over a busy intersection. It's like ownership with none of the benefits.

How much do you want to bet that the 1890s Nevada Hotel on the same site would be selling for way more/sqft if if it had not been demolished? If you go through the NYT archives, it's a sad story. Hotel -> SRO -> community activists wanted to save as senior housing (like Hargrave, Hamilton in the nabe) but failed -> builder started to build, then bankrupt, bldg paused, then continued -> Krasnow co-oped in the 80s.

That's a shoe size bet. It would go for more. The original hotel could more easily be torn down and replaced with a True high end Condo on that site.

If it had been NEVER been demolished.

"Now start growing your maintenance by 3% a year, as seems to be standard operating procedure by now. While the ratio is still the same, the $ difference between A and B has widened to $1,300/month by year 10, and will continue widening in perpetuity under this treatment.

inonada: How would you analyze this? Are A and B more likely to converge over time in MM (for the reasons above), or would you continue modeling a 2-3% increase from the starting point for both?"

I would continue modeling 2-3% increases for both, unless there's something with a known terminal duration, like a tax abatement. One typical reason for a differential is land lease. These agreements would be indexed for inflation, I would imagine. And when time came for renegotiation, I would think that would have an inflation-indexed increase at least.

The other typical reason is an underlying mortgage. Here, it's a simple cost-of-money calculation that you have to PV, but then you have to take in the exact details. For example, if the underlying mortgage is a 30-year fixed, then obviously that part doesn't increase.

So, I think 2 things make 2025 look better. First, the maintenance is probably deductible to a good degree after all, even in AMT, because a good chunk is probably interest. Second, if the underlying mortgage is fixed, then that part of maintenance does not increase with inflation. I bet the two of these start making buying at $1.5M pretty attractive, compared to a rent of $10K.

Does anyone know the details of the Nevada mortgage? Fixed-rate? Duration? Fraction of maintenance that goes to pay it?

Nyc10023, you said that you don't think they're paying off interest. Did you mean principal?

Yes, sorry, typo. They're only paying off interest. They have a commercial loan, interest rate isn't fixed for very long (I'm pretty sure less than 10 yrs to go on current rate, possibly less than 5). Commercial loans typically have shorter fixed-rate periods & also typically have prepayment penalties.

From what I recall, 2/3rd of the mtce at the Nevada was tax-deductible (some due to taxes).

Of course a big mortgage that faces refinancing exposes the entire building to rate uncertainty. Add to that it's nearly impossible to sell a coop in that building. It took the tail end of the biggest bull market in memory for the sponsor to finally unload their units. And we're talking about poor construction(8 foot ceilings, elevators that never work properly, drafty bathrooms, basement washer/dryers and no real amenities to speak of.

http://a836-acris.nyc.gov/Scripts/DocSearch.dll/ViewImage?Doc_ID=FT_1570007855757

If I'm not mistaken, their 19m mtge expires soon.

What do people think the rental market is for pre-war C6's and C7's? The problem is there isn't one. I'll somewhat arbitrarily choose a line on WEA where there's been a lot of recent sales activity. So what would this unit rent for, hypothetically?

http://streeteasy.com/nyc/sale/418131-coop-771-west-end-avenue-upper-west-side-new-york

I'm sure on RachelRealty or somewhere there are a few (superficially) similar listings, but the information is so limited to make me I wonder if any real conclusions can be drawn.

So I'd throw out the challenge in the other direction. Can anyone deliver a good rental comp?

In the absence of one, I tend towards apples-to-oranges comparisons. Here's one that will attract a different buyer type, with different preferences, pre-war vs. post-war, classic West End Avenue vs. bustling Lincoln square area, but it's similar enough in size and layout (although WEA is bigger). If price were equal, some people would prefer one, some would prefer the other (for different reasons).

http://streeteasy.com/nyc/rental/504211-condo-111-west-67th-street-lincoln-square-new-york

So. That's 11.5x. People will criticize this example for any number of valid reasons. But IF you want to buy a C7 on WEA, what do people believe is the prevailing price/rent multiple in this current market? There simply isn't a reliable one that I'm aware of. If there is (even a rough one) I would bet that it is below 20x.

Seg, I appreciate the effort on beating your old one, but I think the comp there is a big, big, big stretch. Your rental condo is high-floor at the Park Millenium, has higher "fanciness", floor-to-ceiling windows, in a "superior" location. Most importantly, it has park views. Your coop is facing an building in an "inferior" location. (Truth be told, I love RSD in the 90's, much more than Broadway in the 60's, but that's the market.)

In any case, 32E and 36E sold for $4.65M and $4.94M in Jan 2009. Contracts probably as the world was coming to an end, so a downtick from that, but a higher floor. I'd put it at $4M. Recent sale at 39D (also park view) was at $3M, and this 38E is 30% bigger in size. Thus, I think my $4M guess is decent. You're comping this to a $2M coop!!!

Rental is at $13.5K last ask, so if it went at that, that's 4% or 25x to a $4M price. More likely, it went for something along the lines of $12K: 10% negotiation would be a given on something like this. It was on the market for 6 months before it rented, 3 months at last ask. At that, it's 3.6% or 28x. This is what I'm talking about at the higher end in prime areas. The idea that something like this would go for $12K is what makes me scratch my head on the 2025 Broadway listing at $11K. This was on the market at the same time.

In any case, that's not really what you were asking. You were asking about coop rental comps. The problem here is that coops either don't allow rentals outright or put restrictions like 2-year maximums, so we're screwed. When they do allow comps, I've found that 20x is more typical vs. the 25x you find in condos, like the John Murray House example.

But as nyc10023 is so fondly aware, such places hit the market pretty rarely on the UWS.

It is indeed a big, big, big stretch. FLMAO, as some might say!

Right, coops have restrictions on rentals, one of the reasons they price at discounts to condos. Doesn't change the fact that a buyer should still be implicitly comparing the purchase against renting. If there is not a similar pre-war C7 rental to compare it to, then what SHOULD he/she being comparing to?

As an aside, I don't disagree with your assessment that the Park Millennium condo might fetch $4M. Personally, I find it very, very difficult to justify anything close to that premium vs. the other one. Park views are wonderful, but are they worth paying an extra $2+ million for in a smaller apartment? But as you said, that's the market...not for us to say.

Seg, here's a pre-war comp. A 2031 sq ft C6 on 5th Ave & 100th w/ park views that closed for $3.25M in January:

http://streeteasy.com/nyc/sale/43242-condo-1200-fifth-avenue-east-harlem-new-york

And this rental of the same line, probably a slightly hihger floor, just put up for $10.5K:

http://streeteasy.com/nyc/rental/649465-rental-1200-fifth-avenue-east-harlem-new-york

That works out to 3.9% gross, or 26x. This is what I'm talking about when I say rent vs. buy characteristics tilt even futher towards renting the higher you go.

That's an interesting one. I would not have thought Upper UES above 96th (even on 5th Ave) was still trading for $1,600/sft. But apparently at least that one did.

Here's a prewar UWS rental for consideration.

http://streeteasy.com/nyc/rental/467638-rental-225-west-86th-street-upper-west-side-new-york

Looks like a decent-sized 7 to me (into 6). Slightly unusual layout. What do you think you could buy this apartment for in a coop of similary quality? Doable for $3.25 million? That would be 18x and over $1,200/sft. $4 million? 22x

Questions in my mind:
1. Is this really 2,700 square feet? Without doing a calculation, that looks a bit inflated to me.
2. Just how high-end is Belnord compared to higher-end coops/condos? If you're going to tell me the only valid comp to this is the Apthorp, then you're going to get to a higher price.

It's not that far above 96th, and it has a park view, so I'm not so surprised.

On your UWS rental, I think 2700 looks about right with my quick-and-dirty measurements. I have no idea on a comp ppsf-wise, my comping skills are limited to looking up SE in the same building. You cross block X, this happens, you cross block Y, that happens, etc. Maybe nyc10023 can chime in? Your $3.25M - $4M range sounds reasonable to me. Where in that range, I have no clue.

I also wonder about concessions and negotiaions from ask on the rental.

Co-ops of similar quality - west 86th is flanked by co-ops of similar quality. Not identical, bcs Belnord has better views and (probably) better layouts because of its size. I'd say low 3s for a renovated 7 in the past, possibly high 2s. Look at 151, 161, all the 3xx co-ops on 86th.

It depends on whether you want to say that a co-op on 86th in a less pedigreed bldg is a comp? If the Belnord went condo, you'd probably be looking at high 3m, minimum. But then it would be a condo...

Thanks, nyc10023.

Hey, LICC, welcome back. I was hoping to see your analysis of the John Murray House place...

LICC <> analysis.

Hi nada. What do you want to know?

"What do you want to know?"

The Mighty Karnak.

LICC, the first post copied below is the way I had broken it down, and I think we disagreed on the $400 upkeep. The next 3 posts are the bull / bear / inonada cases I made on that analysis with and without the $400 disagreement. What I'd like to hear is how your numbers break down and your bull case based on those numbers.

========================

So here's what I've got on the net ownership benefit on day 1 for our $950K John Murray House coop (discounted 5% from last ask of $999K) example:

$ 4050 rent benefit (discounted 5% from $4265 given a 3%-superior comp at $4400)
$ 200 saved brokers fees and moving costs
$-1400 maintenance, 50% deductible, but rendered useless because of AMT
$ -100 insurance
# -800 10% transaction costs, amortized over 10 years
$ -400 upkeep
======
$ 1550

My justification for the upkeep is that the average coop in Manhattan is renovated every 25 years, at a cost $120K for an 1100 sq ft apartment. Although one may choose not to renovate their coop, it will lag in terms of appreciation compared to the rest of coop market, which has an average renovation age of 12.5 years. Percentage-wise, $120K works out to 12.5% on a $949K apartment, which seems in line with the discount between a new / newly-renovated coop and a 25-year-old / 25-year-ago-renovated coop.

On the net benefit side, we have $1550, and all of the items listed grow with inflation at 2.5%, so this $1550 benefit grows at 2.5% annually. Given a sale price of $950K, this amounts to a 2.0% net benefit that grows 2.5% anually.

On the financing side, we have a 6% zero-points interest rate on an 20%-down loan. This is discounted by 35%: 28% because of federal deductibility since you are gated by AMT, plus 7% for state+city because you have to first work through $15K of standard deductions with little else available to deduct other than mortgage interest. This gives an effective interest rate of 3.9% on the 80% loan, plus the requirement to put up 20% equity capital.

========================

Now, let me make the bull case on this. You are financing 80% of this asset at 3.9%, so you have to pay out a fixed 3.2% in interest to yield 4.5% (or 4.9%). Thus, you've got a carry of 1.3% (or 1.7%) for your down payment of 20%, so a return on equity of 6.5% (or 8.5%). Booya, not a bad yield. And, it's tax-free.

========================

Now, let me make the bear case on this.

If the world remains steady, then yes you will yield 6.5% (or 8.5%) on your equity. However, that low a yield on equity is way out of equilibrium, an you'll be whacked with a capital loss or lack of appreciation in a way that will put that number back in line.

First problem, we've got a risky asset that yields 2% plus CPI. Hell, I can get exactly that risk-free and extremely liquid through TIPS. That's gotta correct: risky illiquid assets need to yield more than liquid risk-free ones.

Second problem, the debt which is senior to the downpayment demands a 6% yield, and here you are demanding only a 0.5% (or 2.5%) premium to take the brunt of the risk? That's gotta revert to a more normal number.

Third problem, government support for low interest rates will be removed, and when it goes away, yeah you'll have your low cost of financing, but the lack of it for new buyers means that the price will have to come down (or appreciate slower than 2.5%) just to allow for a 6.5% (or 8.5%) return on equity, which is too measly anyways.

In short, the risk of depreciation or lack of 2.5% appreciation is high while the possibility of improvement to that 6.5% (or 8.5%) yield is next to nil. You have a very asymmetric risk profile just to collect that meager yield.

========================

Finally, let me make the inonada case on this.

In my segment of the market, it ain't 19.5x, it's 25x. I'm not saying that 19.5x don't exist, just not where I'm interested. That cuts the net yield to 1.0% (or 1.4%). Maybe some things happen with maintenance (doesn't scale, exit from AMT deduction blockade on taxes) that puts it at 1.5% (or 1.9%). The big problem is that mortgage deduction only counts on the first million. Your cost of financing is no longer 3.9%, more like 5.0% or 5.5%.

So on the one side, you have an asset that yields 1.5% (or 1.9%) plus 2.5% increases, the equivalent of 4.0% or 4.4% fixed. On the other side, you put up 20% and borrow 80%, so your interest amounts to 4.0% or 4.4% of total asset value. Holy crap, the yield on my 20% down payment is 0!!!!

And this is something on which I'd want 15% to make up for the risk and illiquidity.

"First problem, we've got a risky asset that yields 2% plus CPI. Hell, I can get exactly that risk-free and extremely liquid through TIPS. That's gotta correct: risky illiquid assets need to yield more than liquid risk-free ones."

inonada: Can you clarify your thoughts on this? Personally I do not view TIPS as risk-free at all. You could say that buying TIPS approximates the position of a RE-owner in terms of inflation. But if you are long TIPS, you will still lose money if inflation expectations go down. That is not what I call risk-free. Do you see it differently?

I think your analysis is fine - i think a few of your numbers are off (insurance is too high - it does not cost an additional $100/month for co-op insurance vs. renters insurance on that place - maybe $50, some of that maintenance is attributable to interest on the building's mtge, which i believe is deductible, and your maintenance numbers are just way off - when a rental building renovates, they do not re-wire, re-plumb every 20yrs - they replace some finishes and appliances - so take 1/2 off your number), so I would use your higher yield numbers.

What it shows is that at 20x a buyer is saying that with reasonable assumptions they will do fine with the purchase. Its not a screaming buy, nor it is a terrible option.
Remember, that 8.5% yield compares to 13% (fed'l tax savings - you'd get state on the TIPS also) with TIPS. Plus, you can't leverage TIPS in the same tax advantage manner, nor w/o threat of margin calls.
You are fixing 75% or so of your monthly housing costs (which are probably your greatest expenditure of net income) - there is a value to that (hence the reason yield curves are almost always positively sloped). Given that due to the decline in rents over the past 18 months rents are more or less where they were 7 (?) yrs ago, that may be a decent bet.
Finally, and since you are on this board and in some sense looking to buy a place you understand this, you can't live in a bond - there is a value for some people (and a negative for others) to owning your home.

at 20x it is not a clearly terrible or excellent financial decision. it is a mediocre one, but for many the tangible (consumptive) benefits tip you over.

Never mind, I think I see now what you are saying:

TIPS: 2% + CPI (variable/risky) on an underlying US treasury that is "risk-free" (I won't go there...)

RE: 2% + CPI (variable/risky) on an underlying asset that is irrefutably risky

Is that the gist?

Yep, seg. That was my gist. As an aside, TIPS also get a deflation bonus: their coupon is floored at zero, so if there is deflation, then they pay more than CPI.

nada, I think you overstate the "risk and illiquidity". What about the risk of greater than expected rent increases? Or the risk that your LL kicks you out at the end of your lease for whatever reason he or she wants? As printer said, there are intangible benefits to owning. Given the 8.5% positive that you are analogizing strictly on an investment return level (and which may be higher depending on whether your tax deduction analysis was correct), for those who appreciate those intangible ownership benefits, the 20x number in this situation justifies a purchase.
Again, this is a static analysis. If you are trying to market time and believe prices and rents will plummet in the near term (which I do not), you still wouldn't buy.

"for those who appreciate those intangible ownership benefits, the 20x number in this situation justifies a purchase."

What's the cutoff point, LICC? 30x? 40x? 50x?

Third problem, government support for low interest rates will be removed, and when it goes away, yeah you'll have your low cost of financing, but the lack of it for new buyers means that the price will have to come down (or appreciate slower than 2.5%) just to allow for a 6.5% (or 8.5%) return on equity, which is too measly anyways.

Interesting you wrote that, as I believe you are the one who did a lot of the investigative work showing that periods of rising interest rates have not, in fact, correlated with with lower nominal prices.

And many believe that removal of government support of low mortgage rates will lead to some increase in rates, but not major increases.

"at 20x it is not a clearly terrible or excellent financial decision. it is a mediocre one, but for many the tangible (consumptive) benefits tip you over."

I think that's a reasonable statement. IMO, I think at 25x, it looks terrible, at 20x, it looks like perfection is fully-baked into the price, at 16x it starts looking attractive, and at 12x it starts looking excellent. The biggest risk with going in at 20x, IMO, is that there's no margin of safety as the probability of upside is minimal while the probability of downside is appreciable. If the world returns to requiring 14x-18x rather than 20x-25x, then you'll take a 30% effective hit. I can see many paths there. It kinda sucks, but spread over 10 years, it's manageable as it'll appear that you've simpy overpaid renting by 50-60% for the consumptive benefits. The only path I see towards upside is inflation in rents, but it'd take a decade of 6% inflation (that's late 70's & early 80's rates) to get to equilibrium through that path IMO.

"Finally, and since you are on this board and in some sense looking to buy a place you understand this, you can't live in a bond - there is a value for some people (and a negative for others) to owning your home."

Fine, but I'm not looking to buy a place. My preferred mode is renting, and SE is the best resource for finding higher-end condos/coops/townhouses to rent. That's what brought me here. Should buying actually become attractive financially (12-16x), I'd probably adapt, but we're a long ways from there. Until then, I am perfectly happy with having people construct / renovate spaces and then rent them to me for 25x+ as I have better things to do with my at-risk capital than earn 1-2% plus CPI. My prediliction for rent vs. buy conversations is to understand what drives peoples' financial decisions as I believe it helps me with my personal investment decisions.

LICC, thanks. It sounds like your argument is my "bull case", and in place of the "margin of safety" that I'd want, you're willing to trade that off with "intangible benefits of ownership" to those that feel them. Sounds fine.

How about the 25x "inonada" case? Does it at that point become a strict negative to buy? Obviously, one can still purchase for consumptive benefits, but do you agree that it becomes financially negative? If not at 25x, then at what multiple in your eyes?

"Interesting you wrote that, as I believe you are the one who did a lot of the investigative work showing that periods of rising interest rates have not, in fact, correlated with with lower nominal prices."

There's a quesion on the source of the rise in interest rates. By looking at TIPS vs. treasuries, you can see what the market is saying on inflation expectations vs. real yield. Right now, 10-year treasuries are yielding 3.4% and 10-year TIPS are yielding 1.3%. That menas the market is pricing 10-year inflation at 2.1% (there's a risk premium argument to be made on why inflation expectations are actually lower than that, but let's put that aside). This means that a 10-year yield is 2.1% inflation and 1.3% real yield.

If we look at the 90's, the rates averaged 6-7%, made up of 2-3% inflation and 4% real yield. If inflation expectations goes up, then the rise in interest rates is offset (driven by inflation) by the rise in future rent expectations (also driven by inflation). However, if the real yield demanded by investors goes up, then we will see a rise in interest rates (driven by investor demand for better real yield) without a rise in future rent expectations (since it is dependent on inflation, not real yield).

Given that inflation expectations have been pretty steady for the last 20 years, and that we've seen real yield move from 4% down to almost 1% on 10-year treasuries, I'll fathom that if interest rates rise, it's probably going to be from real yield rather than inflation. Just as having real yields drop from 4% down to 1.3% helped home prices go up (the real cost of borrowing dropped), having it go back up to 4% will likely have the opposite effect.

So the question is will investors continue to be satisfied with 1.3% real yields on a 10-year horizon? Why are they willing to accept that now? I think this has to do with Fed policy (which is the whole point of the policy). Right now, we have inflation in the 2-3% range, but short-term yields are 0%. This means real short-term yields are -2-3%: i.e., sitting on money makes you lose money. In this world, then tying up your money for 10 years to get a 1.3% real yield looks attractive compared to losing 2-3% a year in overnight rates. As the Fed raises short-term rates, say they get to 3%, then getting a 1.3% real 10-year yield doesn't look so attractive any more compared to getting a 0-1% real overnight yield.

To me, that is the more likely source of rises in interest rates. We've seen a 20-year period where inflation expectations have remained flat-ish, yet real yields demands have dropped by a factor of 3. I think the likelihood of real yields moving up from 1.3% is much more probably than going down as the Fed has been successful in getting inflation moving again to the desired range and is looking to engineer a transition to a more normal regime, and this is the interest rate risk I'm talking about.

Don't hit them wih the logic hammer, nada. It'll leave a mark.

As an aside, this equity mkt action is fantastic, plus the currency and commodities. Therez gonna bez some serious money to be made. Damn!!!!! I'm loving my 2% cash yield!!!!! Fantastic turn of events for me.

W67: when are you going to buy into the equity market?

And what were your reasons for not buying March '09?

When equity? Who knows. Btwn my wife and my 401k and 20+ yrs More of feeding into it, I'm in no hurry to be full in at the moment. I was a bull/bear in headlights in 3-09, 10% of me accepted I missed the greatest buying equty mkt in life, but 90% felt like a bubble that had dog walkers buying $1mm alcove studios and miami beach condos was not 'done' and 'corrected' in 8 months.

Like I've said all along, it ain't over. Now aren't you glad you didn't wig out and buy a French villa last year? It's 15% off in 3 weeks. Damn I may also have to rejigger summer plans. Great to be an American, even a naturalized one!!!!!

How does one argue for being long(progressively?)the equity market, when stock market investors are not considered by board of directors, regulators and CEO's?
1) We allow 60% of stock traders(high frequency traders to front run real buyers
2) Wall street capital structure pays out almost all the profits to the directors/employees
3) We allow corporate fraud(Enron, AIG , Fannie Mae, Moody's...)

Maybe I'm getting old but the stock market feels more and more like a suckers game.

just be happy that someone is responding to your endless nonsense.

660 posts, about half are absurdly long dissertations that non geeks can't read. Just this page alone inonada, couldn't you prove your point the first ultra long post?

Oh dear, I missed a lot in my absence. inonada, some great stuff in this thread (and I have yet to sift through all of it) - really appreciate your work here. Your summary seems pretty spot on to me ("I think that's a reasonable statement. IMO, I think at 25x, it looks terrible, at 20x, it looks like perfection is fully-baked into the price, at 16x it starts looking attractive, and at 12x it starts looking excellent.").

I closed on my place in fall 2010. I just filed my 2011 tax return and if I annualize my tax benefits from MI and RET , my monthly carry is below market rent. by almost a couple hundred a month. Also just refid my mortgage and appraised 9% higher than my purchase price. so far so good...

Does your building allow for dogs and cats?

it does.