My buy vs. rent model

Nice work.

I think tax rates will be going up over time, so I would suggest allowing users to plug in variable annual tax rates, as you do for Appreciation and Inflation.

Also, are you factoring in annual taxes on the Opportunity Costs and on the eventual sale of the apartment?

I didn't go through all the details, but took a quick look. Seems pretty comprehensive. I am not enough of an expert to know all the inputs (for instance, had not realized insurance was that expensive), but I ran for a hypothetical case of an apartment wife and might want to buy.

One quick comment, but the way - I don't think your tax deduction is capped at the $1MM mortgage, like it is in real life.

More generally, I got about the results I expected - in the early years, renting is meaningfully cheaper, but with a long enough time horizon, rents and your taxes/common go up with inflation, but your mortgage stays constant, so buying serves as a pretty good inflation hedge.

Here's my issue, though. I changed both inflation and appreciation to zero, and owning becomes an absolute disaster - $1.5MM in lost net worth on a $1.6MM apartment, because of 30 years of higher carrying costs. Even at 1%, it's pretty ugly. But at 3%, buying is a huge wealth-builder. So the whole case for buying would be predicated on predicting inflation, which I think is notoriously difficult to do. This is not a criticism of your model, just a case of a critical input which has to be a complete guess.

That's why I tend to think of the decision in 3 discrete steps.

1) Pure buy vs. rent math, today, ignoring what happens in the future
2) My expectations of appreciation/depreciation and rent increase/decreases over my time horizon (related to inflation, of course)
3) Other factors - transaction costs, premium of having "your home", personal considerations, hassle of moving, etc.

In any case, thanks for posting.

"I think tax rates will be going up over time, so I would suggest allowing users to plug in variable annual tax rates, as you do for Appreciation and Inflation."

Good idea. With $10T in debt and $50T in unfunded social liabilities, tax rates are going no where but up.

"Also, are you factoring in annual taxes on the Opportunity Costs and on the eventual sale of the apartment?"

That would definitely crimp the returns - good catch. In this model, best to consider that an "after-tax APR".

"had not realized insurance was that expensive)"

I've only bought a home before in Florida and the insurance was much more than that (for obvious reasons). Would be interested in what it really is in Manhattan.

" changed both inflation and appreciation to zero, and owning becomes an absolute disaster - $1.5MM in lost net worth on a $1.6MM apartment, because of 30 years of higher carrying costs. Even at 1%, it's pretty ugly. But at 3%, buying is a huge wealth-builder."

Absolutely. Compounding is going to kill or benefit you tremendously. Now throw in the asset & price deflation we are experiencing now (and who knows how many years) and you get an even more muddy of a picture.

Thanks.

I wonder if nyc10022 will agree with jgr's rent model

I think that you need to look into your model's variables. You need to amortize the real-estate commission over the life of the property, add mortgage recording tax, mansions tax, etc.

Lots of variables missing.

Plus you don't get the "tax benefit" at your marginal rate. You get it at your effective rate. Plus you don't get it if you have no income, so it shouldn't be calculated in. Otherwise, your argument is that the cost of your housing goes up if you lose your job. It doesn't.

What do you mean you don't get a tax benefit or you don't get it at your marginal rate? Of course you get a tax benefit and it is at the extra rate you pay at the higher end. If you are out of a job you shouldn't be buying but hopefully if you are retired you have long paid off your mortgage. Good luck.

"You need to amortize the real-estate commission over the life of the property"

The net worth calculation is done on a year by year basis as if you had sold. Taking it out at the end makes no difference.

"add mortgage recording tax, mansions tax, etc."

Mansion and recording tax is in there, part of the closing costs. You can add on any additional ones there easily.

"Plus you don't get the "tax benefit" at your marginal rate. You get it at your effective rate."

I didn't specify marginal or effective rate in the model.

"Plus you don't get it if you have no income, so it shouldn't be calculated in. Otherwise, your argument is that the cost of your housing goes up if you lose your job. It doesn't."

Shrug. I'm going to go under the assumption that I won't be owning (or renting) for long if I don't have a job. Not sure how this is valid.

Of course you get a tax benefit, but you get it at the same rate as all your other benefits, which is your effective rate. It does not figure in as part of your housing cost, however, as it's a tax benefit, not a housing benefit. Your house still costs the same; your tax bill goes down.

To think otherwise is to swallow the real estate Kool-Aid.

Because you pay for that "benefit" through a higher price. Get rid of it, and prices will collapse to precisely where they equal rents.

Only in recent years, when prices shot up so much, have people thought to include a tax benefit as a "housing benefit." I presume no one has children for the tax benefit. No one should buy a house for it, either, although the dependent benefit is a real benefit because it doesn't affect the price of having or raising children. The mortgage-interest deduction directly affects the price of houses.

Also, I didn't mean for the model to impose a viewpoint...you can set the tax rate to 0% if that's your belief.

"Your house still costs the same; your tax bill goes down."

Sure. That still affects your cash flow and thus your net worth.

"Because you pay for that "benefit" through a higher price. Get rid of it, and prices will collapse to precisely where they equal rents."

Absolutely. But you pay that price, not a theoretical price where there a tax benefit doesn't exist.

"But you pay that price, not a theoretical price where there a tax benefit doesn't exist."

No, actually. The price you pay for the house is real, and it's really higher because of the tax "benefit." They offset each other.

That makes zero sense.

So you would keep the inflated price resulting from the tax benefit and then not include the tax benefit when calculating monthly cash flow and net worth?

Yes, when you pay mortgage interest, you have a deduction on that interest, meaning a lower cost of borrowing from the bank. If you didn't borrow you wouldn't have any interest expense savings (netting) of course. For those of us in the higher brackets, the savings comes out pretty substantial at the marginal rates. Of course I realize that some people make the argument that a tax deduction in and of itself is a goal, which is silly - if you give $1000 to charity, and you get a tax deduction, your cost to the charity at the end of it all is around $600 if your marginal rate is 40%.

That looks great... thanks a lot for sharing... but, once I fill in all the parameters, where do I read whether it s better to rent or to buy ?

What annual appreciation did you assume? Thanks!

"That looks great... thanks a lot for sharing... but, once I fill in all the parameters, where do I read whether it s better to rent or to buy ?"

The second page has a giant table with a few different columns that can help you come to that judgement. Rent - Carry (Difference between renting and owning after accounting for common charges, taxes, rent, insurance, PMI, improvements, and tax deductions, and opportunity costs) and Net Worth Difference (How much has your net worth changed if you were to sell the home in that year). There's no magic "it's better to buy and hold until year X" as that is a very personal decision.

"What annual appreciation did you assume? Thanks!"

Configurable. Columns B18-B22. It can either constant (prices always go up) or you can make it variable on a year by year basis to account for the deflation going on now (on the second tab).

"That makes zero sense."

No. It makes absolute sense.

"you would keep the inflated price resulting from the tax benefit and then not include the tax benefit when calculating monthly cash flow"

Yes when comparing to rents, because it's baked into the purchase price.

I would calculate the price of the house as the price of the house. I would do it just like economists do it - treat it as if it were a market-rate rental to a third party. Under that scenario you can deduct all costs (except principal, which is not a cost). To make the investment you would need at least to break even on a cash-flow basis from the get-go. I'd even allow for 12-months of rent to be included (wouldn't be on a market-rate rental) since I know I'll be living there all 12 months.

Under that scenario, to break even, PITI would have to equal market rents. That's what the bank looks at. Presently, PITI is twice market rents and the gap is increasing. Therefore it makes no sense to buy.

"and net worth?"

Don't know how net worth comes into play.

it seems that the model always regards improvements purely as a carrying charge and that they would never contribute to the value of the property..some improvements (new kitchen, better storage space) tend to be more attractive (to potential buyers) than others (paint)...though i guess you could theoretically tinker with the appreciation rate to make up for it.

there's no parameter for renter's insurance or brokers fees for rentals. obviously the latter has become negotiable lately but that's not common in an average/landlord's market.

otherwise, excellent model! much better than anything on the internet this days.

jgr.. you beat me to the punch. NICE! spreadsheet... that is :)

I can't believe steve is maintaining his idiotic position that the mortgage benefit is measured at your effective rate rather than your marginal rate. He has been proved to be completely wrong on this issue so many times.

jgr, don't bother with steve on this. he's had this same argument again and again. many many people have explained to him why he's wrong about the tax benefits point, he will never give in. its just a waste of your time. nice job on the spreadsheet btw.

Thanks! I sorta get what he's saying, but I don't understand why the money from reducing your taxes doesn't go into your cash flow...where does it go? I usually agree with most of his stuff :)

"It seems that the model always regards improvements purely as a carrying charge and that they would never contribute to the value of the property.."

With few exceptions, improvements never give a net increase (change in value of the home minus improvement cost (at least thats what all the home improvement articles during the bubble claimed). Perhaps that default value is too high. But then again, if you don't update your home after a number of years, you'd have to adjust your appreciation values to be less. Which is why using means or CS to estimate gains in housing prices is always overestimated (they don't account for money spent on improvements) and losses are always underestimated. This of course is unique to every property.

"there's no parameter for renter's insurance or brokers fees for rentals. obviously the latter has become negotiable lately but that's not common in an average/landlord's market."

Yea good point. It's minor in the scheme of things, but it should be there.

"but I don't understand why the money from reducing your taxes doesn't go into your cash flow"

well because those benefits result in an increased purchase price, of course. so you should count the costs of financing that extra price but not the benefits themselves. obvious right?

"I usually agree with most of his stuff"

well, can't help you with that :)

Nice job Jgr! You built your rent. vs buy spreadsheet the same way I built my rent vs. buy spreadsheet. The most important number is net worth difference at your investment horizon, column Z in the YearlyTables tab . Net worth difference goes positive in year 6. That's just about the same result as my sheet. I suspect '03 sellers are in the money.

Nitpicking:no way are buy closing costs on a condo 2% unless you're getting seller concessions. You have the NYS transfer tax listed in cell 22B but is it being referenced?

by '' '03 sellers" I mean people who bought in '03 are selling today

2 comments:

1) Did you address the tax benefit only working up to the $1MM limit? Or did I misunderstand that?
2) 80sMan - yes, 6-year time horizon is great, if you assume average 3.5% appreciation and inflation over that time. I have NO IDEA what those will be in the next 6 years. Neither does anyone else on this thread. Just keep that in mind - great model, but the output is only as good as your assumptions.

Working on spiffy new version with that and some other bug fixes :) Glad I put this up here, you guys found some good stuff.

This ignores all of the benefits of owning your own place.

New version up with:
- Tax rates that can vary
- Max cap on interest deduction
- Accounting for rental deposit & brokerage fee in opportunity cost
- Taxes now crimp opportunity cost returns
- Fixed some bugs on seller closing costs
- Better organization

Thanks for your feedback all.

ccdevi, nice to have you back!

"I don't understand why the money from reducing your taxes doesn't go into your cash flow."

It does go into your cash flow, but cash flow statements do not allocate specific income to specific expenses, which is what you're seeking to do. They say, "This is what came in, this is what went out." One further reason why businesses use the effective tax rate, not the marginal tax rate, when calculating tax burdens. Look at any cash-flow statement and that is what you will see.

In the case of a "tax benefit," however, nothing goes in and nothing goes out. Simply you pay less tax. If your tax rate changes, you pay a different amount of tax. If you pay no tax, you get no benefit. But the amount of tax "benefit" you have is baked into the higher price of the property. Eliminate it, and the price of your house falls.

Your mistake in understanding what I'm talking about is that you are looking at "cash flows" (sort of) and I am looking at a comparison between rents and owners' carrying costs. I am not not counting the tax benefit. I am saying that with the tax benefit there is a specific, long-term ratio between rents and owners' carrying costs. That is not a cash-flow analysis. It's a ratio. And, historically, the ratio is 1:1 - rents = owners' carrying costs.

They do that for any number of reasons, none of which has ever been refuted by anyone with anything other than, "This is the way I do it."

Another reason why it's true is because of the third-party rental scenario that I gave you. You would not buy an apartment to rent it out to an unrelated third party if you would lose money on the transaction at market rates from the get-go. Why, then, would you buy someplace and effectively rent it out to yourself for significantly more than it would cost you to rent it from a third party?

"It does go into your cash flow, but cash flow statements do not allocate specific income to specific expenses, which is what you're seeking to do. They say, "This is what came in, this is what went out." One further reason why businesses use the effective tax rate, not the marginal tax rate, when calculating tax burdens. Look at any cash-flow statement and that is what you will see."

Yeah this is the classic error in any first level economics class ... should the guy who owns the diner sell chewing gum at the check-out counter if he has to allocate a proportionate amount of the rent to the counter space used for the chewing gum and therefore it is unprofitable to sell the chewing gum? Well ...

VWear
about 22 hours ago
ignore this person
report abuse I wonder if nyc10022 will agree with jgr's rent model

Still fascinated by me, I guess...

"should the guy who owns the diner sell chewing gum at the check-out counter if he has to allocate a proportionate amount of the rent to the counter space used for the chewing gum and therefore it is unprofitable to sell the chewing gum?"

Exactly my point. No one allocates like that. Rent is overhead. It's rent for the store, not rent for a box of cereal. You place products based on your margin and volumes. Your profit margin does not include rent.

Banks pay an enormous amount of money maintaining ATM's. They make very little to nothing on ATM's. They're a cost, principally, not an income. If you were to analyze how much they lose on ATM's, you'd get rid of them. Yet if you got rid of them, you'd soon drive your business into the ground.

Taxes are taxes on all your income, not on the interest you pay for your mortgage. That is why each and every argument otherwise is just plain wrong. If you have no income, the amount that you pay for your housing does not change. What changes is the tax you pay.

Realtors will, I'm sure, in the future think of other clever ways for you to afford what you can't afford, like the 40-year mortgage.

Cash flow is cash flow. Look at a balance sheet, on the other hand, and you have debits and credits. The debits tell you what you have; the credits tell you what you owe. If you're a bank and have $1 million in savings account and $1 million in checking accounts (liabilities), and $1.5 million in loans and leases outstanding (assets), how is that $1.5 million divided into the $2 million?

It's not. It's all taken at once, as a whole. As are income statements and cash-flow statements. That is why all these arguments that have been bandied about over the past year that I've been posting have been wrong. You cannot allocate things like that. It simply doesn't work.

Look at a balance sheet, on the other hand, and you have debits and credits. The debits tell you what you have; the credits tell you what you owe

No, not correct.

Smart business do allocate costs. It is called ABC.

Of course, you don't factor counter space into the gum selling, its an add on. Your mistake is... there is no MARGINAL cost to selling that guy in terms of rent.

The easiest attributable costs are COGS. The cost of the gum gets factored into the profitability of the gum. The cost of the food gets factored into that. Of course, it doesn't all work perfectly, and you might take a loss on "loss-leader" items to get other business.

But to pretend you can't attribute some costs to specific revenues is just silly.

"No, not correct."

Yes it is, for a bank. Bank accounting is backwards from nonbank accounting: deposits are liabilities, they are on the credit side of the balance sheet. Loans are assets, they are on the debit side of the balance sheet.

And they must be: banks owe money deposited to them; they own money lent out by them.

Next.

Yes nyc, and I was aware of what you're saying when I wrote it, but again, look at a P&L. On the income side you have Goods - Cost of Goods Sold. COGS does not include rent.

"But to pretend you can't attribute some costs to specific revenues is just silly."

I never made a blanket statement like that. In fact, my point was exactly the opposite, which is why I have always argued that tax benefits are calculated at the effective tax rate, not the marginal tax rate. You take all income and subtract all deductions from it, all at the same rate. Just as you do with COGS.

Yes some decisions are made at the micro level, but you don't say, "It costs me $35 to store a box of flyers for a month." It doesn't, because if it's not the flyers your storing, it will be something or nothing else. Your cost is still your warehouse cost.

ranter, just FYI, you can get a basic education here:

http://www.fool.com/investing/general/2007/01/05/understanding-a-banks-balance-sheet.aspx

How did we get onto a bank's balance sheet? And if you want a better education on bank account I suggest you read this parody :)

http://www.ritholtz.com/blog/2008/12/a-primer-on-fractional-reserve-banking/#more-11052

I don't need fool.com to tell me how a balance sheet is constructed, but reviewing it anyway, you said, "The debits tell you what you have; the credits tell you what you owe" which is untrue, then you said this oddity, "Bank accounting is backwards from nonbank accounting" but you then figured out that you meant to talk about assets and liabilities, not debits and credits, and yes loans are assets not debits and deposits are liabilities not credits.

Hi ranter, you may be new to Streeteasy. Before you continue to argue finances, no matter how meritorious you believe it may be, I suggest you study what these two links can offer you, and then I can answer any additional questions you may have and we can determine how and if to proceed with your points of view here.

The two links are:
http://www.streeteasy.com/nyc/talk/discussion/3410-real-estate-is-a-bad-investment
http://www.youtube.com/watch?v=Zf5ExRvDMgU

I'll be back in a few hours and we can pick this up. The first link will take you some time to go through with the level of detail necessary.

Regards

Oh ranter, please! Asset accounts are debit accounts, liability accounts are credit accounts. That's not even accounting, it's bookkeeping.

As jgr's parody suggests, most people don't understand bank accounting and why everything is backwards. Why loans are assets and deposits are liabilities, when the bank doesn't have the loan money but does have the deposit money. Because if the loan is a liability for you, it must be an asset for the bank.

jgr, we're discussing why it's improper to allocate the mortgage interest tax deduction to rent (that is, your net cost to own), when it is allocated to taxes paid. It's a fundamental mistake that lots of people on this board make and then try to tell me that I'm wrong. It's not possible (within certain limits as nyc says) to allocate expenses to income - tax deductions are allocated to taxes, not to what causes those deductions. Unless you can figure out how to allocate a child tax credit to your child, and claim that it's cheaper for you to have children because they cause a tax deduction.

It's not. Lose your income, lose your deduction.

"One further reason why businesses use the effective tax rate"

"Yes it is, for a bank."

Who said bank? We were talking about people and their mortgages, and then the example of a diner came up. Then you said " It's rent for the store, not rent for a box of cereal. You place products based on your margin and volumes. Your profit margin does not include rent."

You brought in bank.

BTW, I worked at a bank as my first job in high school. If you think banks don't allocate costs, you are wrong there as well....

Hell, you don't think a bank looks at the cost of a branch ocmpared with maintaining the value of deposits in that area?

You think they just spread them out everywhere and they say "its the cost of doing business". Well, chase did try that, but even that backfired.

ClintonB, are you still doing free advertisements for me? This is the second or third time you've posted the same thing on different threads today.

I hope ranter enjoys the stand-up comedy. Regarding "real estate is a bad investment," it most certainly is if it's owner-occupied real estate and you consider it an "investment." It is not. It is a capitalized expense.

If, on the other hand, you consider owner-occupied real estate to be what it is, a capitalized expense, then you will see why it is never a good idea to buy when your capitalized expense is greater than your actual expense would be, and it's always a good idea to buy when your actual expense is higher than your capitalized expense would be.

They are expenses, not investments.

Investment real estate is a different matter.

Worked at a bank in high school? Very impressive. I audited and advised banks all over the world, and gave presentations to chairmen of the board. I spent years working in and around banks. They do not allocate costs for ATM's and look at it in that sense.

"you don't think a bank looks at the cost of a branch compared with maintaining the value of deposits in that area?"

I'm not sure what you mean, but they don't look at the cost of a branch quite like what you seem to imply. Branches often lose money, but there may be very good reasons to keep them. A branch in an airport may not make much at all as it wouldn't make loans or take deposits, but it's a key location for convenience or advertising.

Years ago when I started at Bank of America there were grand dreams of doing away with "bricks and mortar" and replacing branches with electronic services. BofA closed dozens of branches all around California, which is where it operated at the time. And their market share sank and sank, because no one could find a branch when they needed one, so they started to open branches up again (though the damage had been done).

Branches do have goals unquestionably. But their costs are not allocated like that. Back to real estate: tax benefits are allocated to taxes, not to rent.

Thanks Clinton, interesting clip.

Oh ranter, please! Asset accounts are debit accounts, liability accounts are credit accounts. That's not even accounting, it's bookkeeping.

You are correct that performing debits and credits is bookkeeping. You are wrong that assets are debits and that liabilities are credits.

stevejhx: Very impressive. I audited and advised banks all over the world

lol, you think you are some sort of Rodgin Cohen?

> They do not allocate costs for ATM's and look at it in that sense.

Did I say ATMs?

Is that their only expense?

And, you completely skipped 99% of the post.... we were talking about "companies". You are mistaken in that regard.

stevejhx: Back to real estate: tax benefits are allocated to taxes, not to rent.

What does that mean?: Tax benefits are allocated to taxes?
And what does this mean: tax benefits are not allocated to rent???

"You are wrong that assets are debits and that liabilities are credits."

I said assets are debit accounts, and liabilities are credit accounts.

So instead of trying to twist what I said, focus on the matter.

No I am not Cohen, nor would I want to be. I advised on computer systems.

Oh, computer systems.

You said very specifically "The debits tell you what you have; the credits tell you what you owe"

Just say, whoops, got my specific terminology wrong. Then move on.

nyc, what 99%?

I am not mistaken in any regard.

Very easy ranter: you calculate tax benefits as a function of the taxes, not as a function of the things that cause the tax benefit. Because they are fungible. If you buy a property you are in effect capitalizing rent. If that in some way decreases your taxes it doesn't affect how much capitalized rent you are amortizing; it affects how much tax you pay. Lots of other things affect how much tax you pay, as well - you can't pick and choose how you allocate them, as they are allocated as a whole.

"Just say, whoops, got my specific terminology wrong."

No. It was clear what I meant. I will say this: "debit accounts tell you what you have; credit accounts tell you what you owe."

That make you happier?

Now - stick to the discussion, not trying to use the tried and always fails technique of saying that I am wrong about everything because I didn't use a particular term in exactly the way a textbook would. No one does.

Very easy ranter: you calculate tax benefits as a function of the taxes, not as a function of the things that cause the tax benefit.

I got it, the cause has nothing to do with the outcome. Smart cookie you are.

Lots of other things affect how much tax you pay, as well - you can't pick and choose how you allocate them, as they are allocated as a whole.

go read the discussion by glee and nyc10022 on the diner allocating costs to the gum at the counter.

ranter, as a former President who negotiated peace agreements, I must strongly advise you to finish your education by reading the full link that I provided to you, not just watching the video. A continued discussion with stevejhx is like the conflicts in the middle east or between Turks and Armenians or Greeks or the Chinese and the Japanese.

ok Bill, whatever.

stevejhx: Now - stick to the discussion, not trying to use the tried and always fails technique of saying that I am wrong about everything because I didn't use a particular term in exactly the way a textbook would. No one does.

Aren't you the most literal person on streeteasy, always with your exact links and total inflexibility in your opinions. You even do translations for a living and were previously an auditor ... no room for flexibility is your MO.

"total inflexibility in your opinions."

No, very flexible, and one of the few people who has ever admitted he's wrong.

"the cause has nothing to do with the outcome"

Typically inflexible on your part. Causes (usually) do have effects, but it's not a database: there are no pointers. Yes you get a mortgage interest tax deduction, but the value of that deduction is calculated based on more than how much interest you pay. It does not have a 1:1 relationship, so my point is that you have to make it as complex as it truly is, not just say, "I'm in the 35% tax bracket, I pay $10,000 in mortgage interest, I save $3,500 on my taxes, therefore it costs me $3,500 less a year to live there."

No it doesn't. It costs you the same to live there, but you pay less tax. How much less depends on many things other than your tax bracket and income. Which is why at the bottom of every cash-flow statement they tell you the effective tax rate paid. They tell you pretax income and after-tax income. But they don't allocate individual tax benefits to individual items at specific rates, because that will skew the results.

ok I'll stop arguing with you. You have your opinions.

Overall this is a good, comprehensive spreadsheet. I found a few errors however. The first one deals with the mortgage points. Why are you adding the points paid to the principal balance of the loan? They are one-time closing costs paid to buy down the interest rate and by adding them to the principal balance you distort what the actual mortgage payments would be over the entire life of the loan. Also, they can be tax deductible in the year that they are paid.

Second is the mortgage tax. You should add a formula to calculate this. The tax is 1.80% of the mortgage amount on purchases <$500k and 1.925% of the mortgage amount on purchases $500k and up.

For seller closing costs, the NYC portion of the transfer tax is actually 1.425% and NYS collects 0.40% as well for a total of 1.825%. Maybe you should add another field for new construction properties. On these units, the BUYER pays all of the transfer taxes which most people don't realize.

As for PMI, it varies but on average I suppose you could calculate it at 0.5% * loan amount / 12. And this would only apply on loans with < 20% down.

Also, for insurance your apartment is covered by your building's master insurance policy which is included in your common charges/maintenance. This covers your apartment's four outer walls. If you want to insure your belongings that's an entirely separate policy and wouldn't be that expensive.

I'll let you know if I see anything else.

-Allan

"You have your opinions."

It's not an "opinion." It's the way it's done. Unless you can show me where it's not.

So going back to what started this thread, the most elegant way to see whether a property is priced right is what it would cost you to rent it. It should cost you no more to rent a property than to buy it per month, excluding principal. That is the only way you could make money if it were a third-party at market rates.

Look at it like a business, that is, because that's how economists look at it.

In jgr's model, the most difficult parameter to work with is "potential appreciation / depreciation": pick price depreciation, even modest, and it will NEVER be better to buy than to sell because you're losing your principal. But that is not necessarily the case. If prices fall, but rents rise faster, it may very well be a good idea to buy.

Which is why that single model is the most elegant: if you buy it and can break even renting it to a third party and prices fall, it doesn't matter because you're not selling it. You're renting it. Then your concern is that rents fall, but that doesn't matter in the short-term either since you've locked in your cost basis virtually forever.

There is no need to do all of those fancy calculations - there are too many parameters for a spreadsheet, anyway. If you buy a property and could rent it out to an unrelated third party and break even right away or make money, then it's a great idea to buy. If not, then not.

"to buy than to sell" = "to buy than to rent"

"Very impressive. I audited and advised banks all over the world, and gave presentations to chairmen of the board."

Maybe thats why you are making these mistakes... this isn't audit we're talking about.
This is business decision making, which in many ways is the opposite of audit.

I'm not going to give away my later career, but I've also made presentations to chairmen of banks.

Difference is, in my case they were relevant to the topic at hand.

;-)

I agree with stevejhx...sell then rent...

"Difference is, in my case they were relevant to the topic at hand."

Actually, you have no idea what I've done. Read this:

http://www.iht.com/articles/1994/12/24/banesto_0.php

and you will know why I resigned from Price Waterhouse. I told them there was a fraud at Banesto (it was my client) and they wouldn't listen to me.

I know more about the subject than you know.

> Actually, you have no idea what I've done

I just reacted to what you said... and the mistakes you've made. Doesn't matter what you did, you are wrong...

> I know more about the subject than you know.

You don't know what I know, yet you make the claim... usually that sort of logic comes from folks who don't know a whole lot...

Your logic was bad, and you didn't even respond to the comment.

This isn't audit we're talking about. I don't care if you're Ponch from Chips, a mistake is a mistake.

You can show me pictures with President Clinton, it won't undo the mistake.

ok I'll bite:
""You have your opinions."
It's not an "opinion." It's the way it's done. Unless you can show me where it's not."

Show me where it is done that way.

Also, nyc10022 is entirely correct, your POV is as an audit, which shows how you get to looking at the notes to the financial statements for the effective rate vs. having built a pro forma business case and using a company's marginal rate of taxes in the pro forma analysis. Your same error applies to the tax situation for the individual.

Lastly, yes, your point of view stated herein, "the most elegant way to see whether a property is priced right is what it would cost you to rent it. It should cost you no more to rent a property than to buy it per month, excluding principal. That is the only way you could make money if it were a third-party at market rates" is correct, but I think it has been noted that you place different values on the personal benefits of home ownership vs. some others, and those are all lifestyle or flexibility weightings you are applying.

Dear Mr. Ranter,

There is an ignore button for posters on StreetEasy, I suggest you use it to prevent needless responses. Then I won't have to see posts debating things like "is the earth round", "does the sun rise in the east", "is there a tax benefit from owning real estate" with certain posters.

There is no question that there is a tax benefit (calculated at your marginal rate) to owning real estate. No question whatsoever, as you know. As do we all -1.

The ONLY question is in what category would you place someone who claims otherwise? You have several choices, and it may be a tough call which to pick:

http://en.wikipedia.org/wiki/Moron_(psychology)

Ah, the old don't wrestle with a pig warning.

On the other piece, how much money you end up at the end of the day is what matters. You can talk marginal rates, etc., but in the end, its how much $$$ you end up with at the end of the period. Rates and such theoretically point you at that, but the proof is in the pudding. If you save $$$ in taxes, it adds to your net, plain and simple.

"your POV is as an audit"

No. It's as an economist. It has nothing to do with audit. You can't pick and choose what rate each individual tax deduction is applied at as they're all applied simultaneously. Tax benefits are calculated as a function of taxes - "I saved $3,500 in tax" - not as a function of rent - "It cost me $3,500 less to live there."

It doesn't. It cost you the same to live there. I've never denied the benefit, just how people look at it.

And my further argument has always been that the opportunity costs offset the tax benefit when adjusted for risk, because when adjusted for risk all asset classes yield the same over the long-term.

I'm glad you accept how to look at the transaction - versus a third-party rental - but if you accept that it implies accepting the rest of what I say, because it's just a different way of saying it.

Just as saying the price-to-rent ratio does not explicitly take the tax effect into account because it is discounted into the price. Other measures do take the tax effect explicitly into account. Just not that one.

"You place different values on the personal benefits of home ownership vs. some others" is untrue. What I do that others don't do is set a cost to those benefits, as there are also (offsetting) benefits to renting. I would prefer to own in the long-term than rent, but I would also prefer not to lock in a capitalized rent structure that will likely lose me lots of money in the long-term. Just as I would prefer to own stocks than cash, but most of my money is currently in cash because of extreme conditions of volatility.

modern - we were good at no ad-hominem attacks till you showed up.

Begone!

This is nicely done jgr. Too bad steve hijacked your thread to pander more of his malarkey.

On the insurance question, if you are accustomed to insuring a single family home in FL, that will be significantly higher than something here. When you own a condo or co-op unit most insurance will be paid by the building via maintenance fees. The owner only has to cover the inside of the apartment. If you have high end finishes, expensive appliances, or cabinets it could run a little more, but ..50-.70 per square foot per year should cover it.

oh, economist, that's practical to an individual making a decision.

"I've never denied the benefit, just how people look at it."

So this is all a semantic argument?

> No. It's as an economist. It has nothing to do with audit.

OK, then you wasted a LOT of space giving bogus credentials, and none having anything to do with this.

I am an economist by training, btw... and your mistakes are still mistakes.

> Tax benefits are calculated as a function of taxes - "I saved $3,500 in tax" - not as a function of
> rent - "It cost me $3,500 less to live there."

Tax benefits can be calculated as a function of a DECISION.

So, it is absolutely fine to calculate the net cost of a decision and apply tax savings to that solution.

If you don't understand how to calculate the economics - including taxes - of one choice versus another, then I will say that you are a pretty lousy economist.

> And my further argument has always been that the opportunity costs offset the tax benefit when
> adjusted for risk

No they don't.

> because when adjusted for risk all asset classes yield the same over the long-
> term.

Horrible logic... you are choosing your conculsion and then using it as a premise.

Seriously, where did you get your training?

"If you save $$$ in taxes, it adds to your net, plain and simple."

No. Completely untrue, and very easy to prove.

You pay $10,000 in mortgage a month. Even granting you (though I deny it) the marginal tax rate argument, at the 40% rate you would save, in the first year, $3,600 a month in tax (interest of $9,000 a month, approximately). That brings your effective mortgage payment (using your argument) to $6,400. If it only cost you $4,000 a month to rent the place, you're still down $2,400 a month.

But if you tried to rent it out, say you have expenses less principal of $9,000 a month, but you can only get $4,000 a month to rent it, then you have a net loss of $5,000 a month.

That, unfortunately, is the sad truth about prices in Manhattan today.

"because when adjusted for risk all asset classes yield the same over the long-term."

Uh, ok, and the worldwide average temperature right now is 5.3 degrees centigrade.

"I'm glad you accept how to look at the transaction - versus a third-party rental - but if you accept that it implies accepting the rest of what I say, because it's just a different way of saying it."

No, it isn't.

"You place different values on the personal benefits of home ownership vs. some others" is untrue. What I do that others don't do is set a cost to those benefits, as there are also (offsetting) benefits to renting. I would prefer to own in the long-term than rent, but I would also prefer not to lock in a capitalized rent structure that will likely lose me lots of money in the long-term. Just as I would prefer to own stocks than cash, but most of my money is currently in cash because of extreme conditions of volatility.

Do you read and consider what you write before you hit the Reply button? You very clearly stated a preference in your paragraph just above, a preference that reflects a different value to you than it would to any given other individual.

But I bring you back to the average temperature globe and would also like to point out that the average time worldwide right now is Noon.

If JuiceMan disagrees with me I know I must be doing something right.

Ranter seems to agree with me - the way to do the analysis is as a third-party transaction. That's all you need to do.

"Tax benefits can be calculated as a function of a DECISION."

What? No. It is a function of ALL decisions.

"it is absolutely fine to calculate the net cost of a decision and apply tax savings to that solution."

Absolutely not, and that's my point: all of your decisions weigh on how much tax you pay. You must, then, take them as a whole, not individually, because taxes aren't applied individually - each individual item added to the next gives you your tax rate.

"you are choosing your conculsion and then using it as a premise."

What?

"where did you get your training?"

George Washington University, and my advisor was a Nobel-prize winner for national income accounting. I also have an honors degree, my thesis was on the relative weight of inflation and increases in wages in the food-services sector from 1970 - 1980, a period of both high inflation and large increases in the minimum wage, on a sector with wages closely tied to the minimum wage.

It was not possible to determine which had a more significant impact on wages.

"increases in wages" = "increases in minimum wages"

steve, why don't you just continue one of the other 50 threads on this topic? This thread actually had some use.

"No, it isn't."

Yes, actually, it is. Both compare rents to owners' carrying costs, albeit in different ways. Yet it has been statistically proved that rents and property prices are nearly perfectly correlated over time.

The decision I make as to whether to buy a property to rent it out or to live there myself is based on different sets of parameters, but for a market to be in equilibrium they must reach the same conclusion which, as I said, has been proved empirically. What caused the present bubble was a change in leverage and the perception of risk, and that is being corrected, rapidly.

"the average time worldwide right now is Noon."

No, actually, it's not. Think about it and get back to me.

And then think about the discussion of opportunity cost, and why neither the time nor the temperature are related to it. jgr does not weight any of his decisions based on risk. The risk of buying is much higher than the risk of renting.

"You very clearly stated a preference in your paragraph just above"

No I didn't. I always stated the same preference: I prefer to own when it's cheaper to own, I prefer to rent when it's cheaper to rent.

" When you own a condo or co-op unit most insurance will be paid by the building via maintenance fees. The owner only has to cover the inside of the apartment. If you have high end finishes, expensive appliances, or cabinets it could run a little more, but ..50-.70 per square foot per year should cover it."

Thanks JuiceMan. That makes a lot more sense now.

"Why are you adding the points paid to the principal balance of the loan?"

"Second is the mortgage tax. You should add a formula to calculate this. The tax is 1.80% of the mortgage amount on purchases <$500k and 1.925% of the mortgage amount on purchases $500k and up."

Good catches.

"For seller closing costs, the NYC portion of the transfer tax is actually 1.425% and NYS collects 0.40% as well for a total of 1.825%. Maybe you should add another field for new construction properties. On these units, the BUYER pays all of the transfer taxes which most people don't realize."

Ouch.

"As for PMI, it varies but on average I suppose you could calculate it at 0.5% * loan amount / 12. And this would only apply on loans with < 20% down."

I believe the default value I have is at 0.72%. I just used the $ per $100,000 because thats what I most often see it quoted as. The PMI is not included on the yearly tables after the owner has 20% equity whether thats through initial equity, appreciation, or principal payments.

"n jgr's model, the most difficult parameter to work with is "potential appreciation / depreciation": pick price depreciation, even modest, and it will NEVER be better to buy than to sell because you're losing your principal. But that is not necessarily the case. If prices fall, but rents rise faster, it may very well be a good idea to buy."

You didn't look very hard at configurable parameters. You can vary both appreciation and inflation independently

"This thread actually had some use."

It's the same as many other threads. I've seen the model, and I find it, while a good try, to be deficient in a number of aspects. Others have agreed with me. I proposed an alternative, far simpler model that gives the same result without weighing so many variables whose correlations to each other are not known.

Treat it like a business: it you can break even on a cash-flow basis renting the place out that you buy, then it's safe to buy. If it's significantly more expensive, then it's not safe to buy because the market is out of equilibrium. If jgr can come up with a way to incorporate that general principle into the model, then fine.

"You can vary both appreciation and inflation independently"

Check your model's sensitivity to it. If you're paying 5% interest but expect properties to decline in value by 10%, you're actually paying a real interest rate of 15%.

Check your risk-premium: the current risk-free rate is approximately 0%, hovering below 0% at times. You need to adjust for the extra risk of owning.

And my biggest beef remains how you calculate the "tax benefit": we all agree that there is one, but at what rate is it applied? Check the difference between your marginal and effective tax rates, and the effect that that has on your calculation. Let's just say you give me the benefit of the doubt and humor me and let me be right: what's the difference between the two? If you're so sure that you're right on using the marginal rate, then go ahead. But if you're wrong...?

"Check your model's sensitivity to it. If you're paying 5% interest but expect properties to decline in value by 10%, you're actually paying a real interest rate of 15%."

I don't know what you mean by this. Yes, cash flow and net worth calculations are very sensitive to inflation and appreciation on a fixed debt.

"Check your risk-premium: the current risk-free rate is approximately 0%, hovering below 0% at times. You need to adjust for the extra risk of owning."

There is an illiquidity discount parameter in there that you can use this for. I kept it at zero because few would apply it in their own calculations. Personally, I use 5%.

"And my biggest beef remains how you calculate the "tax benefit": we all agree that there is one, but at what rate is it applied? Check the difference between your marginal and effective tax rates, and the effect that that has on your calculation. Let's just say you give me the benefit of the doubt and humor me and let me be right: what's the difference between the two? If you're so sure that you're right on using the marginal rate, then go ahead. But if you're wrong...?"

I don't specify marginal or effective tax rate in there. You are welcome to put it whatever rate (even 0%) you want. I'm going to pass on any further argument about taxes with you.

No matter how you slice it, renting is ALWAYS financially more beneficial over time than owning.

Let's make some financial assumptions that are borne out by decades of empirical evidence:

1) Real property prices and rents increase at the rate of income, or 0.7% per year adjusted for inflation.

2) The S&P 500 increases at a real rate of 8.0% per annum.

These being true, it is ALWAYS better to rent property than to buy, if you invest the down payment in the S&P 500. Watch:

Say you make $100,000. This implies that you can spend up to $2,333.33 per month in total housing expenses (28%).

An 80/20, 30-year fixed $375,000 mortgage at 6% gives you monthly mortgage payments of $2,248.31.

Assume that taxes and common charges amount to a VERY CONSERVATIVE 10% of total mortgage payments, or $224.83 per month.

A $375,000 mortgage implies a purchase price of $468,750, and a down payment of $93,750.

If rented an apartment for the amount of the mortgage payment, you will have paid $903,455.33 in rent over 30 years if it increases 0.7% per year.

If you invest the down payment in the S&P 500 for 30 years, $943,374.08 at the end of 30 years, for a total net profit of
$39,918.75. To that, however, add your yearly maintenance and tax payments $2,697.96, increasing 0.7% per year and accruing 8.0% per year over 30 years, and you will have earned an additional $330,084.36, making your total profit $370,003.11.

Now do the same thing for your house. If your $468,750 home appreciates at a real annual rate of 0.7%, at the end of 30 years you will have a home worth $577,863.68, for a profit of $109,113.68. Add to that the original loan of $375,000 - the rest of the equity you will have built - and you get a gross profit of $484,113.68. But you would have paid $434,393.21 in interest, so your real profit is $49,720.47. In addition, you will have spent $90,343.15 in tax and maintenance, making your GRAND TOTAL PROFIT a whopping NEGATIVE $40,622.68.

That's right! You rent for the amount of your mortgage, all values go up linearly in line with historic data over time, and you will wind up with a total profit of $370,003.11. Whereas if you buy a home you will wind up with a loss of $40,622.68.

This of course excludes special assessments and all the transaction costs associated with owning real estate: brokers' fees, conveyance tax, etc. It also ignores the tax effect on dividends. But dividends and capital gains tax rates are currently the same (and can't be predicted in the future). The only further benefit from owning is the $250,000/$500,000 tax exemption. But it is doubtful that $410,625.79, which is the absolute value of the difference between the owner's loss and the renter's gain.

Guys, it's indisputable: renting is FAR better in the long-term than buying. All the figures and assumptions I used are real and verifiable. Do your own calculations: rent for the price of your mortgage payment, invest the down payment and maintenance and property taxes in the S&P 500 at the real rate of increase of 8.0%, increase your property value, rent, taxes and maintenance payments at the real rate of 0.7%, deduct the mortgage interest paid, and you will see IT IS ALWAYS MORE BENEFICIAL TO RENT.

Do your own calcs, or criticize the model. I'm waiting....

1) From January 1, 1950 through December 31, 2007, the average capital gains from the S&P 500 was 8.66%.

http://www.moneychimp.com/features/market_cagr.htm

That does not include reinvested dividends.

"If you were to go all the way back to 1928 and dissect the S&P 500 into rolling twenty-year periods, there would be fifty-nine of them (1928-1947, 1929-1948, etc.). The average annual rate of return over those periods was approximately 12 percent."

cdn.digitalcity.com/coaches/historic-market-returns-murray05262006.pdf

That's where the 8% real return on the S&P 500 comes from, on a rolling average basis, which corrects for specifically-targeted dates.

2)0.7% real gain on real estate is from Robert Shiller of Case-Shiller fame:

http://en.wikipedia.org/wiki/Housing_bubble

"Robert Shiller's plot of U.S. home prices, population, building costs, and bond yields, from Irrational Exuberance, 2d ed. Shiller shows that inflation adjusted U.S. home prices increased 0.4% per year from 1890–2004, and 0.7% per year from 1940–2004."

3) Market rents are constrained by market factors: 40x monthly rent in income. Therefore, if incomes go up 0.7%, rents can at most go up 0.7% because constraints.

"Rents, just like corporate and personal incomes, are generally tied very closely to supply and demand fundamentals; one rarely sees an unsustainable "rent bubble" (or "income bubble" for that matter)."

http://en.wikipedia.org/wiki/Housing_bubble

And that constraint on the demand side is 40x monthly rent in income, 28% total household income in housing expenses.

4) Historical averages do not equal future returns: that is true in the short-term. But it is also true that over long periods of time everything returns to its equilibrium. And the 12x annual rent = sale price is real, and constant over time specifically because of those market constraints:

The 12x ratio (if that's what you're talking about) exists because of the ratio of prices to income. If you make $100,000, you can you can rent a property that cost you $2,500 ($100,000 / 40). You can buy a property that will cost you $2,333.33 in total cost ($100,000 * 28%).

Let's just use rents vs. mortgages to make it easy. At 6% interest, you can afford a $400,000 mortgage, giving you payments of $2,389.20 You can afford annual rent of $30,000. $400,000 / $30,000 = 13.3.

Very close to the 12x, right? And 6% is a very low interest rate and I greatly simplified the math. If you - like ccdevi - claim that the rent to purchasing price ratio is 18x annual rent, then making $100,000, being able to afford $30,000 a year in rent, you could afford a $540,000 house, but that would give you monthly mortgage payments of $3,237.57. Your monthly pay is $8,333.33, giving you monthly housing costs of 39% of your monthly income.

OH WAIT! I FORGOT! NOBODY WILL LEND YOU THAT MUCH MONEY BECAUSE THE RATIO IS 28% TOTAL HOUSING COSTS TO INCOME!

You say: "If the stock market and real estate go up the same annualized % over the long term (which I think is much more reasonable, especially for manhattan where they are so highly correllated)"

If you the market prevents you from spending more than 40x annual rent / 28% percent of household income on housing expenses, HOW CAN RENTS / PRICES GROW AT 8% UNLESS INCOMES DO?

Well, sweetheart, THEY CAN'T!

"I'm not going to waste my time to go find the numbers for a pointless "discussion" with you, but I think this post of yours once and for all proves that your opinion is basically worthless."

Because you can't. You're in over your head. You're blind to the fact that the market is constrained by 40x/28%, and that real income rise only 0.7% per year on average, and therefore housing prices can rise only that much.

Your claim is so ridiculous that if you take the example of the $468,750 and increase it at a real rate of 8% per year, after 30 years it will be worth $4,716,870.42. But if your $100,000 income only rises a real 0.7% per year, it will be $123,277.58 after 30 years.

WHO MAKING $123,277.58 CAN AFFORD A HOUSE WORTH $4,716,870.42?

Them there's the numbers, baby, if you do what you are claiming.

I'm trying to show that the people who are so "into" real estate don't even know the fundamentals of the market. Yes I would like to buy, but for emotional reasons, not as an "investment," because it's a crappy one from a financial perspective. From having a secure place to live it's a marvelous thing to have.

My numbers are all proved over DECADES. I remember the dot.com bubble - the "New Economy" is special. Well that's what the real estate bubble is all about.

"Take 100 people who have lived in NY City for the past 10 years and have been property owners. Take another pople who have lived in NY City for the past 10 years and have been renters. Same income, same martial status. Steve, I am willing to bet you $10,000 that the hoome owners net worth is not only greater than the renters but significantly greater if not exponentially greater."

That's exactly the danger! Extrapolating from the most significant increase in property values in the history of the world - the last 10 years in Manhattan - onward toward the future. You need to take much longer periods, and moving averages, and look at the market constraints.

All my numbers are real and provable. Claims like property prices rise at a real rate of 8% per year - which is what evillager is betting his future on - are not only historically inaccurate, but theoretically impossible given the market constraints.

could you afford to buy your $1.4 million property on your income today, without using the capital gains from it as part of the down payment. That means you would need $280,000+ in cash for the down payment / closing costs, and at 7% interest over 30 years afford a mortgage payment of $7,451.39, plus let's say $1,000 per month in (unabated) tax and $1,000 in maintenance. You would need a salary of almost $400,000 a year to afford that, versus what your salary was in 2003.

Therein lies the problem.

Rents and home prices CANNOT increase by more than incomes. How could they?

40x / 28%. Study it. If you take the example of the $468,750 house and increase it at a real rate of 8% per year - the S&P 500 real rate - after 30 years it will be worth $4,716,870.42. But if your $100,000 income only rises a real 0.7% per year - which is about average for incomes - it will be $123,277.58 after 30 years.

WHO MAKING $123,277.58 CAN AFFORD A HOUSE WORTH $4,716,870.42?

I am biased only against bubble pricing.

Real estate is wonderful.

petrfitz, again you make my point without knowing it. Incomes increase at the rate of productivity; housing increases at the rate of income. The net worth of corporations increases at a much higher rate because they are able to exploit efficiencies and add more value through product innovation.

That is what made NYC what it is today. It is also why the S&P 500 increases at a much higher rate than housing.

Stock prices are based on an estimate of forward earnings.

The stock certificate represents the value of a company as a producer of income, not as a holder of assets.

Which is why what you say is dumb.

And to say that real estate is not a leveraged investment is even dumber: people borrow up to 110% of its value. That is not leverage?

steve has some of the worst analytical application skills of anyone on this board. He is incapable of taking a concept and correctly applying it. Despite having it spelled out to him by multiple people, in the most elementary terms and with clear examples, he insists on his moronic ideas that: 1) you shouldn't consider the mortgage interest tax deduction when comparing rent costs to ownership costs, and 2) if you do consider the deduction, you should use your effective rate rather than your marginal rate, even though this is clearly incorrect and entirely stupid.
He babbles on and on with wrong ideas to either justify to himself that renting has been better than owning all these years, or to avoid having to admit that he just isn't that intelligent and is wrong. I feel bad for anyone here who reads his comments and uses what he says to make decisions.

Earnings are after a company pays interest expense AND PRINCIPAL to its debt holders.

Thanks for the spam sashamelia

A company borrows money from equity holders just as it does from debt holders.

"Market capitalization (aka market cap, mkt cap or capitalized value) is a measurement of corporate or economic size equal to the share price times the number of shares outstanding of a public company."

http://en.wikipedia.org/wiki/Market_capitalization

Assets - Liabilities = Shareholders Equity. Basic bookkeeping.

I make $100. I repay a loan, $9 in interest, $1 in principal. My net - OBVIOUSLY, according to you - $91 because I don't count the repaid principal. Somehow, I've managed to keep it.

Dumb. I make $100. I repay a loan, $9 in interest, $1 in principal. I have $90 left. Those are my earnings.