Cheaper to own than to rent?

What's the income required to get a 1m mortgage these days and 2k in maintenance payments. Probably around 350k. At that level, you are going to see clawbacks in mtge int. deductability (even w/o AMT). Are you suggesting that on monthly gross payments of just under 10k that the net after-tax payment would be 6k. SNORT!

If you look at this one:
http://www.streeteasy.com/nyc/sale/335951-condo-595-west-end-avenue-upper-west-side-new-york

Selling for $785k (already down from $899k). Same unit is offered at $3500k.

Considering the maintenance / property tax, as well as condo transaction costs, this one is about 22% cheaper to rent than to buy, even if you include the tax benefits (partly offset by opportunity cost of downpayment) and rent increases over time (partly offset by increasing maintenance / property tax).

Again, the only way you make this work is by making a positive assumption on capital appreciation, which seems quite aggressive to me, to say the least!

LICC - I'd love to refute Steve's argument but all I can find so far are examples which proves his point. And I have tried 5 listings already. I don't want to get into discussions on equilibriums and market cycles since 1930, but the reality is that it seems cheaper to rent than to buy currently. Not sure if this will last and I'm sure there are exceptions (I'd love to get a $1700 sq ft loft for $210/ft), but the general rules seems to hold, and Q1 activity stats certainly can't refute it either.

I meant $3500/month

My bad. Did that calculation too quickly. Monthly gross payments of just under 8k. Net after-tax payment of just under 6k. Hmm, do you think this unit will rent for just under 6k or even less? I'm not that familiar with that chunk of the UES. On the UWS, you'd have a hard time getting this on a non-park block, non-shiny new building w/o lots of amenities for a mid-sized 2-bed.

Still, my point holds about clawbacks to deductability.

Look at this apt - larger, 3 beds, equiv. location with outdoor space - http://www.streeteasy.com/nyc/rental/448735-condo-216-east-75th-st-upper-east-side-new-york. $5400.

calimero, that is because you are going beyond actual out-of-pocket costs and using assumptions and projections. When you do you that, your biases skew the analysis. You are projecting 6% annualized returns on securities investments but 0 on price appreciation. That is inconsistent. You also are looking at a short to mid-term time horizon. Many people own for more than 5 years.

licc, historically people have owned for more than 5 years. when the cost to buy is less than the cost to rent most people can afford to buy a home that will suit them for a longer time period. that has not been the case in the bubble markets in the last few years. we're still nowhere near an affordability level that will allow most young couples who wish to have children in the future be able to buy a three bedroom apartment. studios get old for all but the very stalwart.

I have never said that the rent/buy analysis should be used as a projection or as the deciding factor in a purchase decision. Even if the ratio looks good, if prices will continue to decline then you shouldn't buy. But I am correcting some wrong assertions being made that current prices are way beyond current rents, and that prices have to fall 50% to meet current rent levels.

Although Obama's talking about new deductibility clawbacks, the existing ones generally don't matter in a buy/rent calculation because you've already "maxed out" your clawback on state and local taxes. The clawbacks are proportional to income and not to the deductions that you're taking, so increasing the deduction doesn't increase the size of the clawback.

but the total deductions allowed adjust upward for income. if I did not have the real estate taxes, in 2007 I would not have been subject to the AMT.

I would not say my forward looking model skews the analysis... If anything, it refines it. Just immediate out-of-pocket expenses are more skewed by definition, because your scope is much narrower than mine.

What is debatable is not the use of projections, it is the assumptions themselves. But my assumptions are purposely very fair and conservative: 6% HY bond return is far from outrageous, and this is certainly not riskier than one specific piece of RE property in NYC at the moment. Yes, I am not factoring in any appreciation, for obvious reasons. Why is it inconsistent? I didn't say I was expecting the economy or the stock market to grow at 6% and expecting RE to stay at 0 (that would be inconsistent, you are right), I am saying that on a risk adjusted basis, RE is clearly not attractive right now (as stated by many already): for a similar risk profile, yes I can find paper yielding 6% over 5 years while this unit is not likely to generate much upside in a 5-yr timeframe.

Also, my model averages 5 and 7-yr horizons. I would not call that short to mid term, and I was under the impression that my 5-7 year horizon was fairly standard in NYC, but if you plan on holding on to it for longer than that, then you would be obviously correct.

and considering my equity would be levered 4x and tied to one illiquid asset, this is certainly a lot riskier than making an unlevered second lien fixed income investment in the more liquid corporate bond market!

You are projecting 5-7 year returns for junk bonds and forecasting real estate values, and using that to compare current costs. That makes your analysis based what you think will happen in the future, which is fine, but it is not a concrete comparison of current costs.

But, of course, tons of what is analyzed in the model is NOT current costs... its expectation of future. You can't look only at current costs, just as you can't only look at the current rate of appreciation (or depreciation).

You HAVE to put long term factors in.

Of course, most of those are slanted against RE right now.

Fair enough, I agree with you on the methodology.

Just to be precise, I am not projecting any capital gain on junk bonds for 5-7 years (slippery slope), the returns I am talking about are purely yield-based income from clipping coupons that I know for a fact today when I get in. So the only projection I have to make is about default risk because I am holding to maturity.

And as I stated above, losing my principal on an apt when you are 4x levered is much more likely than when you are unlevered into HY bonds (6% is not even junk territory so still relatively safe).

LICC, "I just looked at the featured listings again. Completely random. Here is another that shows steve is wrong:"

Wouldn't that cost over $7,000/mo to own? I don't think it would get that much in rent. Are you saying that by deducting the mortgage interest and the maintenance (all maint. is deductible if it's an investment property), you make a profit? Or are you saying that if you lived in it as a primary residence your after-tax cost would be about what the market rent is? I think you're too optimistic.

Buy a studio in Queens with 20% down and low maintenance and you can rent it out for a profit. All these properties people are using as examples so far only make me think the prices need to come down another 15% at least. Whether they will come down or not I'm not so sure of.

You have default risk and reinvestment risk. Where are you going to reinvest those coupons for 7 years?
Who says that losing principal on your apartment after 7 years is a more common occurrence than losing money on junk bonds? You are making arguable assumptions.

I'll repeat again, I am not saying real estate will not decline further, I am disputing others' claims that current rents are wildly out of line with current prices. If you think we will only hit a bottom if prices fall 50% relative to rents, I believe you do not understand the current rent/buy comparison.

http://www.prudentialelliman.com/Listings.aspx?ListingID=1021304
http://www.prudentialelliman.com/Listings.aspx?ListingID=1021306

waddya think?

30 - very good example: $3,800 to own, $2,700 to rent. Once the tax abatement ends the ownership costs are likely to go up to $4,200.

"But I am correcting some wrong assertions being made that current prices are way beyond current rents, and that prices have to fall 50% to meet current rent levels."

I don't think you've come anywhere near close to that, LICC. You chose apartments for rent that have been delisted because no one will rent them at those prices (yet they remain for sale), ignore the foregone income on the down payment, and say voila, you won.

You haven't even posted ONE apartment that you could make money on when renting it out to an unrelated third party. Instead you try to shift the argument to the "tax benefit" again - which if you need financing can't be used for financing - and ignore the parts you don't like.

Try again: find an apartment that you can rent out to an unrelated third party and make money on.

Then maybe you can ask your BFF JuiceMan why he dropped out of the argument when push came to shove.

Oh - I'm still waiting for JuiceMan's recantation over there being no formulas that don't take the "tax benefit" into account, when I posted a bunch.

Are you weaseling, JuiceMan?

actually $2400 to rent. although it's weird. the sales listing still has also available to rent for $3300. how's that for some rent deflation?

steve, when your statements have been addressed and shown to be worthless, your repeating them over and over again doesn't change anything.

"steve, when your statements have been addressed and shown to be worthless, your repeating them over and over again doesn't change anything."

Then humor me, LICC: which apartment did you find that you could rent out to an unrelated third party and make money on. Just one, please!

Thanks.

JuiceMan, LICC - where are your examples?!

Have you (yet again) decided to declare victory and pull out?

JUST ONE.

Steve does have a point. The apartments I saw that were available for sale/rent were waaaay over the ratio just a few months ago. Prices came down 20%, but rents are down too, and even if its just 10% (I believe its more) that wouldn't have fixed the ratio.

Note that (as usual) JuiceMan and LICC make claims, claim they post data when they don't, and then declare victory and walk away.

They can't even find a single apartment - even ones with inflated rents - that they could purchase and rent out to an unrelated third party, and make money.

Not one.

I don't think that was the original argument that LICC was making. LICC just didn't think prices needed to fall 50-100% in order to break even.

> LICC just didn't think prices needed to fall 50-100% in order to break even.

They do if rents fall 25% (and we're not far from that).

Here's the initial challenge: "here's the challenge: let's look for the same or a virtually identical apartment costs less to own than to rent. Or approximately the same. Or no more than 10% more expensive. Using your standard 30-year fixed mortgage and unabated taxes, deducting (as in any investment property) everything but the principal."

They can't even do that.

Granted, some of the apartments that LICC noted had about 30% to fall (if you use real rents), but those have already been discounted significantly.

This is the first comment from LICC

steve, don't lie again. I never claimed anything other than the cost to own, in general, is nowhere near as high as 50% above the cost to rent, as some claim.

Of course if rents come down another 25%, it will make a difference. But I believe they were talking about current prices. If rents go back up 25% over the next 6 months the opposite will happen.

but bob, we have plenty of examples where that is true, the 50% number.

So bob420 is LICC, as well!

bob420: "I don't think that was the original argument that LICC was making."

bob420: "steve, don't lie again. I never claimed anything other than the cost to own, in general, is nowhere near as high as 50% above the cost to rent, as some claim."

Dude, you really have to watch what userids you sign in under.

And there are plenty, plenty of examples, posted here and elsewhere, where the cost to own is more than 50% above the cost to rent.

LICC.

I don't think anyone would argue that there are examples of it but the market as a whole? Not so sure. I seriously doubt you will be getting a 1 BR on the UES/UWS that is currently listed at 700K for 350K.

Bob420 is LICC as well? What is that supposed to mean? I copied the first post from LICC. I have no idea who LICC is.

no bob, where the monthly cost to own is at least 50% more than the monthly cost to rent the same or comparable unit.

Oh, I misread! My bad!

Gotcha

I thought stevejhx said somewhere in another thread that actual prices would drop 50% from here, I just assumed that this was a continuation of that thread.

That was LICC's first post, but not mine. Not what this thread is about.

This is just a simple case to find just ONE apartment that can be rented out at a profit. Just one.

I have said that actual prices would drop 50%. And they will. They're already on their way down, & if you look at the declines in some of the properties LICC linked to, you'll see that.

steve seems to think that when someone posts something agreeing with me, that it is me signing in under a different id. Paranoia, conspiracy theory - you decide.

There are not lots of examples of the cost of owning being 50% higher than the cost of renting, on a monthly after-tax out-of-pocket cost basis. In general, the rent ratio is nowhere near 50% below ownership cost, as a few of the renter bears here proclaim. That was always my point. steve's changing of the conversation to compare investment property ratios is irrelevant and worthless. He just does it so he can appear in his own mind to win an argument and he doesn't have to admit he is wrong, again.

"steve seems to think that when someone posts something agreeing with me, that it is me signing in under a different id."

No, actually, I didn't see the first line of the post.

"There are not lots of examples of the cost of owning being 50% higher than the cost of renting, on a monthly after-tax out-of-pocket cost basis."

Actually, there are tons of them posted here and elsewhere. Even with your unique way of calculating "out-of-pocket costs," that is, excluding how much extra income you'd have to deduct from your rent if you invested your down payment elsewhere.

"steve's changing of the conversation to compare investment property ratios is irrelevant and worthless."

Even though your BFF's own post said that the cost of owning should be the same as the cost of renting?!

Are you contradicting JuiceMan?

Err, you are discussing my posts steve, not Juiceman's, but I have never seen Juiceman state that you should measure the cost of owning on a pre-tax basis. In fact, I believe he stated that you didn't read his post correctly and you drew the wrong conclusions. Maybe you should talk to him about that.

So let me understand your point, Mr. LICC. Two questions:

1) Under your theory, if you put down $200,000 on a $1,000,000 property, you can deduct the income tax benefit as part of your "out-of-pocket expenses."

I assume you will agree with that one.

So the second question is:

2) If you choose to rent instead, can you deduct from your rent the amount that you would otherwise earn on the $200,000 down payment?

A simple yes or no will do.

Thanks.

How much would this place rent for?

http://www.streeteasy.com/nyc/sale/406065-coop-269-w-72nd-st-upper-west-side-new-york

$2,600-$2,800?

We have gone through this steve. If you want to add back in the price appreciation of the property, then you can deduct the opportunity costs of your down payment. But now you have changed the analysis beyond an out-of-pocket cost comparison.

steve likes to only include the parts of the equation that support his argument and ignore the parts that show he is wrong.

I agree lowery, the monthly ownership cost would be right in that range.

Do the breakdown for that place. I realize most people here are talking about much more expensive properties but that one would be cheaper to own after tax benefits.

Around $2,500.

LICC - I have no problem with this:

1) Increasing rents, common charges, taxes, etc., at the pace of incomes.
2) Increasing "equity" at the Case-Shiller post-WWII rate.
3) Increasing the "down payment" invested in stock at the post-WWII moving average, reinvested dividends.

for the life of the mortgage (30 years). And you can suggest other factors.

However, for the purpose of this example, let's just take the first year. Can we agree to that?

Why would you increase taxes at the pace of incomes rather than the same pace of "equity"? Property taxes are based on real estate values.
Why base the "equity" rate on post-WWII when today's housing market, as it currently functions, really began in the 1930s when FDR's federal agencies changed the way property purchases were financed?
Why use stock returns to measure the down payment opportunity costs? Most people who buy would not otherwise invest all their down payment in stocks.
Why are you only looking at one year? Most people who buy own for many years, not one.

Classic steve, trying to cherry-pick his assumptions to manipulate a result.

Cheap to own than rent?

So by making a 20%-30% of down payment today, you will own the entire apartment free and clear after 30 years, and be cash flow positive every month along the way?

I am not saying this never happens in history, but do people really expect this is the kind of return they SHOULD get?

1) I would increase income taxes at the rate of incomes, and property taxes at the rate of property prices (even though in Manhattan imputed rents are used for tax purposes, not property values).

2) Post-WWII is generally considered the beginning of the modern era, since neither the Great Depression nor WWII were "normal" periods. Moreover, there were wage and price controls during those periods, which skew the data further. And there is no accurate information on the performance of the S&P 500 for that time period, as the measure did not exist.

3) Stocks are an investment of equal risk to real estate. If you use the risk-free rate for the down payment, then you would have to adjust increases in property prices downward for the increased risk, and you would come out with essentially the same answer.

4) I would look for the entire 30 year period, as I said. I just said one year to start.

Does that answer your concerns? There is no cherry-picking there.

And where is JuiceMan's apology?

And where are his examples of properties you can buy to rent at a profit?

JuiceMan?! JuiceMan?!

So, wouldn't that last example be about equal to own when considering mortgage interest and deductible maintenance?

To do this right you need
BUY ASSUMPTIONS
HOME PURCHASE PRICE
MORTGAGE INTEREST RATE
DOWN PAYMENT RATE
APPRECIATION RATE
CLOSING COSTS RATE
SELLING COSTS RATE
MARGINAL TAX RATE
HOLDING PERIOD
MORTGAGE TERM
INFLATION RATE/YEAR
MORTGAGE VALUE

RENT ASSUMPTIONS
MONTHLY RENT PAYMENT $
INFLATION RATE/YEAR
ALTERNATE INTEREST RATE @
FOR HOLDING PERIOD OF YEARS

LICC... "out of pocket expenses" ???? WTF does this mean? Isn't being on the hook for a mortgage that's 5x leveraged not "out of pocket"?

This example?

http://www.streeteasy.com/nyc/sale/406065-coop-269-w-72nd-st-upper-west-side-new-york

Not even in the first year:

Down Payment $105,000
Mortgage Amount $420,000
Mortgage Payment $2,385
Total Monthly Payment $3,585

You pay about $2,300 a month in interest, or $27,600. You get about 35% of that off your taxes, lowering your costs about $805 a month. Let's call it $1,000 a month with tax-deductible maintenance. So your monthly "out-of-pocket" costs, according to LICC, are about $2,600, which is more than the rent.

Take, though, that $100,000 down payment and invest it in stocks with a conservative 5% yield (it's twice that historically), you get $5,000. Divide that by 12 is about $417 a month in income. Subtract that from the rent of $2,500 and you get "out-of-pocket" expenses, and you get rent of $2,100 a month, less than the $2,600 from LICC.

That, of course, ignores lots of important stuff such as transaction costs, the fact that if you lose your job you lose your tax deduction so (according to LICC) the cost of your housing goes up, whereas the cost of rent does not. (Which is why, logically, tax deductions are tax deductions and taken as a function of taxes, not of "living expenses.")

Over time, your mortgage interest deduction goes down. If subject to AMT you lose the ability to deduct property taxes. It's still, therefore, even using LICC's ridiculous assumptions, much cheaper to rent than to buy.

Of course, that doesn't take into account what would happen if the property goes down in value. If, say, it goes down $50,000 and stays there, that $50,000 comes from your money, not the bank's. Which means, if you only amortize it over 1 year, your housing expenses increase by about $4,000 a month, bringing the total to $6,600, versus $2,100 to rent.

Which is why there is no way that LICC (or anyone) can make sense out of this.

Then you put in transaction costs:

1) 6% realtor's fee
2) 2% flip tax
3) Conveyance tax
4) Mortgage tax (for a condo)
5) Closing costs
6) Attorney's fees

and you have another 10% gross off the top. So If you buy a $525,000 apartment that goes down $50,000 in value, and you have another $50,000 in total transaction costs, it will cost you an additional $100,000 to live there. If you live there just 5 years, that is $20,000 per year, or about $1,700 a month, in addition to the $2,600 that you get by doing LICC's (ridiculous) calculation, bringing the total to $4,300 per month, versus the $2,500 it costs to rent.

You kick his ASS stevie... it's the same math I've done for the last 4 yrs... no brainer on renting in this current market :)

I just spent some time going through rental listing (looking for Julia, to be honest). Then decided to see what kind of three bedroom I could get for under $6k. Both of those rental markets are tanking.

To do an apples to apples comparison -- taxes do matter
If you rent and invest the money, that money is taxable -- so the $417 is more like $250.
If you buy and sell the first $250k (or $500k for married couples) of profit is not taxed
Also housing (like stocks) are a great hedge against inflation. If you have a holding period of more than 5 years you can expect some serious inflation

"If you rent and invest the money, that money is taxable -- so the $417 is more like $250."

Not really. LT capital gains and qualified dividends are taxable at a much lower rate, and the 5% I used is actually 11% nominal over long periods of time. It depends on what it is. If you invest instead in rental property the tax is deferrable forever as long as you reinvest it.

"Also housing (like stocks) are a great hedge against inflation."

No they're not. Nothing is.

And if prices go down - which is what is happening - you can have all of the tax-free money you want. You won't pay any tax because you won't make any gains.

No one denies that each situation is different, but as a general rule, until housing stabilizes at a carrying cost approximately equivalent to rent, you will lose your shirt for the next 10-15 years.

Capital Gains
Fair point re: tax rate but its still not the $417 --

In terms of inflation - -will have to disagree
hard assets are a great hedge (ie gold/commodities/real estate) -- they keep being priced in nominal terms --

Almost every economist in the world expects inflation with all the money that is flooding the system. While NYC might not appreciate in real terms, if you have inflation, RE will certainly appreciate in nominal terms.

as for prices going down, different debate.

Steve, you throw out high or low numbers to suit your argument. Of course the numbers will never make sense if you always assume that the property has to be sold at a substantial loss.

LICC, "I agree lowery, the monthly ownership cost would be right in that range."

Do you mean the unit I think would rent for $2,600-$2,800? Or the 1.1-some million coop 2br that I think would cost $7,000+ gross to own?

BTW, I walked through the QB area of LIC a couple weeks ago and was amazed at how different the condos are making even that section look (i.e., the area near the dreaded PJs, not near CityLights). I actually don't get the repulsion people have expressed for being near those projects; the new condos, if fully occupied, would someday balance out the demographics in the area. I think that area, though basically ugly as sin, is much more convenient to Midtown than the cluster of condos around CityLights. I'm not yet seeing lots of evidence of amenities, but even the commercial tenants right on Queens Plaza are miles above what they were 10 years ago, and the new plants in the traffic islands make a difference. But walking a little further into the 'gisland, I still think Astoria, Sunnyside, Woodside and the rest have much more to offer, so I "get" LIC, but at the same time I don't get it.

steve, your analysis of the 72nd street place is laughable. You assume a 5% gain in the stock market, why not assume a 5% gain in price? And a 5% increase in rents? What a joke. You assume factors to back your argument and ignore the ones that show you are wrong.

So you don't want to include a period with wage and price controls, are you going to exclude the 1970s from your analysis?

lowery - I mean the $2600-$2800 one.

LIC has two main areas for new condos - the Queens Plaza/Court Square area, and the area by the water, which is more desirable. Either is convenient to midtown - Court Square has the E or the V one stop to 53rd Street, and the Vernon/Jackson stop for the 7 train is 5 minutes to Grand Central and about 10 to Times Square.

Stevehjx,

Its all simplified in cap rate.

(rent - cc - net taxes)/price = cap rate

Until the cap rates are equal to the (current 8%) cap rates of the large apartment REITs time the marginal tax rate (60%), it is cheaper to rent and put the cash into the REITs.

The cap rates on Manhattan apartments are 3 to 3.5% at current (2009) prices.

The cap rates of the apartment REITs is .6 * 8% = 4.8%. It is 4.8/3.25 times cheaper to rent than to buy.

If one is buying with a partially deductable mortgage (over $1 mm), the comparison is worse, i.e. much cheaper to rent.

If one has room in the IRA/401K for REITs, the comparison is worse, i.e. much cheaper to buy.

I have run the comparison on a few dozen potential apartments that I am considering, and it is always cheaper to rent in the same building than to buy.

Show me a Manhattan apartment with cap rate > 4.8%.

justin - excellent point which I touched upon earlier. It makes NO SENSE for an apartment to be cash flow positive on a gross rental basis from day one. If that were the case, demand would drive the price up.
steve really has a hard time understanding economic fundamentals.

Rent_or_Buy is spot on with his list of criteria - you need to fill in all of those blanks to do a proper analysis. I think over the next 5 years or so, it is indeed almost impossible to make the math work if you consider all of the buying expenses and especially the near certainty of price drops. However, if I were to use the property as investment and collect rent on it - why sell in the next 5 years? That is, even if I move out, I can keep the property for all 30 years of my mortgage and rent it out.

So I ran a 30 year NPV analysis with various numbers, and very modest assumptions about rent growth and property price growth (2%, 1% and in a few examples even zero) tend to get to positive NPV with discount rates of up to 7% and, for simplicity, WITHOUT CONSIDERING ANY TAX BENEFITS WHATSOEVER. This is true for many properties in Brooklyn (which is where I'm looking) - Manhattan may still be more difficult because of both higher price/rent ratios and much higher maintenance.

Now, that basically implies a 7% IRR on a 4:1 levered investment - which would not keep any PE investor at the table for very long, but given that (i) few here will disagree that over a 30 year horizon, real estate is a pretty safe way to park money even if over short term it has proving to be rather volatile and (ii) a steady return of 7% is not easy to find in any sort of "safe" securities and (iii) levering your securities investment will introduce an unacceptable degree of risk. And factoring tax benefits in (to the extent applicable to investment properties) would only enhance the 30 yr analysis.

So if you got a 20% downpayment that you can part with for the foreseeable future, I don't think NY RE is such a terrible thing at current levels. I do agree with various posters here that it will undoubtedly become an even better deal in relatively short order.

LICC you forget that there is a barrier to entry for buying. When I moved to New York in the 90's I could have afforded a $80K studio but I didn't have $25K for the downpayment, fees, etc. So I rented one for $900.

Since then, that studio has doubled in price to rent and gone up 4-5 times to buy.

"Of course the numbers will never make sense if you always assume that the property has to be sold at a substantial loss."

I'm just looking at current market conditions and the downside risk, which people forget during a bubble.

"You assume a 5% gain in the stock market, why not assume a 5% gain in price? And a 5% increase in rents? What a joke. You assume factors to back your argument and ignore the ones that show you are wrong."

No. Those assumptions are based on historical values over long periods of time, and they are conservative.

"So you don't want to include a period with wage and price controls, are you going to exclude the 1970s from your analysis?"

If they had been successful or lasted a long time, yes I would. But they were neither.

"Its all simplified in cap rate."

I agree, but lots of people don't understand that. The example I put forth is what most people would face.

Actually, LIC, I have an honors degree in Economics. "It makes NO SENSE for an apartment to be cash flow positive on a gross rental basis from day one. If that were the case, demand would drive the price up."

It makes no sense - and no one will give you money - if you present a business plan where you lose money indefinitely with no hope of recovering it. What "demand would drive the price up" - prices would rise when people are barely breaking even?

But in a sense you're right - when capitalized rent is cheaper than market rent then prices will start to rise. We're a long way from there.

Funny that you haven't been able to present even ONE property yet. Instead, you a) change the subject; and b) try to disprove the question. Even though your BFF's own academic paper - and ALL economic theory - says that buying and renting should cost the same, because the output is the same: a place to live.

BTW what happened to your BFF? JuiceMan?! JuiceMan?! Where is your retraction and apology?

hmmm here is an example
http://www.streeteasy.com/nyc/building/201-east-17-street-new_york

Rents for about 2800/2900

Market for the apt is about 600k
2800 x 12 = 33,600

with 25% down
Mortgage is 450k
I/O 5% mortgage is 22.5k
Common Charges are $850 x 12 = 10.2x

Cash flow positive

Now you can argue whether we should use i/o or what rate mortgage is

Im thinking i/o is appropriate b/c otherwise you are should paying off your investment

Rents for $2,900. Here is the sale listing for that apartment:

Down Payment $139,800
Mortgage Amount $559,200
Mortgage Payment $3,175
Total Monthly Payment $3,983

Using a standard 30-year 80/20 mortgage.

How is $2,900 - $3,983 "cash-flow positive"?

Thanks.

What happens if you take that $100k you want to invest "conservatively" and you magically turn it into $75k because the market goes down, because you mad bad choices or because of a million other things that could hammer your portfolio?

So, the stock market is a given positive investment now?

What if I took that $100k and put it on the Yankees tonight? Why, I could double my money....or lose it all + the vig.

700k is not realistic in the building now -- 625 is what the apartment would sell for today

25E in the building recently went to contract at 595k -- (slightly smaller)

So I guess we are comparing apples and oranges if you disagree with my 625k valuation

But in terms of valuation -- shouldnt we only consider I/O mortgages -- that is the cost of carrying the property . . .

waverly, no investment is guaranteed in the short-term. The figures I used were historical averages, and very conservative ones, at that.

Even without that, there is no way that that apartment cited is "cash-flow positive."

"shouldnt we only consider I/O mortgages"

The best way to do it is using the cap rate. Apart from that, the best way to do it is by using the standard financing vehicles. If you use an i/o mortgage, you need to adjust it for the increased risk.

I could easily say if the property was held 20 years, there would be a 100K profit and calculate that into the assumptions. 50K in closing costs?

The numbers aren't 4300/month to own and 2500/month to rent.

Steve - for most properties right now I agree with you in principle, just not that it is 50% mor expensive (although in some it is).

I do think there are properties where it is close enough (72nd street apt.) and where there are enough variable that it probably is a good buy (not a lot, but some are out there). Heck, maybe you could get it for $500k or $490k, then it would be an even better situation.

BTW, as far as Kenny-Boy goes, you should put 2.5 cents into escrow for the time being since his shareholder meeting. He must have gone home and kicked the dog that night.

Also, could you even get an I/O loan now? I agree that we should use an 80/20 for evaluation purposes.

Also, could you even get an I/O loan now? I agree that we should use an 80/20 for evaluation purposes.

"I'm just looking at current market conditions and the downside risk, which people forget during a bubble."

Fair, but if you use current market conditions for RE, you should compare them with current market conditions for your down payment - which, as Waverly says, can go up or down over your time period - I agree that for a 30 year market return, 5% is conservative, but not for a 10 year market return (as evidenced by the lost decade...). Also, the "risk free" rate for the last 10 years was not 5%, it was closer to...2-3%.

steve, owning your home is not a business. This is another aspect that you can't grasp.

I've already shown two properties, from a completely random source, that shows you are wrong.

"owning your home is not a business."

Actually, LICC, under economic theory it is - you own in lieu of renting.

"I've already shown two properties, from a completely random source, that shows you are wrong."

And neither one meets the criteria of break even in the first year.

Not even close.

Try again!

And where is JuiceMan?

LICC, "I mean the $2600-$2800 one" - you don't mean that you can own it with a 20% downpayment and amortizing mortgage so that your mortgage + maintenance equal $2600-2800 before your tax savings based on the deductibility of mortgage interest? About whether stevejhx's criteria for a good investment are asking for too much... that's not as absolute as he makes it out to be, but surely you can agree that if you were to ONLY buy IF you applied his demands (immediately generate positive cash flow, resell for a profit decades later with no remaining mortage, etc.), then it's a no-brainer. He is unwilling to do it unless it's that much of a no-brainer. Most people fall somewhere on a scale between that no-brainer and the way-too-optimistic strategies of people who, as an example invented out of thin air, would have paid $500,000 for an unfinished tract home in a new development in the Mojave Desert with no money down and interest only mortgage and expected to sell it the day the last tract home in the subdivion was no longer for sale, for a 25% profit. I don't believe buying a condo in LICC two years ago is the Mojave Desert unfinished tract home, but I do believe the LICC condo will not rent out at a rate to pay for itself (tenant slowly pays off principal balance on mortgage and landlord contributes nothing to carrying costs) for the next few years, nor will it sell for a profit in the next few years. You're just going to keep screaming at each other.

Stevejhx: "The best way to do it is using the cap rate. Apart from that, the best way to do it is by using the standard financing vehicles."

Neither of these statements is correct. The cap rate is a very rough measure. It's fine if you are a REIT and you know your WACC, have done a bunch of CRE acquisitions and want to compare the price of one to the price of another on an apples-to-apples basis. It gives very little information about the pricing as an abstract matter. You can't claim that a <4% cap rate is always bad. It's not. It depends (i) your own cost of capital (ii) leverage.Plus, it gives a completely static day-1 picture. The second sentence is incorrect because you can't count principal accumulation as a carry cost. That's equivalent to depreciating real property as if it were a refrigirator or a car with little or no residual value. Since you profess to have both accounting and economic background I would have thought you'd be congnizant of that, but that's obviously too much to hope for.

On a separate point. There are a whole number of business projects that are either capital intensive or R&D and loose money for 2-3 years before actually starting to make any. If future cash flow projections are reasonably predictable, if future cash flows are reasonably predictable DO get debt financing. In other words, it's out of this world silly to say that your investment has to be cash flow positive from day one. That is just false. The only thing that is true is that it has to give you positive NPV on discounted cash flow basis over the life of the project. Which brings us back to the original point that cap rates simply do not give you enough information to make the correct decision.

The earlier post got chopped off...

Stevejhx: "The best way to do it is using the cap rate. Apart from that, the best way to do it is by using the standard financing vehicles."

Neither of these statements is correct. The cap rate is a very rough measure. It's fine if you are a REIT and you know your WACC, have done a bunch of CRE acquisitions and want to compare the price of one to the price of another on an apples-to-apples basis. It gives very little information about the pricing as an abstract matter as it does not take into account your own cost of capital and makes a comparison on an all-equity financing basis. If your debt is cheap enough, you can make a 4% cap rate project worthwhile too by levering up. The second sentence is false too. You need to either to I/O financing OR take into account the sale price of the property (discounted, of course). Otherwise, what you're doing is depreciating real estate as though it were a refrigerator or a car with little or no residual value. Which is stupid.

On another point: there are plenty of capital intensive or R&D intensive business projects that are cash flow negative for the first several years. So out of this world silly to say that your investment has to be cash flow positive from day one. That is just false. The only thing that is true is that it has to give you positive NPV on discounted cash flow basis over the life of the project. Which brings us back to the original point that cap rates simply do not give you enough information to make the correct decision.

Neophiliac, I don't disagree with most of what you say. There is no single measure to give you an absolute answer to anything when it comes to investing. However, while "there are plenty of capital intensive or R&D intensive business projects that are cash flow negative for the first several years" is a true statement (and many never make money), that has nothing to do with real estate, EXCEPT:

The investment in R&D is counted as a capitalized expense that is amortized over time; buying a property is a capitalized expense that is amortized over time. If the amortized cost of buying a property is in excess of market rents, it makes no sense to capitalize the expense by buying.

The point on using the cap rate was to take financing out of the equation. In that sense it is a very useful thing to know. So are many other indicators. But to equate real estate with pharmaceuticals is just silly.

"what you're doing is depreciating real estate as though it were a refrigerator or a car with little or no residual value. Which is stupid."

Not true. Real estate is, in fact, depreciated like a refrigerator or a car, except over 28.5 years (and not the land). Which is why the 30-year 80/20 fixed rate mortgage is used - it approximates the depreciation period and the exclusion of the land from depreciation. This makes a huge difference if you're in the business of real estate, if you depreciate the building and sell it & invest in another building, you don't have to pay taxes on the recaptured depreciated value; they are deferred.

I'm afraid you are too stuck on abstract notions of accounting that are used by CRE developers for tax planning more than anythings else. Depreciation means that your residual value is lower than initial value. That's very rarely true in RE and certainly not over 30 years. Developers might indeed depreciate buildings to be able to use them as a "capital expense". In the end of their depreciation period they have an asset with book value of nearly zero but with market value of substantially more than zero.

In case of us simple folks buying residential property taking a similar accounting approach does not give you a similar tax benefit, so it makes no sense to do it even for purely accounting reasons. From an economic perspective, depreciating your apartment on your cash flow spreadsheet is akin to saying "I intend to demolish this thing in 30 years." Are you planning to do that? Didn't think so.

And my point re R&D intensive projects was not to compare RE to biotech, but to refute your point that a business needs to be cash flow positive on day one. That is patently not true for any business. And in RE, it can NEVER be true. In year 1, you are ALWAYS cash flow negative with that big fat downpayment you need to make. No amount of rent will compensate you for that. The reasons things tend to work out in the end of the day is that both the value of your real estate and the rents increase over time, however slowly. Obviously when they do not things tend to go haywire, but I don't think you can show me a 30 year period where RE has declined in nominal terms.

Key take away point: you still need to do an NPV analysis to get to the right answer. The outcome of that analysis will depend on many things including the length of your "project." If you are looking to be cash flow positive from day 1 that is never going to happen. If you are looking to get to a positive NPV over a reasonably long period of time, that might be easier than you imply in your posts, even with Manhattan prices.

Neophiliac, you're digging yourself a very deep hole. "In year 1, you are ALWAYS cash flow negative with that big fat downpayment you need to make. No amount of rent will compensate you for that."

A down payment in real estate is a capital contribution; it is never depreciated under any circumstance. It is on the right-hand side of the balance sheet; the property is on the left-hand side.

"That's very rarely true in RE and certainly not over 30 years."

This statement, coupled with the last, demonstrates that you have no idea how companies work. Are you sure you're not really Andrew Ross Sorkin complaining to Joe Scarborough that converting preferred stock into common equity has no effect on a company's finances?

NPV is no more accurate than any other measure - it depends on the discount rate that you use, and you can pick any one you want.

You really don't understand what you're talking about.

Holy crap steve, you are obsessed with me. Anyway, I'm not "weaseling"...never have, I actually have a job (must be something in the water, man, many, root canals). Just assume that if I don't answer you steve, I'm not reading. That way you won't spit the dummy without me.

As for the topic at hand, you are wrong and I am right. That was easy wasn't it? Back to work, gotta fill some cavities......

And your statements demonstrate familiarity with balance sheets but zero knowledge of cash flow valuation analysis. For the purposes of NPV analysis, EVERYTHING is a cash flow item. Including initial capex, depreciation (not applicable here), residual value, working capital, etc. Once you have everything, you calculate net cash flows for each period and discount to PV. If you exclude that item or this, you have incomplete picture. The fact that I even have to say this shows how far astray you have taken the conversation, that has nothing to do with balance sheets and accounting and everything to do with NPV.

So while my statement was obviously meant to be a bit facetious, it does hold true for buyers who do not and should not do balance sheets and SEC filings, but SHOULD do cash flow analysis: the down payment is a negative cash flow item in year 1. On my NPV calculation spreadsheet, I also have a positive cash flow item in year 30: the residual value of the property when sold. Yes, that's right, when I sell the property in 30 years and after my mortgage is repaid, I will have a positive cash flow in the amount equal to the value of the property, less sale/marketing espenses. That money is going to go into my bank account. It's the opposite of teh downpayment which is coming out of my bank account.

Neo - you make very intelligent, coherent, rational points. Obviously, steve can't comprehend them or respond to them with anything valid, so he tries to misstate things and make inappropriate comparisons to hide the fact that he is wrong. Again.

Neophiliac, this is what I said was the problem: "and discount to PV."

Pick your discount rate.

And regarding depreciation, what I said (as you admit) is correct. It is a negative cash flow item, it is NOT depreciated. Ever. I am very familiar with what you're talking about.

"So while my statement was obviously meant to be a bit facetious"

Obviously. But I'm glad you have an NPV spreadsheet to set the record straight!

JuiceMan: "you are wrong and I am right"

Claim victory and run away!

Very good comment, LICC. Excellent.

Finally, neophiliac, perhaps you can get LICC to explain to you how valid a 30-year cash flow statement is, discounted to the net present value or not.

So if you really think you're going to get the money you've predicted after 30 years, you might be disappointed.

"The fact that I even have to say this shows how far astray you have taken the conversation"

I started the conversation, so it would be impossible for me to lead it astray.

"that has nothing to do with balance sheets"

Depreciation and amortization are profit and loss accounts, not balance sheet accounts. Accumulated depreciation and amortization are balance sheet accounts.

Just FYI.

I don't see anything wrong with neo taking a long-term perspective.

Figures you wouldn't, LICC.

Nor can you explain what he says.

Nor do you fathom that what he is saying is basically what banks were saying to value their toxic assets, rather than marking them to market.

There is nothing inherently wrong with what neo says (for the most part) - except it's just one measure, no better or worse than others.

Neo quite clearly pointed out how steve incorrectly applies certain accounting principles and concepts to residential real estate. Neo also points out how applying the appropriate accounting analogy to residential real estate shows that steve is wrong in his conclusions. steve can huff and puff all he wants about it, but he is still shown to be wrong.

Yup, LICC.

Depreciation and amortization are profit and loss accounts, not balance sheet accounts.