Buying Now Beats Renting

(sry repost)

SWE, don't know where you got your "facts" from regarding the average psf - certainly not from the link I provided.

The FACT is the Link "comp" is not the only one, and it's an outlier: much higher than comparable no-fee rentals. And even still it's 50% overpriced.

As soon as you can buy an apartment and rent it out breakeven with an arm's length transaction, that's when the market will be equilibrium. We're still far, far from there.

steve's assertion that an apartment needs to be breakeven with its rental value on day one of the purchase is completely foolish. There is no basis in logic for such an assertion.

LICC: true. Normally investors expect to earn a positive return from day one.

In fact, since the investor is holding the equity position, which is necessarily more risky than the lender's position, normally investors should expect a higher return than the lender, again from day one. Otherwise, it would make more sense to invest in mortgages than real estate.

Moreover, if investors cannot earn this normal return on rental properties, then they can make a super-normal return by buying rentals and converting them into owner-occupied units, thus tending to increase rents and decrease prices until they converge at equilibrium, when the equity returns on renting are higher than the returns on mortgage lending.

The only significant exception is in a bubble. In a bubble, investors start to include magical capital gains as part of the value they expect to receive. Thus, they are willing to pay more than rental value (or any value calculation that excludes capital gains) because they assume that they will be able to sell for even more to someone else also willing to ignore fundamental considerations. By assuming capital gains that would be impossible in a non-bubble market, investors can justify any price at all. Bubbles, as a result, tend to feed on themselves, creating ever more irrational pricing, until they suck up all the available buyers. At that point, the promised capital gains disappear, and potential buyers need to recalculate using fundamentals, perhaps with a kicker of expected capital losses.

Accordingly, bubbles tend to end well BELOW fundamental equilibrium. Anyone buying now should plan on prices dropping to below equilibrium before the bubble is over.

To calculate equilibrium you should assume that investors will demand a return higher than that demanded by unsubsidized (non-conforming) mortgage lenders. If they can't earn more than mortgage lenders for actually running the place and taking on the equity risk, rational investors would, instead, invest in mortgage loans. And they'll make this calculation without taking into account capital gains, because at equilibrium, capital losses are just as likely as capital gains -- each depends on unpredictable aspects of the future.

To justify any price higher than this, you need to believe (1) the bubble is coming back, or (2) the government or some other force is going to be able to suppress the ordinary workings of capitalism and prevent investors from shifting to investments that make more money, or (3) the supply of irrational buyers is so large that it can permanently overcome the ability of investors and builders to sell them what they want, or (4) it is about to get permanently and dramatically more expensive to build or convert.

I don't think it's "completely foolish." Whether there is some immutable Law of the Universe which rules that all prices will eventually revert to a mean, that mean being Steve's posited break-even point is another question entirely. He may have to wait the rest of his life for purchasing to be worth the expense to him, but that's how he defines a good purchase. A few years ago most buyers seemed to define a good price as any price at all for the privilege of owning.

"steve's assertion that an apartment needs to be breakeven with its rental value on day one of the purchase is completely foolish. There is no basis in logic for such an assertion."

Very good point as usual, LICC. Like this comp:

http://streeteasy.com/nyc/sale/470588-condo-310-west-52nd-street-clinton-new-york

Where you can pay $10,000 a month for the privilege of renting it out at $5,600?

It's like the $6 I won on last week's Powerball: cost me $10 in tickets to win it.

HAHAHAHA!

FinanceG: your point is well taken - mine was somewhat different: it's when owners' carrying costs = market rent.

LICC is just trying to justify his purchase in a slum at 30x the annual rental price.

financeguy:

When you measure the return of an investor in a rental property, what is the right assumption to make for future rents? Looking back over time rents swing up and down but they generally rise in nominal if not real terms. Of course, rents have done next to nothing over the past 10 years, but looking forward, I see no reason to believe they will not keep pace with inflation.

Point being, if a buy-and-hold investor is trying to make their best estimate of future return, and they have fixed cost of capital, then to keep things simple isn't the investor comparing 2 streams of cash flows*: their fixed capital costs and their variable revenue stream (rent). IF you accept the uncertain premise that rent tracks CPI, then unless we have LT deflation the nominal "return" will naturally be back-end weighted under a fixed cost of capital. Hence Day 1 will tend to look worse vs. future periods, if history holds. I think this is what LICC was getting at.

Your post seems to not address this issue, or else reject it, by saying an investor needs positive cash-on-cash return day 1. Wondering if you could clarify?

* Of course there are other cash flows too like taxes and maintenance that tend to go up and need to be accounted for.

financeguy, that was a bush league flaw in your analysis. You make lots of analytical mistakes but this one was basic.
Requiring positive cash flow on day 1 of a long-term term purchase is devoid of logic or intelligent analysis. Typical of steve, and a major flaw for financeguy.

Another consideration is that while I said capital costs are "fixed", it would be more accurate to say that they are "capped" under a prepayable fixed mortgage. This goes to the point that others have made about the benefits of buying when rates are high at a low multiple then later refinancing. Imagine a purchase made mid-cycle where the owner gets a couple of years of strong rents then the economy cools and he refi's for a lower monthly capital cost. As compared to Day 1, the future could mean higher rents AND lower monthly capital costs.

I cannot point to an academic study to prove it, but considering the embedded refinancing option in the mortgage, and the LT trend of nominal growth in rents, I would expect that rent/buy equilibrium should be reached at some point where Day 1 tax-adjusted carrying costs of ownership are HIGHER than Day 1 comparable rent. Exactly how much higher is up for debate. But the common sense logic should be that the owner should still expect an equity return under these circumstances, unless you expect that future rents will be flat or down forever (or gains fully offset by taxes/MM) and financing costs cannot be lowered.

Anyone disagree with this and if so why?

Finance guy, I vote for option (3) the supply of irrational buyers is so large that it can permanently overcome the ability of investors and builders to sell them what they want

"Requiring positive cash flow on day 1 of a long-term term purchase is devoid of logic or intelligent analysis"

In the logic of anybody who would invest their life savings in Long Island City, that is probably true. In terms of whether or not an owner's costs = market rents, it is not only logical, it is the definition.

Judging by LICC's posts, he would likely swear that the opposite of dog is cat.

Certainly on a nationwide bases, rent tracks CPI quite well because it makes up around a third of CPI. Given that the market is pricing CPI at 2-3%, assuming 2-3% rent increases is about right. That still leaves the question of how one can compare a fixed cost of capital against increasing income.

The best way to do this, IMO, is to get an inflation-indexed yield. For example, if you believe rents are 20-25x in today's market (I personally think the latter is more accurate), then you have a 4-5% gross yield. Taxes, maintenance, insurance, and upkeep (remember this is a deteriorating asset you're holding for 10-ish years, if not longer) eat 1-2% annually, and these are all inflation-indexed. Furthermore, assuming a 10-year holding horizon, the 10% transaction costs can be amortized to another 1% annually. Thus, your inflation-indexed net yield is around 2%.

The open question, then, is at what cost of capital does something yielding 2% now plus 2-3% annually equal just a fixed return. It turns out that you can just add the two. I.e., you should be indifferent to indefinitely collecting 2% with a 2-3% annual increase vs. indefinitely collecting 4-5% annually. The problem, of course, is that the cost of financing this position is higher: the 80% debt position costs 6% to finance, so 4.8% of the overall price. However, even with rent increases there is only 4-5% juice. This means that your 20% higher-risk down payment is yielding nothing.

You know what an asset that yields $0 should be worth in a sane world? $0.

If we look back to better times investment-wise, the idea that "you don't need to be cash-flow positive on day 1" makes perfect sense. In the 90s, price-to-rents were around 10x, so a gross yield of 10%. Maintenance, etc., and transaction costs amortized to 4% annually. Thus, you had a 6% net yield that grew with inflation, with inflation expectations being around 3% back then, so the equivalent of 9%. Mortgages ran around 7.5%, so the cost of financing 80% came out to 6% of the total purchase price. Thus, when you started out you were just "breaking even" despite your down payment. However, the 20% you put up was earning the remaining 3% of that 9%. I.e., you were being rewarded with a 15% return on your riskier equity position.

At least that by the time I am as old as steve, I won't have been renting for over 20 years and living in a dumpy building on 52nd and 8th.

steve, way to ignore all the analysis here that requiring being cash flow positive on day one is completely stupid.

inonada, I'm not sure I agree with just adding the inflation expectation to the net yield, because of compounding, but other than that I would agree. My point is not that it makes sense to buy at 20x or 25x. Rather I'm trying to dispel the pervasive notion that buying does not make sense unless total carrying costs are less than rental costs. I just don't think that's true in any general way.

BTW, it seems to me that your assessment of 25x for this market is based mostly on condos, which are priced at a premium to coops. Further, unless I misunderstand it seems that some of the examples have been newer tax-abated condos. I wonder if the tax abatement has an impact on rent multiples. i.e., Owners are able to accept lower rents in early years because their taxes are lower (at first).

"inonada, I'm not sure I agree with just adding the inflation expectation to the net yield, because of compounding, but other than that I would agree."

Yes, it's not clear why I did that. I could give you equations, but I'm guessing you'd understand better with an example. Fire up Excel, and in one column put $2, and multiply that by 1.03 down for a few hundred cells. That's you cash flow from investing $100 at 2% with a 3% annual increase. In the another column, just put $5 fixed down for the same number of few hundred cells. That's your cash flow from investing $100 at 5% fixed. The cash flows will be different for different years, and $5 now is worth more than $5 a decade from now. To deal with this, discount each column by 5% per year (which we are claiming is the fixed cost of capital): i.e., make new columns where you divide the cash flow by 1.05^(year number). This will give you the cash flow in terms of present value. You will discover that the sum of the two columns will magically be the same.

"Rather I'm trying to dispel the pervasive notion that buying does not make sense unless total carrying costs are less than rental costs."

Sure, I understand. I'm just trying to put hard numbers behind it rather than fuzzy unquantified notions. The point I'm making is that the only extra juice you get is 2-3% from inflation, that's it. In my 90's example, the first-year-cash-flow-flat situation did not leave a tremendous amount of room before your 15% return-on-equity started dipping below the 7.5% cost of capital on the lower-risk debt.

"BTW, it seems to me that your assessment of 25x for this market is based mostly on condos, which are priced at a premium to coops."

Given that coops rent infrequently and usually with difficulty (2-year maxes), I'm not sure how one can compare really. You may think that coops represent better value than condos price-wise, and that's a fine judgement, but there's an entire market out there that doesn't share your view, right or wrong. In any case, in parts of the market I'm interested in, I find 25x in coops as well. Nevertheless, others may not be as interested as me in finding a great rental deal and are willing to pay 25% more rent than me, which is why I said 20-25x. It really makes little difference in the analysis.

"Owners are able to accept lower rents in early years because their taxes are lower (at first)."

Owners don't give a crap about their taxes: they simply want the highest rent possible, whether or not taxes are being abated. Nasty little creatures, no ;). FWIW, I haven't personally found any correlation between abated taxes and 25x price-to-rents in my searches on things that actually transact. I have found correlation between abated taxes and things that don't transact: because abated taxes are usually from newer developments, they have a higher percentage of unrealistic asking rents because the owner thinks that by asking for a rent that is well higher than the market, they will somehow be able to reduce the size of their negative carry. Several months of zero incoming cash usually corrects this notion: renters don't give a crap about owners' costs.

inonada: Excellent work.

One subtle point, though. I think rents actually track household income, not CPI. Back when Steve was reading the Shiller studies to us all in the audience, I think Shiller makes the point that HHI drives rent increases. Certainly, causally the arrow is in that direction. Now, this probably doesn't matter often because I'm not sure how often the two diverge because, as you point out, it is a huge component of CPI. However, I think this might turn out to be an important distinction going forward with weird inflation effects -- and if you have regional/local employment market that may get disconnected from CPI.

One important way this could make your calculations problematic is if you get CPI going up due to energy inflation but HHI decreasing. You would have rent declines but expense increases.

I have no problem with Inonada's analysis; it is more careful than mine but not necessarily more accurate. Prophecies are always rough, so it isn't worth being too careful.

The main point is to realize that at 20x rents, or an expected return well below market mortgage rates, market pressure is overwhelmingly likely to force prices down. Betting on this market staying stable or rising is basically betting that the ordinary rules of capitalism have been repealed.

SNS: I think you are misstating Shiller's evidence. Rents tend to track household income in the aggregate, but that is because as people get richer they want more house. He does not suggest that rents for a given property at a given quality level rise with income.

Instead, his evidence fits better with standard pricing theory in all markets: rents reflect marginal cost, i.e., what it would cost to create an additional unit of comparable quality rental housing. Since housing is a manufactured good, the cost of creating it tends to drop over time (due to increased efficiency), so STANDARD QUALITY housing ought to tend to drop in cost in real dollars.

Shiller's charts, which are based on repeat sales but not adjusted for renovations, presumably partly reflect increased quality and size. In any event, they show same units tracking inflation quite closely. Since housing is such a large part of measured CPI, this is almost inevitable.

"The point I'm making is that the only extra juice you get is 2-3% from inflation, that's it. In my 90's example, the first-year-cash-flow-flat situation did not leave a tremendous amount of room before your 15% return-on-equity started dipping below the 7.5% cost of capital on the lower-risk debt."

Got it. But for the fifth (or hundredth) time, you are readily acknowledging 2-3% inflation. As your Excel exercise demonstrates, that inflation benefit accrues over time, not on Day 1. As for the 15% ROE, not leaving a tremendous amount of room is right, but the sensitivity is high in both directions.

"I haven't personally found any correlation between abated taxes and 25x price-to-rents in my searches on things that actually transact."

In practice maybe there is no relationship. But in your analytical framework, how can you ignore it? Your analysis started with a cap rate type of calculation. All else equal, lower taxes entail a higher cap rate, which would not be captured in the price-to-rent multiple, right?

Seg, I actually think the inflation benefit accrues even on day 1. After a year passes, rents are 3% higher. Rather than collecting future rents, you can instead sell for a 3% higher price (transaction costs ignored) to a new buyer who gets the same exact economics that you did. I'm ignoring the market dynamics here, of course...

On the taxes, you're right, they affect the cap rate. However, a typical tax rate is around 0.5-1.0% of purchase price, abated over 10 years, so roughly the equivalent of 5 years of full abatement. This works out to a benefit that is 2.5-5.0% of purchase price. On the scale of 20x or 25x rent multiples, that amounts to something like 0.5-1.0x. It's a decent amount but doesn't the big picture IMO.

SNS, I was thinking the same thing as FG, that part of the HHI included quality improvements. I'm not sure, though.

"By the time I am as old as steve, I won't have been renting for over 20 years and living in a dumpy building on 52nd and 8th."

No. You'll be owning in Long Island City, trying to recover your down payment and get above-water on your mortgage.

"steve, way to ignore all the analysis here that requiring being cash flow positive on day one is completely stupid."

What "all the analysis here" are you talking about LICC? You can't read - nobody did anything but agree with me.

"To justify any price higher than this, you need to believe (1) the bubble is coming back, or (2) the government or some other force is going to be able to suppress the ordinary workings of capitalism"

There's still a lot of that suppressing the ordinary workings of capitalism going on right now, nada, and not just in the housing market.

Financeguy: "rents reflect marginal cost, i.e., what it would cost to create an additional unit of comparable quality rental housing. Since housing is a manufactured good, the cost of creating it tends to drop over time (due to increased efficiency), so STANDARD QUALITY housing ought to tend to drop in cost in real dollars."

That is not true. Rents reflect incomes, without regard to the marginal cost of creating an additional unit. Housing is not a "manufactured good" - it's a long-term fixed asset that, unlike manufactured goods, is repeatedly sold and resold. Provided that there is a stable population - very much the case in Europe, for instance - not one additional unit of housing ever needs to be built. There are also serious constraints on the construction of new housing which do not exist for manufactured goods.

Your analysis is seriously flawed.

Ok, interesting.

So, if the rent increases are generally coming from improvements in the housing stock, how do you expect to capture them with a static quality product?

BTW: I'm not sure that price = mc in this market, but I'm still working out the implications and usefulness of this.

> As soon as you can buy an apartment and rent it out breakeven with an arm's length transaction,
> that's when the market will be equilibrium. We're still far, far from there

True, but 52nd and 8th will still suck, and will be still be much cheaper than the better neighborhoods noted at that point.

Remember that CPI attempts to make hedonic adjustments. I.e., if you improve the quality of something by 1% and charge 1% more for it, that's not inflation but rather GDP improvement. Thus, CPI doesn't look at it as making the same thing for less, but rather making more of the same. Semantics, but it skews the view from the perspective of inflation.

In any case, I think housing stock imroves over time through replacement. If inonada says that you should budget 0.25-0.5% a year for upkeep, bulls go crazy. If inonada says that a home probably gets the equivalent of a gut reno over 50 years, the equivalent of 25-50% of a home's value, inonada sounds less crazy. But it's the same thing. People often think "but I'm not making any improvements" but fail to recognize that the rest of the market, their yardstick for appreciation, is.

"Seg, I actually think the inflation benefit accrues even on day 1."

inonada, I must be explaining myself very poorly. Let's take your own example from Excel. In early periods the numbers in the 2% column are lower than the 5%. That is negative carry. In later periods the numbers in the 2% column are higher than the 5%. That is future positive carry. The same is true if you PV the individual numbers. And as you said, if you PV the entire streams, you get to the exact same place.

This was my original point from the beginning of this thread when I was responding to financeguy. All I'm saying that an owner can be negative carry on Day 1 and still end up equivalent (or better). I know this is obvious to you, but you often hear people claiming that the opposite is true. Your numbers, not mine.

"True, but 52nd and 8th will still suck, and will be still be much cheaper than the better neighborhoods noted at that point."

Not when you go by ZIP codes - 10019 very much more expensive than Madison Park.

Only when you don't know math, Steve...

"All I'm saying that an owner can be negative carry on Day 1 and still end up equivalent (or better). I know this is obvious to you, but you often hear people claiming that the opposite is true."

Agreed. However, the thing that is often missed is that ending up equivalent to a risk-free yield after accounting for the yield growth is a big problem. If you're holding a risky 2% asset that has 3% growth, and you have to finance it at 5%, you are taking extra risk for no reward. While it is true that "in the end" you will break even, the market will spank you in the middle in the form of capital losses.

The problem is that "in the middle" is actually pretty far out. In our example, the PV of 30 years of cash flow from the 2% plus 3% growth asset is only 57% of the PV of the 5% fixed asset. The cash flows from the former have still not gone above 5% after those 30 years. Yikes! While it is true that capital gains will make up the difference if the market continues to believe that the risky asset should not be worth any premium to the risk-free one, to the extent that this is no longer believed, you will take it in the shorts.

Hence, I think "approximately cash-flow even on day 1" is a good rule of thumb for RE: to ensure that you are getting inflation-based growth as the reward for your risk. Most may not understand the reasoning, but there is backing for it.

"If you're holding a risky 2% asset that has 3% growth, and you have to finance it at 5%, you are taking extra risk for no reward."

True. Now, if one could find a way to buy the asset at say 4% + 3% growth, at the same 5% financing cost. That purchase will generate exceptionally strong compound returns over time. Yet, it's still negative carry on Day 1.

Whatever the case may be, I can't argue with your rule of thumb, as CF even provides an extra level of safety to a buyer, however difficult to find currently.

nada, we are discussing owner-occupied real estate. You are looking at capital appreciation, inflation and financing rates, but what about the alternative costs? By buying, you lock in (for the most part) your long-term costs. The alternative, renting, entails long-term increasing costs. This is why requiring break-even on day 1 is not based on logic.

LICC, I account for the rent increases. Re-read my first couple of posts on this page.

My basic analysis was this. Buying yields you a net benefit of 2% of purchase price on day 1, accounting for the rent benefit minus monthlies, insurance, an upkeep budget, and amortized transaction costs. All those items grow with inflation, which the market places at 2-3% annually for the next 30 years (probably billions of dollars traded daily on this). So you have an asset that yields 2% at first, growing by 2-3% annually (as in 2.06% yield at year 2). The question is what fixed yield is equivalent to that. It turns out that you just add the 2% and the 2-3%: i.e., it's equivalent to a fixed 4-5% yield. If someone were offering you a fixed 6% yield, for example, you should prefer that over 2% plus 2-3%.

So yes, the fixed cost vs increasing cost thing is worth something. However, it is not worth infinite amounts. I have tried to quantify it here.

"nada, we are discussing owner-occupied real estate."

I don't know that YOU are discussing anything, LICC. I haven't seen a single thing you have said to support your "points," other than your points itself.

"You are looking at capital appreciation, inflation and financing rates, but what about the alternative costs? By buying, you lock in (for the most part) your long-term costs."

You're exactly right, which is why it makes no sense to start out negative: you lock in a cost that is negative, from the get-go you're losing money. How many investments do you routinely purchase that you know will lose you money?

I won $6 on the Powerball last week. To win it I bought $10 in tickets. By LICC's reasoning, I made 60%. To the normal person, I lost $4.

"The alternative, renting, entails long-term increasing costs."

Perhaps, perhaps not. If you assume that you're in the same place at all times then yes, it might. So will your property tax and maintenance go up. But if you rent, you can always get out fast at a very low transaction cost.

"This is why requiring break-even on day 1 is not based on logic."

Non sequitur.

nada, you are making disputable assumptions on your yield numbers. And how are you accounting for the property's price appreciation?

Who uses and idiotic analysis of a 7 to 30 year investment that bases the value of that investment on whether it breaks even on day one, instead of looking at all costs and expenses for the life of the investment? Oh, right, steve does that.

Thanks for the Powerball analogy- a completely unrelated analogy stupidly meant to distort the argument. Typical steve.

Property tax and maintenance are a much smaller percentage of cost than rent for comparable apartments. So your theory comes down to: if rents increase, you can always find a dumpy place for cheap on 52nd and 8th and try to fool yourself that it is really nice.

"How many investments do you routinely purchase that you know will lose you money?"

Hmmm... immediate cash flow negative.... how about most capital investments made by most companies on this planet?

If you need all your investments to be immediately cash flow positive, you are a lousy investor.

"Who uses and idiotic analysis of a 7 to 30 year investment that bases the value of that investment on whether it breaks even on day one, instead of looking at all costs and expenses for the life of the investment? "

And who claims they can make an analysis of any market 7 to 30 years hence?

Oh yeah right - LICC!

This one's a real beaut - like the time LICC claimed that unemployment isn't a fundamental economic factor: "Property tax and maintenance are a much smaller percentage of cost than rent for comparable apartments."

How about, "Mortgage amortization is a much smaller percentage of cost than rent for comparable apartments."

Makes exactly the same amount of sense, even if your rent is $2,000 and your mortgage $20,000: rent is 100% of the cost of renting an apartment; mortgage amortization is not.

"So your theory comes down to: if rents increase, you can always find a dumpy place for cheap on 52nd and 8th":

http://www.ellingtonnyc.com/

"and try to fool yourself that it is really nice."

Like Long Island City, you mean?

http://www.nytimes.com/interactive/2010/04/25/realestate/20100425liv_ss.html#2

or

http://www.nytimes.com/interactive/2010/04/25/realestate/20100425liv_ss.html#6

I'll keep my "dumpy" place on 52nd & 8th over your concept of "Long Island City Luxury" any day.

According to steve, every CFO of every company that does an IRR projection to determine an investment is just wrong. They either have to be cash-flow positive on day 1 or it is a bad investment. No wonder steve couldn't make it in the finance industry.

Also note that steve cannot find any quote by me that says what he claims. Liars usually can't.

steve, thanks also for stating a lot of nonsense that does nothing to dispute what I said: for comparable apartments, property tax and maintenance are a much smaller percentage of monthly cost than rent.

I've said before, no one who bought a nice, new luxury condo at the waterfront in LIC would prefer to be in a dumpy rental on 52nd and 8th.

"nada, you are making disputable assumptions on your yield numbers."

OK, dispute away. I made an assumption of a rental yield of 4-5%, an assumption of maintenance/tax/insurance/upkeep of 1-2%, and an assumption of 1% for amortizing transaction costs of 10% over a 10-year holding period. Furthermore, I have assumed that all those increase with inflation at 2-3% annually (e.g., rents make up a third of CPI), behind which is a vast and liquid market willing to trade billions of dollars daily for those who think they know better. As far as I can tell, those numbers are pretty accurate. Please tell me which specific bit you dispute, and what you think is a more accurate number. What's the point in vagaries?

"And how are you accounting for the property's price appreciation?"

That's a good question. Let's look at the 2%-plus-3% growth example compared to the 5% example. Say that on day 1, the market is willing to pay $100 for both the asset that's yielding $2 plus 3% annual increases as well as the one that's yielding $5. A year passes, and one guy's got $2 plus his one asset, and the other guy's got $5 plus his asset. Assuming they each decide to sell rather than hold on for the cash flow, then the question you're asking is what will each make on capital appreciation. Well, given that the $5-yieling asset will have the same yield characteristics as the prior year, then it should be worth the same as it was previously: $100. Hence, the $5 guy has no price appreciation. The $2-yeilding guy has an asset that looks just as it did the year before, except it's now yielding 3% higher. I.e., instead of yielding $2-plus-3%, it's now yielding $2.06-plus-3%. In all ways, it looks like an asset that yields the same exact cash flow as the prior year, except 3% higher. Hence, it should be worth 3% more than it was last year, $103. Thus, the capital appreciation should be $3.

Note the bit of magic here. In one case, the investor made $2 in yield and $3 in appreciation, and in the other case the investor made $5 in yield and $0 in appreciation. They make the same exact amount! It doesn't matter whether you sell after year 1 vs. year 10 vs. never. The 2%-plus-3%-growth asset and the 5% asset should yield the same amount between cash flow and appreciation at all points in time.

Make sense?

This isn't rocket science.

To figure out yield - think about it this way - assume you buy a place for all cash, add your closing costs. Subtract maintenance, taxes, upkeep, insurance, whatever is applicable on an annual basis. Divide the annual rent you would get for this place by your total cost. That's your yield as an investor.

It's not that hard to figure out whether renting beats buying. Similar calculation. Assume mtge is interest only to keep the annual tax impact the same and to take out the forced savings aspect of amortizing mtges. Add appropriate amount for upkeep, taxes, insurance (note that insurance will be more because you'll need replacement cost) - annualize this cost over your projected tenure. Add transaction costs (buying and closing costs) - annualize over your projected tenure. Also annualize the interest you would have been getting on your downpayment. Your annual interest payments towards mtge will be reduced by tax deduction. Also annualize your projected return on the apt over your tenure.

Rent - agree on an inflation rate to use. And yes, if you pay broker fees, annualize over your tenure.

Based on the above factors, because I've done this calculation so many times - I can tell you RIGHT off the bat that if you divide the selling price of the place you would buy by the annual rent and get a result >20, you are better off renting if you are thinking of staying in the same place for 5 years.

It may not be rocket science but To me (and I would bet many readers) these are complex hard to understand concepts. Inonada has explained this in a way even I can really understand. He has done this on other threads and I really appreciate his input.

"every CFO of every company that does an IRR projection to determine an investment is just wrong."

Can you please tell me what the internal rate of return has to do with this?

http://www.investopedia.com/terms/i/irr.asp

Doing what you claim to do, your IRR is negative.

In any case, buying owner-occupied residential real estate is not an "investment" - it is a capitalized expense. Any CFO that would capitalize an expense whose amortization is greater than simply paying rent for the same asset would be fired.

And that is what you do when you buy a place to live that is more expensive than renting the same place.

This might shed some light on the matter for you:

http://www.investopedia.com/terms/o/owners-equivalent-rent.asp

And - how's about dem pics of Long Island City?

BEAUTIMOUS, no?

nada, how do you justify a static rental yield over the life of the investment?

NYCD: sorry if I snarked. LICC/Steve are going around in circles forever.

One unaddressed issue is what if there is no rental inventory in your area of interest? Do you just jump in and buy at 20+X presumed rent (if you could find a rental)? Or just suck it up, not quite living where you want to until you find something. This is a quality-of-life issue.

Any CFO that would capitalize an expense whose amortization is greater than simply paying rent for the same asset would be fired.

True, but any CFO that would base the comparison on day 1 and who would pay more rent than the cost of capitalizing the expense when capitalizing would cost less over the life of the investment.

Thanks for effectively admitting you are wrong.

LIC pics- http://www.flickr.com/groups/1304838@N23/

"You're exactly right, which is why it makes no sense to start out negative: you lock in a cost that is negative, from the get-go you're losing money. How many investments do you routinely purchase that you know will lose you money?"

That's fairly short-sighted, Steve. Granted, markets aren't perfectly efficient, but investments that are immediately cash-flow positive tend to get snatched up pretty fast, and don't usually have much upside. Returns can fluctuate (remember falling rents?) independently of purchase/transaction costs. Is it me, or isn't this stuff fairly obvious?

Nyc10023. If anywhere near a bubble, you rent. QOL = not raional, given most ppl still look for sales and clip coupons. It's like buying a $5mm penis shaped Ferrari, yeah it might fit your life style but you'll take it in the backend, and if you don your estate will.

Amazing, itz f'n manhattan, everything is an extra 10 minutes away. Bet ppl here spend 20 minutes a day trying I figure out how to lesson cost of car ownership, groceries, next vaca, next clothing run, next diaper run, next costco run. Yeah but 'home'. I'll work 10 more yrs, but I won't put that in the credit side of my asset ledger. Flmao. Flavor Flav mfkers!

This is the best you can come up with for Long Island City:

http://www.flickr.com/photos/grobie/4362886313/in/pool-1304838@N23

an empty chair in a swamp?

LICC - you're confusing two different things. One is whether or not you're paying more than market rent when you buy a place to live in. That is and remains my point. The other - which is what you seem to be grasping at - is the concept of "imputed rent," which deals with long-term flows. They are similar in concept, but not the same thing.

"but investments that are immediately cash-flow positive tend to get snatched up pretty fast, and don't usually have much upside."

That is true for liquid assets, but not for illiquid assets like rental property, which is very expensive and the risks are very high. In fact, if you couldn't show positive cash flow from Day 1, because of the risk and expense, you likely couldn't get financing.

"According to steve, every CFO of every company that does an IRR projection to determine an investment is just wrong. They either have to be cash-flow positive on day 1 or it is a bad investment. No wonder steve couldn't make it in the finance industry"

I'm still laughing about this one.

steve, it is clear to all that you are the confused one. We are comparing the monthly cost to own, after-tax and out of pocket, to the monthly rent. It makes no sense that the day one cost as to be equal or less than rent. It is a long-term purchase and what matters is the overall cost for the life of ownership.

bjw is right. This is obvious to everyone except steve.

Bingo - Steve, if over the life of the investment you've made money, but weren't cash-flow positive for a certain period of time, you still consider that a bad investment apparently. That's amusing.

W67: 'coz it's not a discretionary expense. It's way easier to sweat the small stuff.

And you have to wake up where you wake up every day. How often am I going to drive that Ferrari?

10 mins. in Manhattan is like 30 mins elsewhere. Really. I've tried it myself.

"No wonder steve couldn't make it in the finance industry"

I did pretty well today.

"steve, it is clear to all that you are the confused one."

Oh! I'm confused about the subject matter that I brought up. Cool.

"It is a long-term purchase and what matters is the overall cost for the life of ownership."

So you finally admit - as you've denied before - that transaction costs are amortized over the life of ownership?

"Steve, if over the life of the investment you've made money, but weren't cash-flow positive for a certain period of time, you still consider that a bad investment apparently."

Did I say that? No. I said that to tell whether you're paying more than market rent to buy a place to live, then your total ownership costs cannot exceed the comparable rent.

Is that difficult to understand.

Really, LICC, SWE, and BJW should be watching the Goldman hearings - get a little taste of the Kool-Aid that got us here.

"Did I say that? No. I said that to tell whether you're paying more than market rent to buy a place to live, then your total ownership costs cannot exceed the comparable rent."

Ok, but is that analysis done as a snapshot at the time of purchase, or as a trend over the whole occupancy period? If you say the latter, then rental income being less than carrying cost is far less important than rental trends.

I said: "Requiring positive cash flow on day 1 of a long-term term purchase is devoid of logic or intelligent analysis"

Then steve said: In terms of whether or not an owner's costs = market rents, it is not only logical, it is the definition.

Then bjw said: "Steve, if over the life of the investment you've made money, but weren't cash-flow positive for a certain period of time, you still consider that a bad investment apparently."

Then steve said: Did I say that? No. I said that to tell whether you're paying more than market rent to buy a place to live, then your total ownership costs cannot exceed the comparable rent.

Hmmm, a bit of revisionism on steve's part, I would say . . .

If you boil down buying to a single ratio, I have no idea if this mathematical conclusion is correct. But who raises a family solely based on mathematics? Have one child and tell him or her that math means that there's no little brother or sister? Such simplifications are shameful and frankly not the way civilizations have been developed.

Yep...you have no idea.

I have no idea? I think my family's success and my family's security wouldn't support that conclusion.

Ah..an empty braggart. Excellent.

And are you part of what you believe is 25% of Americans who have lost everything?

your family's "success" is only based on your self assertions.

you don't sound like the successful sort to me.

My family's success isn't based on my self assertions.

of course they are. just like your derogative statements regrading our current and future living arrangements are based on "facts".

Can columbiacounty please explain his statement that 25% of American homeowners have lost everything and then some? 25%? Everything?

Sure. 25% of Americans have lost their equity (all). Most put in granite countertops and that cost $10k extra. Hence 'and then some'.

Next.

Oh, so now 25% of all Americans, not even homeowners. But I guess you lowered the bar, they lost their equity (which in some cases was less than 5%) but not everything they had ("and then some").

I thought 25% of American homeowners were going through the bankruptcy process, according to columbiacounty's statistic.

Perhaps you can quote where I said they were going through bankruptcy? I don't recall saying that.

No, you didn't. That's what I thought based on your statement that 25% of American homeowners lost "everything and then some". Sorry to misinterpret your very clear statement that 25% of American homeowners have nothing left. You are correct that going through the bankruptcy process is different from having lost everything ("and then some").

Still wondering what percent would be acceptable to you?

So now you stand by the statement that you made about 25% of American homeowners having lost everything, even though just a few minutes ago you said you didn't stand by it? Or are you just changing the subject?

By the way, what percent of home owners don't have a mortgage?

You asked me a question. I said I didn't know. You provided an answer about 25% of American homeowners having lost everything ("and then some"), and then you backed off of it. Do you now support it again?

Let's assume that one third don't have mortgages. In that case the 25 percent is reduced by a third. So only 16 percent of home owners have lost everything and more. Does that make it all ok?

So your prior statement wasn't true. But you believe that 1 in 6 American homeowners have nothing?

Are you checking out Marketwatch for a new statistic?

columbiacounty?

columbiacounty? 1 in 6 American homeowners need your assistance since they have absolutely nothing. Where are you?

columbiacounty?

"nada, how do you justify a static rental yield over the life of the investment?"

LIC, how do you justify one-line responses to prior questions that have been answered in detail? More seriously, I don't understand what you are asking. I don't assume a static rental yield, I assume one that grows with the rate of inflation, at 2-3% a year. I think I've stated that about 12 times on this page of the thread. Can you explain yourself better?

In any case, I'm glad my ramblings were helpful to at least one person, NYCDreamer.

nada, your ramblings are always welcome.

take a look at the alexander. dabulls thinks it's a good investment for the more sophisticated buyer.

nada, your conclusions can't tie out the way you are explaining your assumptions. If you have a growing rental yield and a lower-base cost yield that grows at the same rate, the spread will grow over time.

"Hmmm, a bit of revisionism on steve's part, I would say . . ."

You would? Well GOOD FOR YOU, because I have always said the exact same thing and that is it. Nuance isn't your strong point, LICC (not that I've ever been able to figure out what is).

"Ok, but is that analysis done as a snapshot at the time of purchase, or as a trend over the whole occupancy period? If you say the latter, then rental income being less than carrying cost is far less important than rental trends."

You're talking about something different. Here's the issue:

1) Are you paying more to buy than to rent the same apartment?

That is a "today" question, and relatively easy to figure out.

It DOES NOT include many very material costs such as transaction costs and opportunity costs.

2) Will you be paying more in the future to buy than to rent the same apartment?

That is somewhat more difficult to determine, but the further away you are from it on Day 1, the more difficult it will be to achieve. Historically, the ratio in #1 is constant. There are many complex calculations requiring all sorts of assumptions such as the risk-free rate, change in property values, taxes, rents, insurance, that you could try to figure out over 30 years. But I have never seen anyone calculate it for more than 2 with any accuracy.

What will interest rates be in 2029? LICC, can you tell me? Are you willing to make a malraux bet?

No one knows, which is why such long-term predictions with so many different variables are not worth very much at all.

Steve, are you happy where you live? If so, I'm happy for you.
I said recently that it's a great time to sign a two year lease, and if you signed a lease in late Fall, you got good timing on it and I think timing was good through Q1 though it definitely has gotten at least seasonally tighter since mid-March. I think the incentives on better buildings started being taken down at the end of February and through the month of March but even still rents haven't started to factor in the fact that landlord monthly costs are probably incresing over the next year or so (taxes, labor and energy), so still good timing for renting, and I don't know where purchasing prices are going but I suspect up in the short term (6-12 months) and down after that for a few years (ie dead cat bounce now).
Why worry about Long Island City? I can't even tell you the last time I was there and it seems you are in the same boat.

Splake, I signed a 2-year lease in November, tickled pink over it. Never made such a good move.

Regarding this:

"I think the incentives on better buildings started being taken down at the end of February and through the month of March but even still rents haven't started to factor in the fact that landlord monthly costs are probably incresing over the next year or so (taxes, labor and energy)"

Incentives are coming down, not to reappear until the fall again, but a landlord's input costs have nothing to do with the rents they charge. They can only charge what the market will bear, regardless of what their cost structure is.

steve, as usual, uses a lot of words to say nothing. Nothing he said counters the fact that his assertion that a purchase has to be cash-flow positive compared to renting on day 1 to be a good purchase is ridiculously illogical and unintelligent.

"Nothing he said counters the fact that his assertion that a purchase has to be cash-flow positive compared to renting on day 1 to be a good purchase is ridiculously illogical and unintelligent."

Good enough, LICC - INVEST AWAY!

HAHAHAHAHA!

Try to get financing.

HAHAHAHAHA!

Use the buy and hold strategy: buy for $10,000 a month, rent for $5,000, and hold your breath.

HAHAHAHAHA!

It's not illogical. The real answer is based on risk tolerance and the amount of the purchase price on a relative basis to what you are trying to accomplish. e.g. buy a fixer upper for a low price and then spend $$ in renovations might be a good idea and might be comparable to buying a nicely finished place and then not spending additional $$ on it. You can buy a rent controlled apartment for cheap and expect negative cash flow for some indefinite period of time before having the ability to sell at a higher price, but then you have to have a good purchase price and a higher risk tolerance and probably more diversification in your real estate portfolio.
LICComment, are you happy with your apartment? If you are happy then I'm happy for you. Steve is probably happy for you too because you are not his neighbor, and vice versa.

splaken, we are talking about comparable apartments. We are not talking about outliers or rent controlled apartments. For the types of apartments we are discussing, the assertion is entirely irrational.

"For the types of apartments we are discussing, the assertion is entirely irrational."

Then give us your scenario of rational, LICC. How much can you LOSE per month on an apartment before you go bankrupt?

If you try to buy a rental apartment they will only allow you to consider 11 months' rental income in the calculation, and based on that you have to be cash-flow positive from Day 1.

So - where are you getting this money from?

HAHAHAHAHA!

"You're talking about something different. Here's the issue:
1) Are you paying more to buy than to rent the same apartment?
That is a "today" question, and relatively easy to figure out."

Steve, that's pure verbal chicanery. I'm talking about exactly the same thing - the "snapshot" I mentioned is the "today" question. It is not necessarily a bad investment if you're paying more at first. What matters is what rents do over the time of ownership vs common charges and taxes.

"Historically, the ratio in #1 is constant."

No, it isn't, as evidenced by these last 7 or so years. Unfortunately, life doesn't move according to PITI and any other neatly packaged little formulas. That's why economists came up with a fancy term for "we can't figure this out": externalities.

steve, rational would be looking at two comparable courses of action that last years and even decades, determining the costs of each over the life of each, and then deciding based on that determination which of the two is more or less costly.

Irrational, which is steve, is doing the same analysis but deciding that one course of action costs more than the other only by looking at the first month.

And keep laughing like a lunatic in every post steve, it fits you.

"It is not necessarily a bad investment if you're paying more at first."

Then how do you tell? What crystal ball do you have that will determine "what rents do over the time of ownership vs common charges and taxes."

I don't think you have one. Moreover, I think you need to look up "externalities."

"rational would be looking at two comparable courses of action that last years and even decades, determining the costs of each over the life of each, and then deciding based on that determination which of the two is more or less costly."

Again, LICC: same issue. How do you determine "two comparable courses of action that last years and even decades."

What will interest rates be in 2019, LICC? Any clue?

Watch your English, too: "it fits you" = "it befits you."

"nada, your conclusions can't tie out the way you are explaining your assumptions. If you have a growing rental yield and a lower-base cost yield that grows at the same rate, the spread will grow over time."

LICC, are you being difficult on purpose? I said rental yield in on day 1 is 4-5%. Let's call it 4%. Cost yield is 2-3%, let's call it 2%. Your spread on day 1 is 4% - 2%, which is 2%. After a year, your rental yield increases by 3% to 4.06%. Your cost yield increases by 3% to 2.03%. Your spread is then 4.06% - 2.03%, which is 2.03%. See, the yield spread grows over time. It starts at 2%, and it grows by 3% annually.

"take a look at the alexander."

Yowza, that's a lot of uncleared inventory.

"Then how do you tell? What crystal ball do you have that will determine "what rents do over the time of ownership vs common charges and taxes."
I don't think you have one. Moreover, I think you need to look up "externalities.""

That's why all investing is a gamble, Steve. You make projections and assessments and use that information to inform your decision making. That's pretty obvious, Steve. And I know what externalities are, thank you. I was being a bit facetious, but the point remains the same - religious adherence to formulas doesn't do you many favors.

"That's why all investing is a gamble, Steve."

What? You can retract that if you want.

"You make projections and assessments and use that information to inform your decision making."

Fine. And what "projections and assessments" can you make about 25 years hence?

None.

"religious adherence to formulas doesn't do you many favors."

Which directly contradicts your "projections and assessments" comment, no?

I do wish you would - a) admit you didn't know what "externalities" are; and b) admit that real estate is a long-term illiquid asset that does not behave like stocks. It doesn't behave like manufactured goods, either.

If you buy a property that costs you $6,000 a month to maintain, but you can only rent it for $5,000 a month - IF you can rent it at all - then you're bound to lose $1,000 a month. Thinking that maybe - just maybe - you might be able to break even the following year is foolhardy: you know no more about next year's rental market than I do.

Long-term illiquid assets are very risky. No button pushing to get rid of them like stocks. No "buying on the dips" or "selling on the news." You're stuck with it.

If you and LICC think it's a good idea to buy a place to try to rent it out at a long-term loss, feel free. You will be alone on that.

The whole long-term "breakeven point" argument is dumb for real estate. It works for manufactured goods and services where the "breakeven point" is driven by marginal costs and volumes. There is no such thing in real estate. There is no "marginal cost to build the next apartment," and if you have 1 or 20 properties, that's how many you have. You can't just decide that you're going to rent out 21, if you only have 20. And if you can't rent out even 1 at a profit, you just can't dump the place onto somebody else at a slight loss. You're stuck with it. It's illiquid.

That's why your point, LICC's, and "finance"guy's are just moronic. It doesn't work that way.

"What? You can retract that if you want."

Asinine comment. Of course investing is a gamble - there's risk involved.

"Fine. And what "projections and assessments" can you make about 25 years hence?
None."

Again, asinine. Who said 25 years? You're the one always citing 7 years. You can certainly make projections several years out. Obviously there's a discount factor the further you go out, but this kind of valuation is done all the time. Is it difficult to do? Of course. But that doesn't mean you can't do it and be successful.

"Which directly contradicts your "projections and assessments" comment, no?"

Asinine trifecta. I specifically said you use these to inform your decision making. You don't just do what Excel tells you to. Regardless, your comment does nothing to disprove the point made.

"If you and LICC think it's a good idea to buy a place to try to rent it out at a long-term loss, feel free."

Yeah, no one said that. Long-term loss? What a joke. We're talking about a day 1 loss, which you think is code for "don't invest." That's the point I disagree with.