ATTN: financeguy & bears

1. The standard bubble error is to assume fixed supply. You can see it on these boards daily.

If supply is fixed, prices are determined by demand. But in fact, supply is relatively elastic over the medium term. In the boom all the fancy neighborhoods grew, some dramatically -- by renovations, increasing density and expanding the socially acceptable boundaries -- and lots of new ones appeared out of nowhere. There are even new GV townhouses, not to mention an astonishing number of old rentals turned into new single family mansions.

In all markets, investor-sellers will create new supply as long as they can make a profit doing so. As a result, prices don't stay above costs for long. Even if buyers would be willing to pay more, they won't have to.

Most Manhattan housing remains rentals. As long as owner-occupied units remain higher priced than rentals and commercial, landlords will find ways to convert. So, prices are highly likely to drop so long as it is more profitable for an investor to sell to an owner-occupant than to rent out the same unit. But conversion and building is slow, so there is no reason to expect the drop to be fast. Real estate bubbles usually don't "pop." They fade.

2. Wealth isn't irrelevant, but it won't determine prices in our most likely future.

Bubbles require momentum to continue: the only reason people are willing to pay so much is because they think they'll be able to sell for more. In a bubble, buying is free: you are just going to sell for more. Bubble logic, that is, suggests spending as much as possible -- the more you spend, the more you are going to make. So one way that bubbles end is when buyers hit the limits of what they can afford or borrow, making it impossible for prices to keep going up. This, as much as supply catching up with excess bubble demand, is what has happened nationally in the last few years.

Once the bubble is clearly over, however, people start to think differently. Money that you spend on housing is gone, just like money that you spend on anything else. So fewer people will be willing to spend right up to their wealth limits. No one spends 30% of their income on chocolate even if they like chocolate a whole lot. Demand will drop.

But the supply story is more powerful. In the end, it is a capitalist market. Demand, however strong, can't keep prices above the costs of producing new supply forever. Sooner or later, investors will create supply to match strong demand.

So if you are trying to predict what prices will be when you sell at some indefinite time in the post-bubble future, you should ignore strong demand. If demand is strong, prices will be set by INVESTOR costs. Building and rents are expensive in NYC; investors aren't going to be able to create much supply at $250 psf. But even nice rental buildings are worth far less than $1000 psf.

If demand is weak, that's a different story. If post-bubble buyers can't afford or aren't willing to pay as much as the investors need to create new supply, building/conversion stops and prices drop to whatever buyers are willing to pay. That's what happened in NYC from the '30s to the '70s, or Nevada and Detroit now. If you are looking for worst case scenarios, wealth (and willingness to spend it) matters a great deal. I just don't think that those possibilities are likely enough to worry about. Seems to me that demand is strong in NYC and likely to remain so.

3. Please note what I am NOT arguing. If you've decided to buy and the issue is now or in 6 months, this analysis is useless. In the short run, supply IS fixed, and predictions need to be based on the sort of short-term inventory issues that Urbandigs specializes in.

Equilibrium analysis is primarily useful for people who want to try to figure out how much of the money they spend on buying is likely to return to them when they sell. It strongly suggests buyers should expect to sell for less than current prices, because prices are highly likely to drop, unless rents or construction costs rise rather dramatically or all the entrepreneurs in NY real estate disappear.

what if you just want a nice home you can afford?

Can you afford a major price drop? If not, find a nice rental and enjoy your home.

"Bubbles require momentum to continue: the only reason people are willing to pay so much is because they think they'll be able to sell for more."

I won't argue about the precise definition of "bubble", and whether we're still in one or past one. However, I disagree that the prospect of future capital gains is the ONLY reason why people pay high prices. This is one reason, but not the ONLY reason. There's a risk in either decision.

Suppose one has a view that prices will fall even over the medium-term, and that buying is still generally more expensive than renting. Even with that belief there are still real risks with either decision for a rational buyer.

A. You buy and your view turns out to be correct: prices fall. At best you lose the difference in carrying costs between buying and renting. At worst you are forced to sell you lose lots of money.

B. You rent and your view turns out to be wrong: rents start to rise and the market gets stronger. In this case you may spend several years or more delaying a desired home purchase...with the result being that if you later choose to buy, you must do so in a stronger market, and potentially with higher mortgage rates.

Rightly or wrongly, there is some subset of buyers who are happier living with some negative carry in A, instead of taking on the uncertainties of the B outcome. Perhaps this is just a psychological quirk about risk tolerance, but I do hear it a lot, though frankly not much on this board. Of course this only works for buyers who can credibly believe they will not be a forced seller. So the logic doesn't work for a bubble purchaser putting 5% or 10% down.

Whatever the case, this is one type of psychology -- in addition to pure bubble-logic -- that can explain the buying decision, especially when the rent vs. buy calculation gets closer.

Thanks for the response. Interesting all around.

People on here take this financeguy way too seriously, and he takes his theory way too seriously. How do bubbles emerge in the first place, if things work this logically?.......

The issue is Financeguy assumes that prices have to drop over the long term. Number 3 clearly states that all buyers have to assume when they sell they will have a loss. Last time i checked real estate was like the stock market, cyclical. it goes up, it goes down, it runs sideways then it goes up again. i would argue it is purely timing.

He also takes all other decisions out of his analysis. Some people such as myself want to be in an apartment that we can call our own. I want to design and renovate as i see fit so that i feel comfortable and don't have the concern of having to go to someone else to see if they want to change their apartment. I also am not at the whim of some landlord deciding what market rent is and when the economy is better holding that line with no negotiations. Simply put i do not want to move ever, unless life forces that decision.

so when buying for the long term, not the 3-5 years that a lot of people think is rational, does not really fall neatly into financeguys theories as all he is talking to is potential supply. His argument is that they will build build build until there is so much supply that prices have to drop because there is no longer any demand. Well i guess the best place to look is brooklyn with all the excess supply. I would think then that prices would continue to drop there as there is way to much supply even when the economy rebounds based on his theoy.

He's not assuming that prices always drop over time. He's making the case for why, at this entry point, the most likely scenario is for prices to be lower over the long term. If you don't care or don't believe his theory, go forward and buy.

Seg: In any market, there are always people who are willing to pay more than they need to. The issue is not whether some (or many) people decide that renting is riskier than overpaying for a highly leveraged, undiversified investment. Some always will. The question is whether their willingness to pay (demand) sets the price independent of supply. It doesn't.

Buyerbuyer:

Bubbles emerge when enough people decide that normal market economics don't apply and prices can rise indefinitely. If you imagine that prices are going to go up, it follows logically that you ought to pay as much as you can, since the more you pay the more you will make, the richer you get and the less the RE is going to cost you in the long run. Obviously, this theory generates a lot of demand.

In the short run, this increase in demand generates shortages. Therefore prices go up. The price increases both vindicate the bubble theory and increase buyers' ability to pay (many buyers are also sellers and lenders are more willing to lend when prices are going up), thus making demand grow even more, shortages increase, prices rise, etc. On the demand side, this can continue until everyone has spent all that they have and can borrow (which is why late-bubble pricing theories all concentrate on how much people can theoretically afford).

However, investors respond to high prices by creating more supply. Usually with a lag. See, e.g., the proposal to convert Stuy Town to coop. At some point, either supply catches up or ability to pay runs out. In either case, the shortages end and therefore price increases end. As people realize that the bubble theory was wrong, the process reverses.

Bubbles and collapses are a regular feature of every market-based economy and well-understood by every student of markets except the Chicago-school fundamentalists (who deny that they exist, since in a fully efficient market, prices always reflect fair value by definition). They are perfectly logical results of the lag between demand and supply--you can generate them even in computer models (google "Sugarscape").

Mikev: See CC. There are plenty of theoretical ways prices could go up. I just don't see any reason to expect them in the real world.

For example, investors could expect rents to rise rapidly in the near future. This seems unlikely to me: Rents barely rose during the boom, so why should they rise when times are tougher for NY's main industries? But if investors disagree with me, or if NYC actually generates enough high paying jobs that increase in pay fast enough, and if demand goes up enough to make construction/conversion costs go up, then rents will go up, and rents they go up enough and steadily enough, current prices will be entirely sustainable. If I was very confident in 10% rent increase/year for at least a decade, I think I could justify paying current prices.

Alternatively, construction and conversion could be far more expensive than I imagine. If long-term rental investors can make a profit at $500 psf and it costs $500 psf to bring the average rental property up to the quality level of the average estate sale, plus $200 psf for the conversion from rental to coop/condo, then current prices make sense. But since it costs nothing at all to convert a currently- rented new-construction condo to owner-occupancy, I don't think this is what is going on.

If you think prices are going to stay where they are (over time periods of more than a year or two), it seems to follow that you think rents are going up, conversion and construction are going to stop, or the basic capitalist incentives have failed. Which is it? Or do the standard theories miss something major?

Mikev, continued: Or I could be wrong in thinking that this bubble has peaked. Perhaps lenders will quickly return to lending based on asset value instead of income. Perhaps Seg's friends, who still fear price rises but not price declines, are more widespread and have more cash on hand than I think. Perhaps inflation/socialism/collapse fears will lead huge numbers of people to conclude that buying in NYC (but not building there!) is a safe haven. Perhaps the Fed's low interest rates will convince people that there is no opportunity cost to their down payment. These could generate so much demand that supply won't be able to keep up, causing another bubble. That's not what's happened in the past. Usually, people move on to new myths when the old illusions fail. Pets.com stock is still worthless and tulips are still not as valuable as houses. But there is no logical reason to assume it can't happen for a first time. I just don't think it is very likely.

And if there is another bubble, maybe your life will turn out to have the right timing to allow you to sell before it peaks. In the aggregate, that seems like a lousy bet to me. But someone wins the lottery, despite its negative expected return, and someone will win (and lose) on the next bubble too.

"If I was very confident in 10% rent increase/year for at least a decade, I think I could justify paying current prices."

I think you overestimate the degree to which rents must go up to justify current prices. It does not take 10% per year, even if you assume zero future increase in prices (or negative real prics). Unless you are requiring a return on equity that if far in excess of today's returns on other investments of similar risk (to my thinking anyway).

But hey, no need to start another rent vs. buy thread.

Short version of long posts above:

Bubble theories focus on demand and forget about supply. Supply isn't fixed. Investors respond to high prices by creating more supply, thus bringing prices down. Anytime investors can make super-normal profits by increasing supply, you should predict increases in supply and therefore drops in price.

The cheapest way for this to happen in NYC is for condo owners and other landlords to switch from renting to selling.

"Perhaps Seg's friends, who still fear price rises but not price declines, are more widespread and have more cash on hand than I think."

I never said anyone doesn't not fear price declines. They do. I said it's naturally a balancing act between the two. It would seem to me that a rational person should be concerned about the possbilities of both falling prices and rising prices/rents.

The question is, to what extent should a person be willing to overpay (with the degree of overpayment being debatable) in order to lock in P&I and eliminate the risk of prices running away from them for some indeterminate period of time, which is inherently unknown. Some potential buyers (with young kids for example) simply don't want to wait 10 years for prices to return to equilibrium. You don't get unlimited chances.

This is the core of my inquiry. Is it rational to examine both risks -- not just the risk that prices fall, but also the risk that rents and prices rise. If you are trying to de-risk the latter, then what, if anything, should a decision-maker be willing to pay for this?

It seems the general view of bears is a resounding "Zero" -- that it is not worth de-risking the latter, even if there is some chance that the bearish view will turn out wrong. I still think it's an interesting question. And I would be interested to whether you think it is worth considering.

Seg:

ROE needs to be higher than the interest rate on a non-government subsidized mortgage, since the risk is necessarily higher on an equity investment than a loan on the same property. But I haven't thought about how much higher, because I haven't been able to make the numbers work even at mortgage rates, and the market's view on risk seems schizophrenic.

And since the future sales price is, at equilibrium, equal to the present discounted value of net future rents, you should omit it in a calculation of equilibrium price; otherwise you are double counting your expected net rent increases.

Seg: Re fear of price/rent increases.

There are many reasons why people choose to overpay. This may be one. It's not necessarily irrational, although most risk analyses are: we tend to regret losses more than we like gains, making it easy to generate inconsistent results depending on how the issue is framed.

But outside of bubbles and panics, willingness to pay doesn't determine market prices.

Finance, you need to re-evaluate your definition of ROE. ROE is not simply defined on a 1 year basis. Many stocks have dividend yields lower than a company's corresponding bond yield. I guess all equity investors are schizophrenic?

Also there are real reasons why buying a property should be more expensive than renting. One reason is that an owner has the option to alter a property. That "option" has value, that the renter does not have.

Jhooooch. I just out a nail into my rental. And given current rent/buy craziness. My rental in a new development needed zero work. It's so well laid out with much more amenities than any buy that I could do in the last 5 yrs of the bubble. And yet my ll subsidizes 'me to live here thinking the mkt will turn in 1 yr. He's been doing this for the last 3 yrs. I don't dispell his 'wait till next yr' rallying cry! Flmaozzzz

JHochle: Do you really think people buy stocks because they expect to make less money than they would buying bonds? If so, I have a shirt business you might be interested in. It loses money on each shirt sold, but they plan to make it up on volume.

No, my whole point is that there are other components of income or cash flow than a yearly dividend (stocks or real estate). Which is why people are willing to buy stocks at a lower annual yield than bonds. They expect some form of growth in the dividend (earnings) or stock price (or rental income, or sale price). This is not purely bubble mentality, this is normal finance. A P/E ratio is affected by growth rates or expected growth. You expect to make more money buying the bond, even though it has a lower current yield. If you cannot understand that, you need to change your moniker.

If people expect rents to increase at 1% or 3% or 5%, or whatever, it may make sense to buy an apartment now even though it is currently cheaper to rent.

You expect to make more money buying the *stock than the * bond, even though it has a lower current yield.

Your arguments seems to be that since rental yields are lower than mortgage rates, the market must be overvalued. I am saying that is not true. There are other factors. It may be overvalued, but your view ignores many important factors.

jhochle:
keep in when an investor buys a 2% dividend yield stock, the company is most likely earning a higher % earnings yield and reinvesting their earnings to generate not just nominal growth, but real growth. Or they're trying to anyway.

with a real estate investment at 2% yield, there is not excess earnings on top of that for reinvestment. Growth in rents usually based on nominal/inflationary growth. So a 2% dividend on Wal-Mart stock, for instance, it not entirely comparable to a 2% cap rate on a NYC apartment.

I generally agree with the spirit of what you're saying -- but am also pointing out that reinvested earnings represent 1 big difference that complicates the comparison between stocks and RE.

seg- I understand and agree, just pointing out finance's overly simplified analysis.

Ex: "Equilibrium is when an INVESTOR in a similar unit would be indifferent between buying, selling, holding to rent, constructing a new one or renovating an obsolete one, converting a rental to owner-occupied, or putting money in a different investment with similar risk."

I for one think that buying would cost more than renting even in an hypothetical equilibrium, since owners have the option to improve their place. Renters for the most part do not. That option is worth something, maybe a lot. Redevelopment on a large scale or small scale can yield very attractive returns in some environments.

A big problem with his analysis is that it is focused on the investor, and the investor may not, and in Manhattan is certainly not, the marginal buyer. This matters, because in an environment such as now, the cost of capital for the investor/developer is substantially higher (if even available) than it is for the owner-occupier. Clearly if the capital costs me less than it costs the developer, I can pay more and still have the same economic benefit. I'm not sure how this fits into financeguy's equation.

you guys remind me of my daughter.... I'll buy that cause it's pink! -really cute on a 6 yo-

Why don't you little girls let the grown ups make the decisions on a leveraged asset purchase in a deflating bubble market.

Is your daughter having a hissy fit?

w67thstreet
about 2 weeks ago
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report abuse
I've got a 6yo and a 4yo. I've got a built in excuse for anything.

Why did I miss the golf outing, kid woke up 'puking'. Why'd I misread that prospectus? My daughter had a hissy fit about her dress bc it didn't have enough colors!
https://streeteasy.com/nyc/talk/discussion/21728-smoking

The big issue with buying is that NYC's supply of rentals is often inferior to what you can get in a condo purchase. I can buy a $1.2M apartment downtown that has about 1200 square feet. With 1200 in maintenance has a monthly payment of roughly 4500 with 20% down. 5000 max. There is no rental in Manhattan with that quality for 5000/mo. 5000/mo gets you 700 sq ft with few amenities and old GE appliances. So there is demand for higher quality square footage. Comparing a stock to an apartment in which you live is apples and oranges. Unless you are buying it to rent out, there is significant utility value.

That said, there may be a tipping point where condos cannot find buyers above cost to build and they all convert to rentals thus making renter options higher. When that tipping point comes, you will all be out of a job anyway.

Oh no, no more hissy fit for 67

jhochle:
Re: Expectations of future rent increases can justify current prices. I agree. Do you expect the rent increases implied in current prices? Why?

Re: option to repair: The marginal supplier is an investor. If prices go up above rental value, the marginal supplier will sell a previously rented unit to a homeowner who wants the option to repair. Supply increases until investor suppliers are indifferent between holding-to-rent or selling.

If the unit is worth more with owner/bank financing than landlord/bank financing, then either prices will come down or rents will go up, because investors don't care whether they give you the option to repair or not. At least some of them just want to make money.

Printer: Re marginal buyers. No, you've missed the point. Prices are determined by supply and demand, and it is supply, not demand, that makes price declines likely.

Re: Differential financing. As a theoretical matter, if financing were consistently cheaper for individuals than for developers, as you claim, the market would shift to condos and away from rentals and coops. That happens in countries with unsophisticated finance sectors. During the transition (but not at equilibrium) there would be a premium for condos.

But why do you think that the US has changed so that only individuals will be able to get financing? Do you think the private sector is incapable of spotting a good investment? Is it that you think current prices make taxpayer-funded subsidies for owner-occupants the only reason to invest in RE? Or do you think that the NYC financial markets are permanently broken?

w67thstreet
about 3 hours ago
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report abuse you guys remind me of my daughter.... I'll buy that cause it's pink! -really cute on a 6 yo-

Someone owes aboutready an apology. Apparently YOUR daughter had the hissy fit, not hers. Well, whoever owes aboutready an apology, I'm sure aboutready will be back within 10 days or so to receive the apology, because I did read someone thought that aboutready would be back within 3 weeks.

w67thstreet http://streeteasy.com/nyc/talk/discussion/21728-smoking
about 3 weeks ago
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report abuse
I've got a 6yo and a 4yo. I've got a built in excuse for anything.

Why did I miss the golf outing, kid woke up 'puking'. Why'd I misread that prospectus? My daughter had a hissy fit about her dress bc it didn't have enough colors!

you like pink zzzbuyer? who's gonna fire me, myself?

w67 - if you are self employed I hope you have inherited money as you wont be able to get a loan anyway with those 1099s.

Who has more z's?

by the way, zzzbuyer, it will take us a few days to figure out what other name you normally post by, can you just make it easy? Come on, do it for me and columbiacounty.

you're slipping....way off your game.

oh hey columbiacounty, how are you?

>> The big issue with buying is that NYC's supply of rentals is often inferior to what you can get in a condo purchase.

Someone needs to tell that to the owners at the Residences at the Mandarin. The HOTEL rooms look better than the apartments. It sure is expensive to be unattractive.

Re: Differential financing. As a theoretical matter, if financing were consistently cheaper for individuals than for developers, as you claim, the market would shift to condos and away from rentals and coops. That happens in countries with unsophisticated finance sectors. During the transition (but not at equilibrium) there would be a premium for condos.

let's see: in NYC, condos do trade at a premium to co-ops - somewhere on the order of 10-20%. Financing is consistently cheaper for individuals than developers due to the fact that tax law lets you deduct mortgage interest from other income. Which means that, in the vast majority of cases, the individual is the marginal buyer - we saw very little of the small scale buy, put in granite, and flip that the bubble areas of the nation saw. Only developers can realistically supply new housing due to the scale needed to put up a multi-unit building.

> what if you just want a nice home you can afford?

simple, rent. You'll be much likely able to afford what you consider "nice" (and/or pay less for it).

how about you want someplace nice that you can make your own. I am talking being able to move things around as i am currently doing.

I believe that the added value of not being concerned with someone else having control on what you do and how much you pay is worth part of the difference that everyone talks about. A lot of the discussion always centers around the if you believe Financeguy the inevitable decrease in the value of the home i just purchased. However there is no offset with the inenvitable increase in rents over time. Sure you can argue that we just saw a decrease in rents over the past few years, but judging from the market, incentives are going or have gone away and rents have started to stabalize and move up. There is no stopping a market rate apartment landlord from increasing rent 10% or more in a good year. So your option is to pay and continue in the place you have tried to make your own, or move and pay a broker, a mover, etc.

There is a higher chance that the carrying costs of a rental will increase much higher then my carrying costs of my apartment as the only thing that could possibly change is my share of the common charges as everything else is fixed.

doesnt that bring you back to the simple idea of throwing away $ each month, and building nothing in the way of equity for the future?
not talking about flip money in 2-3 years . . .

HOME--for like a decade or 2 then maybe sell at different point in life?

Mikev. You are so so wrong on the montlies on a owner unit. And so so wrong on all your emotional justification to buy in a bubble popping.

Here is a question. In a year, if your unit above you sold for $100k less, ie mikev one floor above you can afford to take his entire family around the world vaca and you can't afford it, how much value is there in painting your walls pink?

House rich life poor.

"how about you want someplace nice that you can make your own. I am talking being able to move things around as i am currently doing."

I like being able to switch to a different type of apartment as my needs change. Add a bedroom... or try switching from a loft to a high-rise with views to something else if I feel like it.

And paying less the whole while.

Either way, you're off the topic. There are pros and cons on both sides.

But you do have to figure... this is supposed to be a DYNAMIC city right? We live here for the new and exciting and pace and change. And yet so many people want the apartment they're going to die in? (or maybe they just want to rationalize what they already did)

"I believe that the added value of not being concerned with someone else having control on what you do and how much you pay is worth part of the difference that everyone talks about."

Bad logic. Because we're talking about extra difference over historical. Your claimed benefit isn't new... but the gap now is.

> However there is no offset with the inenvitable increase in rents over time.

Well, first off we've had rent decreases. Second, if you're calling them inevitable, so is inflation. Thats certainly an offset. Third, it gets factored into the equation anyway! Even with that, its still cheaper to rent.

> There is no stopping a market rate apartment landlord from increasing rent 10% or more in a good year

Or down 15% in a bad year.

By the same "nothing stopping" point (which isn't actually true), what is to stop those major tax increases we're seeing? Or the 20% declines in apartment value (with 20% down, thats a 100% capital loss). Or maintenance costs, etc.

"So your option is to pay and continue in the place you have tried to make your own, or move and pay a broker, a mover, etc."

Lets compare for a sec..... brokers fee for buying.... vs. renting. Not even close. And the average owner only last 5 years. Brokers fees work out better for renters in this case... and thats only if you pay them! I didn't, and got a free month.

And, again, if your costs are 50% less, you're arguing about an extra month here and there. Thats just illogical.

"There is a higher chance that the carrying costs of a rental will increase much higher then my carrying costs of my apartment as the only thing that could possibly change is my share of the common charges as everything else is fixed."

So what. You're costs are guaranteed to be way higher than mine for a long time AOTBE. Say I increase 10% a year while you increase 5%. Gonna be a long, long while of me still paying less than you.

Which is cheaper, paying $100 a month, or paying $50 a month going up to $75 a month?

You're acting like none of this is factored in to the equation, but it is.

Your point seems to rest on why YOU like buying (fine for you) and ignoring why others see a huge value in renting (mega cost savings just being a part of it).

> doesnt that bring you back to the simple idea of throwing away $ each month, and building nothing in
> the way of equity for the future?

This is the mistake that suckered a lot of people.

Overpaying for equity is throwing money away. If I can rent the same for half the carrying cost, then buying is throwing money away, plain and simple.

If you have to pay $500k extra for $100k in equity, you just burned $400k.

> not talking about flip money in 2-3 years . .

Don't have to be.

Equity has a value. But if you buy an overpriced home, you overpaid for it.

if the concept is properly understood . . . .

I'm doing ok with the situation where the potential rental amount, roughly, equals the monthly carry cost??