Rent vs Buy, Round 37 (warning lots of math)

flmaoz... yes cc's never go up? Interest rates will go lower in month 240 when you want to sell....

paying down a leveraged loan on a depreciating asset is "paying ourselves savings"?????!!!!!!!! holy crap, my sides hurt from laughing!

FLMAOz.... another financial ninny about to be a lemming bubble bursting buyer... THANK YOU SIR! may I have another!

oh and what if rents keep dropping, is that paying yourself negative savings or will you just poke your financial eyes out at that point?! OMFG... you are a little ninny.

I just gave myself a thumbs down.... is that legal?

Care to share your calculations with us oh wise one? Unless you are psychic, I could care less about your prognostications. I think I made it perfectly clear this thread was about facts, not opinions.

Where is the factual basis for your assumption that future appreciation will be a wash with transaction costs?

If you assume 0% appreciation on the property, transaction costs will play a huge role in this decision. Also, interest rate risk + rate of inflation on monthly carry.

If this is a condo, lets talk about transaction costs for a moment.

To Buy --> $24,000 (4%)
To Sell --> $45,000 (7.5% - broker commissions, atty fees, move out fees, transfer taxes)

So you got 70,000 or 28 months of rent covered by transaction costs alone. Then you take into account the other elements, deductions, IR rate risk, inflation on monthly carry, etc..

"oh and what if rents keep dropping, is that paying yourself negative savings or will you just poke your financial eyes out at that point?!"

FLMAO. What if rents go up? My goodness, what happens then w67th?

"I think I made it perfectly clear this thread was about facts, not opinions."

If you are long term, things are looking pretty good right now. There is risk of market volatility that should be included in your calculation (as w67th tried to point out) but it is very difficult to quantify. I would also spread the transaction costs over the term of the loan. Other than that, your facts look pretty good bhh.

A few problems with your calculations: you can't deduct the "equity" (594 in your example above) unless you feel comfortable counting ghost chicks. Read Aesop's fable about spilt milk for more information. Second, you indicate your marginal tax rate as 33% and apply a straight chop to your cost of money. You may want to actually recalculate your taxes for a more accurate number. Between AMT and other deductions, the actual tax break can be less. In any case, I wouldn't extend any calculations more than 4 or 5 years; that's the average length of stay in a 1-bedroom apartment.

bhh,

You ignored the best part...the numbers for month 360 and 361+...
By 360, the entire payment has been going to principal. (mostly paying yourself)
At 361, there is no payment at all. Total cost of living is $600/mo (plus inflation)

Looking backwards, if you're 55 today, and you bought at 25, your housing cost is $600/mo. (mortgage paid) If you're 55, and you never bought, your housing cost is $2500/mo.

The assumption is that you actually live there for the long haul and get the back-loaded jackpot.
If you sell, then it really just comes down to price action in the interim. As monthly costs are comparable for much of that time...If it went up, it was best decision you ever made (as evidenced by the scores of older NY'ers who are sitting on multi 6-fig equity that would have taken several lifetimes to accumulate by hand). If it goes down, it was a bad decision b/c you walk and lost your down-payment. But that is the best asymmetric risk/reward in your favor that you'll ever get.

Amortizing transaction cost over time is a good idea. I will add that.

The reason I am unconcerned with volatility is that I am sufficiently liquid to ride it out. This could be an all-cash purchase if I didn't have a better use for the other 1/2 million dollars.

captive,
I have it. Month 360 is all equity but we still have maintenance and the opportunity cost on our down-payment has compounded to $1,090.94 per month so we still have a "cost of housing" number of $1,697.03 in month 360. I agree though that will most-likely be a tiny amount of money in 2040 dollars. I am comfortable assuming maintenance will not climb at 4x the rate of inflation so that is why I am comfortable allowing those two to conservatively cancel each other out.

bhh:
1. It is improper to subtract your monthly principal payment from your calculation of rent equivalent cost to own
2. Your opportunity cost on your downpayment should be at a rate of return for a risky leveraged investment in real estate (which is what your are making) and should be based on an increasing amount at risk every month as you make principal payments on your mortgage
3. Transaction costs have been covered by others
4. Tax rate should be examined carefully especially since there is a risk at some point over your time horizon that the heavy tax advantages of "luxury" real estate ownership will be curtailed by Federal and State/Local governments.

It is almost never the case in NYC that a rent vs buy calculation with no price appreciation in the equation will result in ownership being cheaper.....which doesn't mean people are irrational when they buy.....just want the things that go along with ownership that don't come with renting.....but don't kid yourself....owning is very expensive if you don't get bailed out by appreciation

And VERY expensive if you find yourself unexpectedly buying at a bubble market top or anywhere near it....ask anyone who did......

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

"It is almost never the case in NYC that a rent vs buy calculation with no price appreciation in the equation will result in ownership being cheaper."

Can you elaborate, Mjs? How does locking in costs over 30 years *not* become cheaper over time? Even if your apartment doesn't appreciate in real terms, historically housing typically keeps up with inflation and acts as a hedge. Is there something about New York properties that prevents this from happening?

exbreezy, I stopped reading after

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

"The S&P 500 increases at a real rate of 8.0% per annum.
These being true, it is ALWAYS better to rent property than to buy, if you invest the down payment in the S&P 500."

That's a huge assumption. I think most people would not consider putting their DP money in the S&P500, because it's too volatile. When you buy a house, you generally don't wonder what the day-to-day value of your home is (if you do, there's probably a name for that disorder). But, if a big chunk of your wealth is flip-flopping with the SPY's, it might be tough to sleep, for many people. Obviously, you can't quantify this "feeling", but I'm just pointing out that the average person wouldn't be earning 8% on their DP in the market/bank/whatever.

Exbreezy - What was your source for real property prices and rents incrfeasing at 0.7% per annum and how does it relate to actual experience in Manhattan over that same period?

Was it calculated over the same time horizon as your S&P real rate of return?

My hypothesis is that there has been a concentration of wealth in the last few decades which has resulted in property prices in select global cities (where the wealthy are attracted to) such as London, New York, Hong Kong etc.. to escalate at levels far above the baseline growth in property prices in those countries as a whole. Perhaps if you had data on real income growith of the 90th or 99th percentile of income over an extended period I would look at this model as a proxy.

Also, I'm not sold that the S&P's real growth of 8% can be sustainable in the 21st century. The US in the 19th and 20th century were times of remarkable growth to the financial powerhouse of today. Perhaps if you were to suggest investing in the Shanghai market it may be a better solution than investing in property etc... but that then gets into another flaw of your model. Investing in equity is ultimately a more risky proposition than property and should have higher rewards. If the economy implodes at any point, you are left with worthless paper whilst the investor in property has somewhere to live.

Funny. I started investing in college with babysitting money and I'm pretty sure I've lost money over the past twelve years.

The answer always depends on your assumptions not on the model.

1) If you use a risk free rate as your opportunity cost when comparing saving to a buying a risky asset (housing) then you will always buy the risky asset. Whereas if you use the long term return of the stock market as your opportunity cost, you will likely choose to 'save' instead.

2) If you assume that neither rents nor housing costs will rise, then you will choose to rent forever at the current rental rate and never buy. After all, why buy a non-appreciating asset. But if you choose to assume that both rents and housing prices will rise steadily, then you'll want to abandon that ballooning monthly rent payment for a fixed payment on an increasing asset. Why do you think all those, as someone called them lemmings, chose to continue to escape rentals and try to buy all the way up to the end of the bubble. In a rising market it's the logical thing to do.

3) If you assume you will live in the same house for more than 30 years then you will always choose to buy because on that time horizon you will certainly see substantial increases in both rents and housing prices, and you'll be around to collect the prize of living mortgage-free. But if you assume that you'll move in the next 3 years then you'll never buy because the transaction costs won't possibly be recouped and you might even lose pricipal (unless prices are going up like they were 5 years ago).

4) If you assume you have a 20% down payment laying around with nothing better to do then invest in CDs then you're probably going to buy. If coming up with 20% of $600,000 or $1,500,000 in the next couple months is not in the cards, so you're really looking at 10% down, most of which is really borrowed from friends and family and you're going to pay back one way or another, then you'll think really hard about whether it might make more sense to rent.

To sum it up, there is a set of assumptions that underlies the rent vs. buy calculation for the market:
1) The current and projected future mortgage rates
2) the current and projected future rate of increase of both rents and housing prices
3) the current and projected future returns on investments of substantially similar duration and risk to a housing purchase
4) the at large availability of capital for downpayments
5) the average tax rate of potential buyers
... I am sure there are more.

In truth those underlying assumptions (as the market sees them) when combined with a properly constructed model should yield the exact relationship between the rental price and the cost to buy. It is after all a fairly large, self-correcting, rational marketplace. Once you go through that exercise, stop building models and ask yourself what your assumptions are. Your assumptions about the future, along with your current financial status, clearly point to an answer. Assume rising prices = BUY. Assume flat or declining prices = RENT. It's really just all about your assumptions.

Are the required returns for owning your apartment higher or less than buying the S&P?

> Guys, it's indisputable: renting is FAR better in the long-term than buying.

As he writes his $4000/mo. rent check from his stock portfolio that has been flat over 10 years..

"1) If you use a risk free rate as your opportunity cost when comparing saving to a buying a risky asset (housing) then you will always buy the risky asset. Whereas if you use the long term return of the stock market as your opportunity cost, you will likely choose to 'save' instead."

Quantifying this risk is difficult so people use anecdotes, theories, and gut instead. This is one reason streeteasy is so popular, it is filled with people attempting to quantify this risk. I bet over 50% of the content of this site is an attempt at answering this question.

I think if you can stay in your house long enough so that you cover transaction costs and can then sell at what you paid, then you have lived rent free..no ?

The revulsion to buy now is matched only be the fever to buy in 2004, 2005 and 2006. Funny, most of those afflicted are renters.

macro_m: well played. you're totally right. if you're in NYC for the long haul, you can't be a perma-renter.

gmsrealestate,
I appreciate your cool-headed approach. I don't have a pony in this horse race and therefore don't feel particularly biased one way or another. My goal is to simply determine the threshold rent level for me based on what I feel are reasonable assumptions and as little speculation as possible so I have a definitive point in which to switch gears. As I said, I have been a bear and a neurotic saver for the past 5-years as I was incredibly pessimistic but I am equally cautious about becoming a perma-bear as well. There WILL be a time when it makes sense and I want to determine when that point is, for me.

jobless,
interesting question. I would say less for me because I do assign a little quality of life "value" for certain things. An example is that I own some land and a small cottage upstate. This is a portion of my "retirement assets" that I require less return on because it provides a far greater "quality of life" value in the short-term than does the balance of retirement assets that may or may not return more but provide zero quality-of-life value in the short-term. I should also add that I DO have non-downpayment assets(DP sitting in savings) in the S&P via SPY so I do have equity exposure. Transitioning from renting to buying would provide some asset diversification which is difficult to quantify.

bhh, did you plug your numbers in here? It seems more geared towards houses, but give it a whirl.
http://www.nytimes.com/interactive/business/buy-rent-calculator.html

marco_m
43 minutes ago
I think if you can stay in your house long enough so that you cover transaction costs and can then sell at what you paid, then you have lived rent free..no ?

No. You are forgetting about all those interest payments, tax payments, common charges, opportunity cost and the gut reno costs needed after living there for 30 years. Things renters don't have to pay for.

I think the buy-rent calculator does a great job of showing how the smallest changes in rent increase and/or real estate appreciation sway the answer. If you expect prices to go down another 30% in the next 2 years (like some bears here), it makes sense to wait. If you think prices will be flattish for the next few years and you intend to stay in your home for 10 or 20 years or more, it would make sense to buy now with the current very low interest rates. So, as much as you want to avoid discussions about what the future holds, expectations about the future really drive the conversation.
To go back to your own particulars, since you actually have enough money saved to buy what you want cash, I personally think it would be foolish to buy now. If you had to borrow, the risk of a higher rate would balance out the risk of a lower price. You should also seriously examine how long you will be happy in a 1-bedroom apartment; for most people, this is not a 30 years+ home.

Hotproperty, you're really naive if you think renters don't end up paying for those things. It just doesn't show up in the form of writing a separate check. And if you actually read Bhh's analysis, he accounts for all of those things: interest payments, taxes, etc.

Your analysis boils down to 'does my cash flow improve if I have no mortgage?' with 2% yields..... Oh f'k what a ninny

w67thstreet, how many "thousands of people have touched [your] wife"? You said thousands touched her, but that is a wide range. No pun intended.

No kidding evnyc. I'm not arguing with Bhh's analysis. I'm arguing Marco's assertion that owner's don't pay "rent". The interest payments, tax payments, common charges, opportunity cost and wear and tear depreciation are expenses, just like rent, that owner's seem to forget about. I'm not naive-I'm an owner so I know what I'm paying.

Well, you just contradicted yourself, so the clarity of your argument could use a bit of work.

> 1-bedroom apartment; for most people, this is not a 30 years+ home.

At least, not forward-looking.
Every college girl also says she'd "die" if she's not married by 30.
However, the city is full of millions of people who ultimately lived out their lives in a 1BR

just keeping things simple...after 5 years of renting, you will get nothing back..after 5 years of woning, you will gte something back. i think a 10 yr window will do even better. Im also assuming that you can own and still invest future money in other assets.

if you want to be accurate as well as simple....

after 5 yrs of renting, you have a certain economic outcome.

after 5 yrs of owning, you may be able to sell and break even, lose or gain. a crap shoot.

marco_m, accurate assumption.
I'm also talking about a 2-bed in Park Slope, if it matters. I am also married, no kids, none planned. SqFt growth would likely take place upstate rather than a larger place in the city as our job & business requirements to be in the city diminish. That is the better use of the other $500k I was referring to, expanding upstate property which will need to be done with cash. We are thinking about beginning to extract ourselves from the rat-race but our friends and social life are and will remain here.

marco_m said "I think if you can stay in your house long enough so that you cover transaction costs and can then sell at what you paid, then you have lived rent free..no ?""

Common misconception. If you pay all cash for a house or apartment and have no mortgage (or stay in it long enough that you pay your mortgage off), this does not mean you are living rent free....it only means that you are living with no out of pocket cost (ignoring maintenance etc for the moment) but with a high opportunity cost...the money you could be making by investing the value of your home in stocks, bonds, gold, whatever and receiving that income stream.

In early 2006, I made exactly the calculation called for here and sold our home in NJ and have been renting ever since....smartest move I ever made in RE.....now the question is when/if to re-enter the market....still too early in my view but not crazy early.......and rents have been coming down for the past 24 months....

There will always be a philosophical argument regarding renting vs. owning...

Some people want to own their home, some people dont care. Evidently, renters can be defensive about justifying their living situation!

For me, the whole idea of financing someone else's nest egg .... nope, it's just not my thing.

gcondo, it's not a philosophical argument, it's about financial consequences. bhh didn't call his thread Rent vs Buy (lots of squishy feelings.) The entire thread does not revolve around who prefers renting vs. who prefers owning. I also didn't detect any defensive tone from the "renters." The very point you make over financing someone else's nest egg just shows you don't quite understand the quandary for new entrants into the marketplace. We are coming from an enormous, giant real estate bubble. Prices are still historically high (if no longer at the highest point.) If prices go back to an historical average over the next 40 or 50 years (through a combination of busts/slowly decreasing prices), buying now may be financing someone else's nest egg: the seller's.
You can argue that it is worth it to you to buy even if it costs double; that is a very fair point, and then we could have a philosophical conversation about money vs. happiness. That wasn't the question though.

What everyone overlooks is the asymmetric risk. If it goes up, you keep the profits. If it does down, you walk. Like I've said before, this the best "house odds" gamble you can ever make. Unlimited upside. 20% downside. You basically have to try very hard to lose money in real estate, if you're a regular Joe. Historically, I'd guess that 1 in 10 buyers actually end up with a loss.

captive914... fking lots of old ppl who were counting on nyc re bubble equity in lieu of savings.. watching it bleed month by month. They got lucky lucky lucky on their timing, akin to tulip buyers who still could've sold at tulip top minus 20%... but but but... most didn't. Learn to like cat food... beyccccth.

And as to your gambling analogy, if you haven't noticed, it's been bet on black for a long while now.. we just had 2 reds come up... me thinkz the house has changed the odds... but you goez girl, lever up baby, lever up.... there's just bargains galore coming. Tell me why aren't you buying MORE? Tell me how many "homes" do you own and how many more will you buy in the next year? oh tell me... fking idiot

captive914, if you think your max downside is your downpayment [and initial closing cost], you are dead wrong. In NY, your lender can choose to let you keep the place and sue you for every penny you owe them. I'm not going to even address the rest of what you wrote, else I might end up sounding even more harsh then w67.

NYT has a rent vs buy spread sheet that I used...it's helpful and goes into detail.

Sorry, but it's been on black for a mere 2 years now. In contrast, anyone who bought in the last 100 years, sans the last 2, made a profit. Every single person who was underwater in the early 90s was back in black a decade ago. With only 36 slots, you have higher odds of winning at the roulette wheel than losing at real estate.

Bottom line, you have to look far and wide and far to find real estate victims. Find me a loser, and I will find you 10 who are sitting on equity, and living with inflation protected, below market "rent".

Lest you think I am some perma-bull, I think real estate is going down. No way I'm a buyer here. Historic bubble is still lot in line with employment and income figures. But timing the RE market is quite different than dismissing it as a "bad" asset class.

Are you really using the risk free rate for your down payment, on a 5x leveraged investment thats volatile enough on its own? If so, thats a huge oversight.

"That's a huge assumption. I think most people would not consider putting their DP money in the S&P500, because it's too volatile. When you buy a house, you generally don't wonder what the day-to-day value of your home is (if you do, there's probably a name for that disorder). But, if a big chunk of your wealth is flip-flopping with the SPY's, it might be tough to sleep, for many people. Obviously, you can't quantify this "feeling", but I'm just pointing out that the average person wouldn't be earning 8% on their DP in the market/bank/whatever."

Aren't your really just talking about ignorance? Not paying attention to volatility doesn't make something any less volatile.

And a 5x or 10x RE investment is far more volatile than the S&P, whether or not you admit it or not.

"Sorry, but it's been on black for a mere 2 years now. In contrast, anyone who bought in the last 100 years, sans the last 2, made a profit."

Self-fulfilling and not quite correct logic.

At the top of a bubble, just about every purchase looks like a good investment. In 1999, dotcom was just as much "always" profitable.

At the peak, everywhere else is down.

So if you are using bubble pricing as your basis for accuracy, you're leading a lot of people down the wrong path.

Not to mention, your original statement isn't very accurate... if you are talking 1) real dollars and 2) include financing costs.

If I pay $200k to buy a $100k house and sell it for $150k 30 years later, are you going to call that "profit"?

Shiller noted that the long term real return on RE is essentially 0.

Like I said, I am not discussing whether NOW is a good time to buy real estate. You can lose to the tune of -20% and "jingle mail". I am simply saying, most people make money most of the time. That does not mean go out and buy a co-op today. That boat has set sail 18 of the last 20 years, and if you didn't get in, you missed it. All I know is there is no chance in hell I plan to reach 60 and be paying market rental rate (vs. living mortgage free with a massive capital gain). Good luck in whichever path you choose.

Somewhereelse,
You raise a valid issue as to what is an appropriate rate of return to use for DP opportunity cost, but the challenge is really what is a more appropriate rate? There is just not not much yield out there to be had, what figure would you recommend? DP payment is currently sitting in savings yielding about nothing but is also serving as emergency liquidity. Although I would not put DP payment money in anything yielding more than probably a 1-year CD, after purchasing I would be replenishing those emergency funds out of equity holdings so the argument could be made that I would be reducing equity exposure and thus sacrificing yield and raising my DP opportunity cost. That move could also save me a 40% haircut if we double-dip and retest the 2009 lows. Maybe someone cares to proselytize on that?

A few others,
It is really hilarious how emotional some of you regarding all of this. Remarkably similar to religious fundamentalism or zealotry actually. This is an academic exercise and there is really no place for all the emotional outburst and pontificating. Chill out and try and conduct yourself with a modicum of dignity.

A realistic cost of money for equity invested in leveraged real estate these days is probably ballpark 5 to 6% aftertax....which is the right way to discount since this whole analysis is after tax benefits...the cost of money of course isn't the most sensitivee element of this analysis....your most sensitive assumption is on your appreciation/depreciation input....which may also explain why people get so emotional about this particular "math" question......

Total aside

"proselytize"

To induce someone to convert to one's faith....Webster's

"Prognosticate" maybe?

nice catch. no, i mean proselytize. Much of what people argue here is "faith-based" an nothing else.

even bigger aside, is bhh trying to get w67th to behave with dignity?

maly - is that possible?

I'd bet on real estate prices going up 10% next year over w67th "conducting himself with a modicum of dignity."

lol

Captive u know how many nycers have donated millions to causes bc of their home 'winnings'? Zip zilch nada. You know how many ppl have donated millions based on their investments in the stock market or starting a company or just doing well in your job?, tons. Flmaoz.

Curious w67, you said thousands of people have touched your wife, and we haven't clarified if that is 2,000 or 3,000 or so, or are we talking about 900,000 or 999,000 or so. But is number increasing? I mean, are there people right now touching your wife, or earlier today, were there any new people touching your wife?

"Captive u know how many nycers have donated millions to causes bc of their home 'winnings'? Zip zilch nada. You know how many ppl have donated millions based on their investments in the stock market or starting a company or just doing well in your job?, tons. Flmaoz. "

You've previously invested in residential real estate, and now in commercial real estate. Should we assume you don't give to charity? Don't you care about people? Or, the lawsuits against your residential tenants ... did that change you from a son of someone who gave away clothing to Goodwill?

"Thousands of people have touched [me]" but no one new in the past day. I'm still stuck with this hairy beast who is bitter at all white people and is a naked a bit too much. I need someone new

Per some good recommendations on this thread, I have updated the spreadsheet to include transaction cost and upped the DP opportunity cost to 5%. This combination has changed things pretty dramatically. My other assumptions remain intact, including subtracting money applied towards principal from the monthly total "Cost of Housing".

I have uploaded the spreadsheet to Google Docs and it can be accessed here...

https://spreadsheets.google.com/ccc?key=0AnE9mQ5bubhrdEdsalZxUTV2MWRVN1lHQ3RPSW5VM1E&hl=en&authkey=CMTZnAg#gid=0

The numbers should be editable by downloading it. The yellow cells on the "info" worksheet are the ones meant to be edited by the user. The month-by-month breakdown is shown on the "monthly" worksheet. This has been a tremendously helpful exercise if for no other reason than to really understand how subtle changes in certain areas impact the long-term results. An example is that basically once opportunity cost exceed the mortgage rate - the cost of housing actually increases every month due to that compounding faster than your equity, coupled with he diminishing tax advantages. Some interesting stuff indeed.

Thanks for sharing the spreadsheet bhh. To accommodate some more changes in the future, I think adding the following variables would be a good idea - I think most will agree that these two values will increase over time.

Annual Maintenance Increase
Annual Tax Increase

"Somewhereelse,
You raise a valid issue as to what is an appropriate rate of return to use for DP opportunity cost, but the challenge is really what is a more appropriate rate? There is just not not much yield out there to be had, what figure would you recommend?"

Admittedly, its tough. But figure stocks are seen to pay out 6-8% a year over long periods for certain volatility. Even if you think RE volatility is half that, go 5x leverage and you're over again. I say 8-10% at a minimum.

> DP payment is currently sitting in savings yielding about nothing but is also serving as emergency liquidity.

Of course, if its your emergency liquidity, why would you put it in your down payment? Thats what screwed a lot of people. You still need the emegency funds... or you could be pushed to sell at a time when its not smart.

"Although I would not put DP payment money in anything yielding more than probably a 1-year CD, after purchasing I would be replenishing those emergency funds out of equity holdings so the argument could be made that I would be reducing equity exposure and thus sacrificing yield and raising my DP opportunity cost."

Correct.

"That move could also save me a 40% haircut if we double-dip and retest the 2009 lows."

True, but not being invested generally costs a lot more than being invested.

Also, by that logic, not having bought pre the RE crash just "saved" you 100%, no? (20% loss x 5x leverage).

Doesn't all of this analysis just beg for a rule of thumb? Basically to properly do this, you have to input your annual expected rent, each year. Same for maintenance and taxes. Simply, you need to be comparing rents and annual cost of ownership every year. While you may be able to say that in the "long run" rents should increase with inflation of approx 3% (or whatever) per year, at least for the next say 5 years, since we are in such an anomalous situation now, you need to be making the annual assumptions on rents, eg they may decline x% for the next couple years and then y% for the next few years after that before resuming a more normal appreciation. Maintenance will jump x% for the next couple years and then .... And then you need an assumption based on .your expected sale timeframe on the exit price which may be based on the current highprices to say that prices could continue to decline annually by say 5% for the next 3 years then not grow at all for another 3 years the resume a more normal appreciation similar to rents. The whole cost of capital question seems to come after you make real assumptions on all of that.

There supposedly is a rule of thumb - I used to think it was 20x yearly rent vs. purchase price - but we go to the calculations because noone agrees on the number, and buyers often thing they have the special specific case.

I've heard everything from 12x-20x annual rents, which is a huge margin. FWIW, my calculations are coming in between 16-18x depending on how aggressive a return you expect on your DP money and assumes a very modest interest rate and monthly maintenance. The "rule of thumb" does not really incorporate maintenance into the equation, which can impact things dramatically but I could easily see sub 15x down to 12x in a higher interest rate environment.

Doing the numbers has allowed me to really understand how the various variables influence the overall picture and what to expect by any one of them changing, assuming a rational market of course.

16-18x as break-even in this interest rate environment.

I think the 20x also comes from a more nationwide approach, where you're more likely to have lawns and exterior painting and this and that that would require more upkeep.

BHH
Or the 200 times monthly rent formula I bring up ad nauseum on this board gives you 16.666 times rent.
It saves all that time and stuff on....errr calculations. :)

From the 1940's to the 90's except for 1987, the NYC rule of thumb was 100 x monthly rents -- which gives an investor a high single digit return before leverage in a stable market assuming no problem tenants and minimal management costs -- a reasonable return given the risks and hassles of the NY market but not much more. At the peak of the 80's bubble, many people switched to 10 x annual rents, which is enough for owner occupants who can take advantage of the various tax subsidies for homeowners (but makes it very hard for other investors to make any money).

Pay any more than that and you are basically either gambling on bubble pricing, paying for future rent appreciation that hasn't happened yet, or assuming that the mortgage market routinely overprices risk. In the end, prices are highly likely to be set by investors, not owner-occupants: if prices are above what investors demand, they'll convert rentals to owner-occupied, which will increase supply and bring prices down.

Fguy
Changes in tax laws made that number higher than 10x in the 90's and new millenium. 10 times is just not realistic....in Manhattan...today.
If we return to Jimmy Carter tax structures though, all bets are off.

"Admittedly, its tough. But figure stocks are seen to pay out 6-8% a year over long periods for certain volatility. Even if you think RE volatility is half that, go 5x leverage and you're over again. I say 8-10% at a minimum."

swe, I don't agree with tinkering with the rate of the down payment return as a basis for risk adjusting a real estate purchase. You have to use the risk free rate to keep the calculation clean, come up with an all-in number, and THEN figure out what the market risk is to the transaction. I think a sensitivity on rate of appreciation (including negative) coupled with probabilities at each rate may be the way to do it. Still subjective, but it focuses the risk in the right place.

Said another way, I cannot compensate for risk in owner occupied real estate by investing in stocks because stocks have their own set of unrelated risks. The way I compensate for risk in owner occupied real estate is buying smart and holding long. How would you adjust your 8-10% based on term held and initial purchase price?

About a decade ago, I recall reading a classic (ie: pre-bubble mentality) real estate investing book that advised to stay within 4-6x annual rent. But, regions vary greatly.
http://www.manausa.com/gross-rent-multiplier-real-estate/

Truthseeker: What change in the tax law?

Where is the "lots of math" in this thread? I'm so confused.

FinanceG, throughout the last 20 years there have been several changes in tax laws that have led to making people accept lower multiples of rent.
Of course there are other things like interest rates as well, but lower tax rates more than anything lets people take more risk than they normally would.
One specific tax law comes to mind, 1031 exchanges. Yes it's been around since the 20s but it didn't get any mainstream light until the 90s. And in the 00s, or do we call it the zeros? ..came reverse 1031s.
In the early zeros, nobody cared how much they paid for a building as long as they found one in 6 months time from the sale of their old one. They didn't mind overpaying 10/20% to save the 40% in taxes they would have to pay, and having Uncle Sam invest it's share of the pie in your new purchase.
For some reason I just envisioned Wimpy saying, "I'll gladly pay you Tuesday for a hamburger today."

Of course, changes in bank laws and interest rates played their share in it too.
In fact we haven't heard the term rent roll in 15 years unless you talked real estate with your dad or uncle. Because everything is CAP rate. A term I personally never accepted for purchasing a property, but 90% of the industry got drunk on it.

Guy....here's a read you may enjoy...
http://www.masseyknakal.com/chairman/634043355622750061.pdf

polisson, broadwayron, Oxymoronic, you fell for an original post by stevejhx. The logic is all his. And agreed to by none.

Today he says
Indeed, let's say you spend $4,000 a month to rent an apartment that would sell for $1 million. Your rent goes up 10%, your apartment goes down 10%. That translates into a $4,800 a year net rent increase, and a $100,000 loss on your "investment."

Truths:

Your 1031 story implies that prices rose because private sector investors decided that they'd rather overpay than pay their taxes (even though, unless they had extraordinarily low basis, they were probably losing money by being anti-patriotic free riders -- 10% overpayment is more than 20% capital gains tax on a 40% gain). No doubt the anti-American fervor of the anti-tax movement was a factor to some degree -- we certainly see plenty of people on this board and on the the Yelling Heads shows on TV who think that "free markets" means "subsidizing businesses that aren't willing or able to make it otherwise" and "patriotism" means "demanding that the government act only to transfer power and wealth from the worse off to the better off."

A stronger tax factor may simply have been the general reduction in taxes on the relatively wealthy: historically low capital gains tax and drastically reduced income taxes for the wealthy, all paid for by higher social security/medicare taxes on ordinary Americans, meant that the upper class had more cash and fewer inhibitions in rapidly trading capital assets. More trading nearly always means wider swings in market prices, with more booms and busts.

But I suspect an even bigger factor is the usual driver of bubbles: when people noticed prices going up in the late '90s, they stopped calculating values based on net rentals and, instead, were willing to pay for future capital gains they expected because they expected that other people would be willing to pay still more for the same thing later. That way of calculating can justify any price and vastly increases demand-- why not pay a million dollars for a pencil you don't need, or a shoebox someone calls real estate, if someone else will buy it from you for a million and a half? So, as the bubble analysis became more accepted, prices rose until they hit the limits of what people could borrow and until builders and more sophisticated investors were able to increase supply to begin to match.

I don't think using Cap rates to calculate is the problem -- the problem is accepting Cap rates (or multiples of rent) that make profit impossible except by finding a bigger sucker. Or, for retail owner-occupants, assuming that it is ok to pay a price that makes no sense based on fundamentals because prices "always go up over a 15 year period."

In the end, however, bubbles fizzle: when people are willing to pay foolish prices, some investors will be willing to create new supply -- by construction or conversion of rentals to owner-occupancy -- to meet the new demand. RE markets are opaque and slow, so it'll take a while, but eventually supply will catch up with inflated demand and prices will drop to the point where investors no longer make more money by selling than renting out.

FG
On 1031s, no, nobody was losing money, or thought they were.

Let's put a scenario out there and you can fine tune that totals as your damn good at it.

LEt's say we have guy who bought a building in 1996 and he payed 1 mil for it. At the time,let's say his rental income was $70K.
In 2004, decides to sell and gets 2.5 mil for it. (Im guessing the appreciation based on my memories of values, feel free to adjust any number)

Now all I can do is report the mindset I remember of people in these type deals which was, do I pay taxes on a 1.5mil gain, or do I buy a $2.5 mil building with it. Now of course there is depreciation, improvements and all kinds of neat tricks but Im guessing on this $1.5 mil profit, this guy's still gonna have to come up with $500K. And what nearly all this/these guys would do would opt to buy the $2.5 new building, which oops, the seller knows you need a purchase in 6 months, the price is $2.8mil.
And this/these guys figure, I'm not paying 300K more,it's just gonna cost $XXXX more a month (interest on the mortgage of the 300K) and besides, the rental income on this new building is $140K per year.

Still in the end though, I don't think we'll really ever see "10 times rent roll" in Manhattan again.
Not under current tax parameters.

TS: Ok, your 1031 scenario makes sense, but it already requires a lot of bubble to get those kinds of gains, so the tax gimmick seems unlikely as a primary cause of the bubble. Obviously, it could have helped to keep the bubble going once it got started. In any event, though, unless I'm much mistaken (always a possibility) 1031 has been around forever, and so have people who think that paying their fair share of the cost of running the country is for the "little people." So again, I don't see how 1031 could either cause or sustain the bubble: it was a factor before the bubble and it'll be a factor after, and it doesn't justify 20 x rent rolls.

There are only two ways I can see to justify 20 x rent rolls: (1) rents are highly likely to rise soon and sharply (the "growth stock" theory for high P/E ratios), or (2) prices are going to rise to 25 x rent rolls relatively soon (the bubble theory).

I see little sign that any significant number of buyers have been driven by (1) at any point in the last decade (it was a major factor in the 1987 boom). (2) on the other hand was all over the place during the bubble and still appears on this board, usually in the form of "over 15 years, prices always rise".

As near as I can tell, it was just a bubble. Bubbles are inherent to markets, just like stampedes are to herds and hurricanes are to tropical weather and for much the same reason: self-referential systems are turbulent. They don't result from policy failure or (quasi)criminal activity, although policy failure and criminal behavior often make them worse and longer than they might be otherwise (and certainly did this time).

If it was a bubble, there is absolutely no reason to think that something fundamental has changed in the real estate market. So, we will see 10 x rent rolls again, and probably even 7 and 8 x as well. It is hard to make a profit from just being a landlord if you pay more than 10x, and if you are even slightly pessimistic -- which investors often are -- you are going to want a margin, which quickly gets you to 7 or 8. Once investors give up on expecting the return of the bubble, which could take a few more years, if they can sell for more than those ratios, they are going to do it -- which just means that the supply of owner occupied will go up, bringing prices down.

And if all the rentals in NYC go owner-occupied and that still isn't enough to bring prices down, builders will build. It's not hard to build profitably at current prices; if builders can convince bankers that these prices are stable, they'll start building again, which will, of course, guarantee that the prices are not stable.

These normal market reactions -- basic Econ 101 -- explain Shiller's statistics showing that over time real estate prices don't rise faster than inflation: markets create enormous incentives for supply to grow to meet demand whenever prices exceed the cost of production.

Whether we will get back to pre-bubble rent ratios and real prices soon enough for people who want to buy family sized apartments before their kids grow up is another story -- it took 10 years to make this mess and it could easily take as long or longer to get out of it.

FG
>TS: Ok, your 1031 scenario makes sense, but it already requires a lot of bubble to get those kinds of gains, so the tax gimmick seems unlikely as a primary cause of the bubble. Obviously, it could have helped to keep the bubble going once it got started. In any event, though, unless I'm much mistaken (always a possibility) 1031 has been around forever, and so have people who think that paying their fair share of the cost of running the country is for the "little people." So again, I don't see how 1031 could either cause or sustain the bubble: it was a factor before the bubble and it'll be a factor after, and it doesn't justify 20 x rent rolls. <

Yes, I never said nor thought it a primary cause of the bubble, but it was without a doubt, water for the grease fire. My initial post was about how overall tax relief during the last 20 years has greatly inspired risk taking including in real estate as well.
And yes as I said, 1031s were around since the 20s, however, nobody knew how to apply it. The IRS didn't issue specific regulations on how to use it until 1991. SO before that, it was an extremely risky venture for people to find out after the fact if it applied or not. THis in fact helped even the playing field for "the little people."

All your points are valid, in fact, I agree with most and your analogies to stampedes are right on.
ANd if you've read me on this board, you know I scream about rents and their relationship to sales all the time. In fact, today's manhattan average rental at $53 per sq ft supports an average sales in manhattan of $883 per sq ft. (my 200 times monthly rent mantra). 2nd quarter sales average $1051. That's a 16% difference. To me, snapshot today, sales are overpriced by at least 16%. But this is a single day snapshot applied to topics in constant seesaw motion.

Now your arguments for 10 times rent roll I somewhat share, meaning, they should be 10 times. Logic and just plain old good business sense. And I would concede, though unlikely prices could see 10 times rent roll ( again I want to reitirate, discussing Manhattan solely), but for 1 year only. Because just like 25 time rent roll can't last, neither can 10. Markets are are living breathing thing, like ocean with constant waves and tides. But the facts are bubbles ar perpetual, some start off fast some slow, some grow fast, some slow. The point is, life happens during the bubbles, not just at the start or at the end of one. And Manhattan get quites bubblicious because it is a chronic global attraction. With all sorts of water to spread new grease fires.

The questions for everyone of course is when to surf the wave.
ANd though some of the above is about as bullish as you'll hear me speak, as long as unemployment and commercial/residential rents remain where they are, air is still coming out of an old bubble and there is no air for a new bubble to start.

>Whether we will get back to pre-bubble rent ratios and real prices soon enough for people who want to buy family sized apartments before their kids grow up is another story -- it took 10 years to make this mess and it could easily take as long or longer to get out of it<

Well we are nearly finishing year 2 of this mess, and I see another three years to get out. But of course, it is usually and especially now impossible to predict how government assistance or interference affects the course. After the bailout, and some other unbelievable acts, there are "rules" to apply to make proper judgements anymore.
I as a business owner am a deer in headlights. I know Im not alone.
I do know living in this state (of mind) does not bode well for short or long term health or growth of our economy.

edit
>After the bailout, and some other unbelievable acts, there are "rules" to apply to make proper judgements anymore.<

to; After the bailout, and some other unbelievable acts, there are NO "rules" to apply to make proper judgements anymore.