Sorry for beginner questions

Did you look at http://streeteasy.com/nyc/sale/553473-condo-340-east-64th-street-lenox-hill-new-york?

Same asking price as the 350E72nd, same taxes, but less than half the CCs.

There you see a big building's economies of scale. Maybe too big, though.

You are clearly correct that a small building inherently lacks economies of scale so its monthlies will always be higher.

If there is no offsetting value to being in a small building, then prices should adjust to reflect that: you should pay less when you buy and receive less when you sell, and overall cost of ownership will be about the same (but with lower mortgage payments and higher doorman charges). On the other hand, if there is a group of people who prefer small buildings and are willing to pay a premium to live in them, small buildings may simply be more expensive.

The second part of your analysis, however, is clearly wrong. When you pay very high prices for an overpriced product, there is no reason to imagine that you will "get the money back when you sell later." Current prices are extremely high relative to any fundamental valuation analysis: developers can make excess profits by building, converting rentals to owner-occupied, or renovating office buildings. Thus, investors are likely to create new housing stock. Unless demand increases faster than investors can expand supply, prices are highly likely to drop -- probably slowly and over an extended period of time -- until they are closer to rental values and construction costs.

Moreover, much of the value of an apartment is consumable: apartments wear out and need to be renovated every 30 years or so. So you are consuming most of the purchase price, not just the monthly charge for services.

For both these reasons, if you buy today, you should assume that the bulk of what you are spending is consumption, not investment, in big and small buildings alike. There are no guarantees, of course, but if you hold for a significant period, it is highly UNlikely that you will be able to sell for enough to cover your current purchase price and the necessary maintenance and renovations in the interim.

NWT: Thanks so much! I've been looking at St. Tropez also...but haven't found the right unit. The units are usually really crappy or renovated and very expensive.

Financeguy: Thanks for your analysis. I'm wondering about this part of your analysis:

"Current prices are extremely high relative to any fundamental valuation analysis: developers can make excess profits by building, converting rentals to owner-occupied, or renovating office buildings. Thus, investors are likely to create new housing stock. Unless demand increases faster than investors can expand supply, prices are highly likely to drop -- probably slowly and over an extended period of time -- until they are closer to rental values and construction costs."

Isn't there a premium placed on ownership in many parts of the world, e.g. Hong Kong, Shanghai, etc.? I'm not arguing...just trying to understand whether this rent vs. buy analysis needs to hold true in NYC real estate market. From what I have seen lately, the prices are headed up. Would your analysis lead you then to buy a co-op then over a condo because co-ops are much cheaper than condos right now? Or are you for renting only at the moment? Thanks so much for explaining your view!

Junderwo2, it's okay to have beginner questions. That's what we're here for.

My colleague 30_yrs, who sometimes haunts these boards, would say that you don't want to lock into a building with a high maintenance because maintenance is never going to go down.

I don't have that much of a hard-and-fast rule about it, but I would urge you to consider your future buyer: if you're buying in a niche where subsequent buyers are going to want white-glove services, then you'll be able to resell a white-glove product. If you're buying in a niche where you think people will no longer want that (or quite possibly, no longer what that in that location) go for a bigger building.

ali r.
DG Neary Realty

Finance guy- If what you say is so true, how about listing the legions of examples that must be out there to prove your point about converting rentals to ownership. You're entitled to your opinion but offering up this pure theory as if it has relevance to what's happening in this market begs the question of what evidence you have.

^^ "no longer WANT that in that location"

Hi junderwoo,

I agree with financeguy & frontporch that it's good to avoid high monthlies. But, what I'm hearing is that you're sounding kinda theoretical re: the "consuming" stuff. How about simplifying your analysis a bit, like what can you comfortably afford? Ideally, cost of housing should not exceed aprox 25%-28% of your net annual income.
How long do you plan to live in the apt? If it's less than 5 years, renting may be a better option. If you're looking at condos, be careful of tax abatements, which can be like time bombs once full taxes kick in. Also consider how much it would cost to rent an equivalent unit. If it would cost a lot more to buy than rent, it isn't a good deal.

$1700 for 1300 sq ft is pretty much the norm, no?

Junderwo -- We are at the tail end of the largest RE bubble in recorded history, so yes, prices are unsustainably high in many places around the world. It is too early to know how the endgame will play out, but bubbles rarely end happily. Eventually ordinary market forces reassert themselves: builders/converters/renovators catch up with bubble-caused demand just as the bubble demand starts to wane, and the result -- more supply and less demand -- brings prices down until investors can no longer profit by creating new units and "buying to sell" is no more profitable than "buying to hold and rent out forever."

Buyerbuyer -- I don't know of anyone who collects rental/owner-occupied data in useful form.

But for anecdotes, just look around: there are builders active all over the city increasing the stock of market rate owner-occupied units, often by converting rentals. The proposed StuyTown conversion is just the biggest. And every bubble condo investor who sells a formerly rented unit to an owner occupant is doing the same thing.

Conversely, how much evidence do you need to believe that someone in NY will notice such a major profit opportunity and take advantage of it? Is there **any** evidence that the usual rules of market capitalism have been suspended -- that prices can stay higher than costs without leading to production? Or that housing stock can increase indefinitely without affecting prices? Or that as prices stop rising, bubble buyers who have complete faith that prices will always rise will never question their faith?

finance guy, I hear your theory that a supply of new apartments should push prices down, but I'm not sure where the supply of new apartments will come from. Remember that the 2000-2008 supply of new condos was encouraged by a tax policy that caused strong distortions in the market (10-year abatements in Tribeca and 25-year abatements in Harlem, WTF?) and it's hard to imagine that repeating anytime soon.

The last real estate bust we had in Manhattan, in the late 80s/early 90s, prices fell roughly 50% peak to trough. At its worst, the market had a roughly seven-year oversupply of inventory.

Now, prices have fallen roughly 20% (actually fell about 25% and recovered about 5%, in aggregate). But the inventory overhang is nowhere near as bad as it was last time, ranging from a few months to a couple of years, depending on who you talk to.

So it's not at all certain that we're going to see a second leg down, or that if we do it's going to be a particularly strong correction.

ali r.
DG Neary Realty

financeguy -- When you say "But for anecdotes, just look around: there are builders active all over the city increasing the stock of market rate owner-occupied units, often by converting rentals.", I'm not sure what you are referring to or meaning to say: are you saying new building supports your thesis that prices are too high and bound to fall? also, what conversions to rentals are you referring to?

I understand the theory as you state it, but in practice one often hears references to buildings intended for sale actually being switched to rentals. Several new rental buildings went up in Williamsburg over the last two years, at least two of which were originally intended for sales. When people discuss "scenarious" for troubled projects out there, many often speculate that if sales go poorly then the developer will go rental.

"Moreover, much of the value of an apartment is consumable: apartments wear out and need to be renovated every 30 years or so. So you are consuming most of the purchase price, not just the monthly charge for services."

This is just silly talk

"Moreover, much of the value of an apartment is consumable: apartments wear out and need to be renovated every 30 years or so. So you are consuming most of the purchase price, not just the monthly charge for services."

Just about the dumbest thing i ever heard. It's an asset that will go up in value over time.

To answer the original question. Here is how I would price in the higher maintenance. Everything else being equal, let us say you maintenance is $1000 per month more. It translates into a ~$300K discount in the current interest rate environment. The details of calculation. What is amount of money you need to invest in safe investments to pay the additional cost. Or what safe investment will give you $12000 per year. 30y treasury is appx 4.25. This means you will need appx $300K in treasuries put away to pay for additional maintenance. This analysis assumed that your maintenance will not grow. If you maintenance grows at the same rate for both apartments, the discount should be higher.

Ali - Inventory and supply are different. We've had tremendous building and conversion and expansion of the gentrified neighborhoods in the last decade, far more than in the '80s. It was absorbed by the bubble demand, but it is going to be spit back up as new bubble buyers fade out, old ones sell and Irish carpenters give up their dreams of cost-free vacation homes and flipping for fun and profit. If the financial industry avoids rapid shrinkage, we may never have the huge inventory overhang that we had in the last collapse -- but that'll just mean that the adjustment will be long, slow and painful.

buyerbuyer -- Developers caught in a sudden downturn do what they must and some of them switched to rentals when finance dried up and the condo market looked like it might collapse quickly. RE markets are not efficient; we will see continuing blips up and countermovements even as the big story remains the same. Each round down of bubble deflation will drive the next, as buyers become more conservative and have less equity to play with, and as the building/renovations/conversions work their way though and back into the market.

How many of those bubble condos were sold to investors who could be doing better if they invested in something else? How long will it take the investors to decide to accept their losses and move on? My guess: a long time. Still, in the end, it is not hard to move apartments from rental to owner-occupied in NYC, so arbitrage is going to press the prices together. The only way prices don't drop significantly, is if rents rise faster than inflation and incomes.

julialg and juiceman: Is it actually your experience that a little patina improves the resale value of the furnace and the roof? Or is your touching faith that divine miracles will overcome the combined forces of entropy and market economics due to a special revelation you found in a holy book somewhere? In the fact-based world, physical assets ordinarily depreciate.

"finance guy- If what you say is so true, how about listing the legions of examples that must be out there to prove your point about converting rentals to ownership."

"also, what conversions to rentals are you referring to?"

buyerbuyer: Conversions from rental to condo - as financeguy is referring to - have been abundant in recent years. See Devonshire House, Apthorp, 905 West End Avenue, 845 WEA, 240 W 98th, 1200 5th Ave, to name just a few. There are many more in all different neighborhoods.

There are counterpoints to this. If current prices enable developers to make excess "build to sell" profits that are out of line with "build to hold" valuations, then explain the construction of high-end rental buildings -- see Corner, Aire, Aldyn -- and probably others in areas that I am less familiar with. The explanation could be that a) the developers of those buildings have acted irrationally; b) there were obstacles to building those as condos that I am not aware of; and/or c) current prices are not so obviously high related to long-term fundamental value as many say they are.

Regarding the inventory situation as Ali discusses, there is obviously shadow inventory that remains unabsorbed. Question for people close to the market, is there still a sizable pipeline of new construction/conversion on the way? If not, why not?

Is it just me or does financeguy bear a peculiar resemblance to our friend W67?

Bubba, is dat you in dat bow tie and spell checker?

spin, i think it's just you.

while i'm certain bubba could dress up nicely and articulate, i don't think he has the patience, and more to the point, the inclination.

there can be intellectual discourse in w67th's posts, but damned if he's going to make it easy to find.

Spin:

My posts are very standard market economics and finance as taught in every business school and most law schools. Anyone who has taken undergraduate first year economics and basic finance can do the analysis I do. Several other posters, including W67, seem to have taken these same courses or picked up the standard analysis along the way.

Standard analysis is likely to be shared by many people: that two people add 2 2 and get 4 is not evidence that they are cooperating, let alone the same. To identify posters who use multiple identities, you need to focus on idiosyncratic errors.

This one seemed particularly idiosyncratic: "We are at the tail end of the largest RE bubble in recorded history.." But then again, maybe you're just plagiarizing bubba's tag line.

Anyhooo, I'm wondering if we might find your fingerprints on the ligature that has in this mess, or if you're one of the more soulful masters of the universe. In any case, your high brow clairvoyance when it comes to these matters creeps me out a tad.

fg--very good point that there is a consumption component to home ownership--if i had to put an avg on it, i'd say, in ny, a fresh renovation is worth 25% of face value of a given property, such that same property in need of a complete update should trade at a 25% discount

and there is update, and there is total gut--total gut represents even more discount

and i think that, even without any wear and tear, a renovation is out of date in 15 years--tastes change fast

if one lives in an apt, especailly with a family, it's more like an 8 year time-to-trashed; unless you keep your kids seriously locked down; and get crazy attending to each and every piece of wear and tear

Speaking as if their is absolute certainty about the direction of the price of assets seems odd in any kind of market.

there....

frigidaire farmers make me giggle.

finance guys make me gag.

"We are at the tail end," etc., is plagiarized from the Economist and Shiller and Krugman and Dean Baker and Calculated Risk and Roubini and J Galbraith, among others. It's a standard trope. I suspect that W67 reads the Economist, if not the others.

As for clairvoyance, predicting that bubbles will deflate doesn't require much of a crystal ball. I cribbed the idea from Wikipedia on the Tulip Bubble, but I could have gotten it from, eg., Reinhart and Rogoff, This Time It's Different, or Steiglitz, Freefall, or Shiller, Excess Volatility, or Minsky, Stabilizing an Unstable Economy, or Mandelbrot, the Misbehavior of Markets, or reading the Economist.

In any event, the only prediction I make -- that prices will not remain permanently above the cost of production -- follows automatically from basic classical microeconomics as taught by Samuelson and his opponents alike. It's hard to have taken micro at any time in the last 100 years and not to have learned either that bubbles correct (classical, neoclassical, etc.) or that they can't exist in the first place (ECMH); only the unreconstructed Old Left Marxists (inevitable contradictions of capitalism lead to its collapse) have a model that argues that market forces have no power to correct imbalances.

To be sure, LICC/Julialg and the other proponents of "RE prices must go up" often sound like Lloyd George or mirror-image vulgar Marxists in their conclusions, but they seem to be operating on some combination of faith and slogans, not a model of how real estate markets work. A market based model predicting ever higher prices would have to explain why arbitrage is difficult, the profit motive suppressed, monopoly important, political power more important than the pricing mechanism, construction/conversion costs far higher than I imagine, or why the forces that created the bubble remain stronger than the fundamental and momentum forces now leading to its deflation, or some other reason why the usual expectation that prices tend to drop to marginal cost doesn't apply.

Buyerbuyer has suggested that I'm overestimating the arbitrage profits waiting investors; but that logically implies that buying to rent makes sense even if the investor plans to hold for the economic life of the asset, and I haven't seen anyone make that argument with numbers in any of the rent/buy threads.

Beyond that, I haven't seen many of these arguments here, despite the obvious influence of Lloyd George's idea that capitalism inevitably collapses as landlords expropriate all value, or the occasional (and strange) contention that legal claims to occupancy in the financial capital of the world would be a profitable investment in the event of a predicted economic and legal collapse into hyperinflation and lawlessness.

"To be sure, LICC/Julialg and the other proponents of "RE prices must go up"" Going up over the very long term. I'm personally bearish to flat at best.(for the next 5 years)

Buyerbuyer:
Short term, markets are hard to predict. "Shocks" and "animal spirits" can move them in any direction and it is hard to predict those except by (inaccurately) assuming trends will continue. Someone who has definitively decided to buy/sell and is only asking whether to do it now or in six months should ignore my models and study at UD's trend lines, discounted by the strong probability that trends will change unexpectedly.

Longer term, however, either competition brings prices close to costs, or markets fail, and market failure usually leads to legal changes. All I'm predicting is that the NYC RE market will NOT become more and more distant from fundamentals forever, making NYC owner-occupied housing both increasingly unaffordable and increasingly profitable to create without limit. That's almost as safe as predicting that the earth will not continue moving away from the sun forever. The prediction could be wrong, of course, but if it is, then so is the entire intellectual basis of our market system.

As has been mentioned occassionally on here, would FG concede that there is at least some element of luxury goods pricing going on in markets like NYC, or London, where wealthy people (sometimes foreigners) are willing to "overpay" or are indifferent to paying what seems too high in basic finance analysis. The "bubble" prices in real estate have coincided with a massive explosion in wealth in far flung places (China, Russia), and that has had an impact in London for sure, and maybe to a lesser extent in NYC.

Have you ever taken a look at London prices?

Spin: just to prove I'm not w67 -- I don't understand your joke.

But if I were deciding whether to buy or lease a car, I wouldn't be willing to pay double to be able to say that I "own" it (subject to a financing agreement), and if I had to, I'd make my decision assuming that the anomaly in the market would resolve before I resold. Secured lending and renting are largely interchangeable methods of financing; it's basic Modigliani and Miller that the method of financing should not affect the price (much, in the long run).

Same for the house: right now, the method of financing affects price. That's unstable. Either rents will go up or sales prices will go down. Rents are tied closely to cost of production (supply) and incomes (demand), neither of which shows any sign of rapid increase in the predictable future. Sales prices are looser, due to the potential for bubble speculation (momentum moving prices away from fundamentals). So it is far more likely that prices will adjust than that rents will. Therefore, as OP makes his buy decision, he'd be sensible to assume that prices are likely to be far lower when he sells.

Buyerbuyer: Looking at demand without considering changes in supply is one of the classic bubble-buyer errors. Of course NYC RE is a luxury good. But even luxury goods respond to market pressures: high profits induce increased supply which brings prices down to costs. Luxury goods have high costs, not exemptions from Adam Smith.

But NYC (and London) RE didn't go up because the rich suddenly became irrational and forgot how markets work. They went up because the rich and the much larger striving classes rationally concluded that in a bubble, it is wealth maximizing to buy as much as you possibly can, and that conclusion created enormous demand that outstripped suppliers ability to rapidly respond. That's what a bubble is: a self-fulfilling prophecy that can only work so long as it keeps growing. It ends when the pool of bubble buyers reaches its debt limit or supply begins to catch up so that the gap between supply and demand starts to shrink. Then, as prices stop rising, the bubble demand disappears too. Because enough people are rational enough that super-normal profits get competed away in the end.

A 2x4 is worth $5 measured and installed in a Texas house, but $10 in a NYC coop. Why is that? Does the wood know it's in Manhattan? Rub that ball my clairvoyant.

I got the point, FG.