I always shake my head when people assume that it is so much more expensive to buy than to rent. When I hear people argue this, I usually find that the assumptions they use are designed to make renting seem cheaper than buying. I think the market has changed (rents up, and sales price down) and people have not adjusted their analysis to reflect this. Take this example: ... [more]
I always shake my head when people assume that it is so much more expensive to buy than to rent. When I hear people argue this, I usually find that the assumptions they use are designed to make renting seem cheaper than buying. I think the market has changed (rents up, and sales price down) and people have not adjusted their analysis to reflect this.
Take this example:
http://streeteasy.com/nyc/sale/647699-coop-196-east-75th-street-upper-east-side-new-york
Assumptions
Potential after tax return (stock or bond market): 3%
Annual Real Estate Appreciation: 1%
Tax Rate: 37%
Buy at 5% off of asking price for $736,250, put down 33% ($243,000), and mortgage $493,250 at 4% for 30 years.
The reason why I use 33% down is that it allows the owner to be 3X levered on their investment (down payment) which makes the appreciation on the down payment to approximately equal the 3% they could get elsewhere in the stock or bond market. This is obviously a simplifying assumption, but I think that 1% appreciation is historically realistic, and 3% elsewhere is also realistic in this current interest rate environment. Many bears will say "I make 10% every year on my investments." Well if that is true then you should open up a huge hedge fund because you are a far better investor than many of the highest paid hedge fund managers in the world. I stand by those assumptions.
Monthly cash payment is $2,355 plus $1,739 maintenance (includes an assessment) for a total $4,094.
To buy in a co-op would add on about $5,000 to $7,000 is closing costs.
Compare that option to...
http://streeteasy.com/nyc/rental/801565-rental-177-east-75th-st-upper-east-side-new-york
$4,100 per month
Renting through a broker would add about $5,000-$7,000 in a brokers fee.
The two apartments are very comparable. The layouts are almost identical. They are right across the street from each other. The rental has an extra .5 bath, but the apt for sale is in much nicer condition with a better kitchen, bathroom, nicer finishes, on a higher floor, and has more closet space.
The cash monthlies are the same even assuming the $214 assessment stays in effect. We haven't even brought up the $700 a month amortization the owner is benefiting from, or the tax advantages. I do not consider amortization to be a cost since it is a function of the borrowers financing decision. The borrower could do an IO loan with no amortization that would be lower by at least $700 a month. Tax benefits can be tricky since they can be wiped out by the AMT. I would say the tax benefits of buying this apt would be $500 to $900 a month. If you are conservative and assume only a $500 monthly tax benefit (from mortgage interest deduction only) the actual cost to the owner is only $2,900 a month. If you got a 7/1 ARM instead of a 30 YR, the mortgage payment could drop, by $300 a month ($200 after tax).
Using aggressive financing, assuming the assessments go away, and assuming you can take full advantage of tax benefits, the owner is only paying $2,000 a month versus $4,100 to rent. So depending on if you use conservative or aggressive financing and tax benefit assumptions the cost to own is $2,000 to $2,900 a month versus $4,100 a month to rent.
When you sell you will have high transaction costs. I think 8-10% is conservative. That will wipe out about 75K. Hey brokers have got to eat too. This means that the buyer will benefit if they stay in the apartment for longer than 3-5 years.
I just don't see how it is cheaper to rent this place than to buy.
In order for renting to be cheaper you have to assume at least one of the following...
-I will be forced to move in the next 3-5 years
-Maintenance will increase at least 3X faster than rents
-The mortgage interest deduction will go away
-I am a superior stock/bond market investor
-The market has further to fall, which will make buying even cheaper compared to renting
-Rents will fall instead of rise
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Wow, you can't argue will really sounds logic like that. By assuming prices will go up the same rate as inflation, you are assuming a growing bubble. By not assuming any rent increases, you in fact assuming that rents will go up 5%. By assuming you can borrow at a rate quoted to you by a bank you are assuming you can borrow at 2% negative interest rates. By comparing which is cheaper, to rent an apartment, or to buy a similar one, you are assuming annual rates of return on your investment. By looking at buying in a co-op, you are buying into the condo bubble. By finding an apartment that does seem to be cheaper to buy than to rent, you are a retarded bubble buyer. Do I have that all correct?
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Response by Brooks2
almost 14 years ago
Posts: 2970
Member since: Aug 2011
yes
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Response by financeguy
almost 14 years ago
Posts: 711
Member since: May 2009
jh:
It was Midtowner who took your mistakes and ran with them, but you made the basic one: you used your assumption that you will be able to sell for a price disconnected from fundamentals as the rationale for paying a price disconnected from fundamentals. That's the perpetual motion bubble machine.
Once you assume that quality-adjusted prices can continue to go up faster than rents for the indefinite future, which implies that investors will accept ever lower rates of return and developers do not respond to potential profits, nothing else in the analysis matters.
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Response by financeguy
almost 14 years ago
Posts: 711
Member since: May 2009
By the way, here is an actual argument for believing that rental prices might not be too out of whack with condo prices. For the bears -- explain this:
1. Developers are building both condos and rentals. Indeed, in the last couple of years, a number of developers switched buildings from condo to rental. Why would they do that if, as the numbers suggest, condos are far more profitable?
2. Does it matter that usually developers reduce the quality when they switch plans to rental?
3. Given that coops are a very sensible way of reducing the credit constraints on middle class buyers (upper middle class in NYC), and are less amenable to bubble speculators, why didn't developers respond to the supposed credit-crunch and end of the bubble by switching to coops?
4. Condos sell at a higher price than coops (after adjusting for the underlying coop mortgage and any tax subsidies) largely because they are easily vehicles for bubble speculation. So they ought to go down faster than coops post-bubble. They haven't. Why is that?
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Sorry about the misunderstanding.
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Response by financeguy
almost 14 years ago
Posts: 711
Member since: May 2009
jhochle:
Without snark, this time.
The standard way to do a fundamental analysis is to ignore capital gains, for the simple reason that what you are buying (and later selling) is a single stream of future rent payments (or housing services/imputed rent, if you live there).
Those rents/housing services have a value, say X, if you live there until the house collapses. X is the same regardless of whether the house has one owner for its entire existence or thousands. You can't increase X by transferring the property -- some buyers (those who sell into a bubble) may make more than their proportional share of X, but that gain will be exactly balanced out by other buyers (who buy in the bubble).
So the first thing to do is to figure out what X would be.
Your calculation of X depends on what you think future rents are going to do.
But it is unaffected by future capital gains.
Once you have a guess about X, you can see whether you are paying more or less than X, by converting the future stream of rent/housing into a single number. You do that by guessing what a reasonable investor would pay right now in a lump sum for X (the future rents/imputed rent). That's why W67 calls owners "prepaid renters."
When the price is exactly equal to the present value of the future X, that's the breakeven point you claim to be looking for.
In your case, the current buyer is fairly clearly paying more than the present value of X using any reasonable discount rate.
That discount rate, by the way, should be based on the risk of this investment and the risk that you've mis-estimated X, not on your alternative investments, which are irrelevant. A reasonable investor is going to pay for X based on what X is worth, not based on what alternatives you have. Your 3% number for your downpayment is not so much wrong as irrelevant.
Since at current prices a buyer is almost certainly paying more than X, that means that to make money, that buyer needs to sell to someone who will pay even more than X. That's possible, of course. But to simply assume such a buyer will appear at the right moment -- as you did by assuming a capital gain -- is to assume both market failure and perpetual motion.
Once you correct these basic errors, we can discuss whether inonada, who knows, is right that you've overestimated current market rents and whether you've included enough paint jobs and repairs in your budget to keep your imputed rents in line with the market.
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Response by financeguy
almost 14 years ago
Posts: 711
Member since: May 2009
You will notice that you assume that the next buyer will pay more for X than the current one, even though you also assume that X will in fact be a smaller number (you assume no rent increase, and time will have passed).
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Response by vic64
almost 14 years ago
Posts: 351
Member since: Mar 2010
By the way, here is an actual argument for believing that rental prices might not be too out of whack with condo prices. For the bears -- explain this:
1. Developers are building both condos and rentals. Indeed, in the last couple of years, a number of developers switched buildings from condo to rental. Why would they do that if, as the numbers suggest, condos are far more profitable?
That is exactly why buying is more feasible for the small guys. For those developer who decided to go rental. The investment return for developer selling the unit out now is not as favorable than renting the unit out. This is like they bought their own unit as investment properties but without the transaction costs.
Fanancdguy kept pounding that people cannot make assumption that property value would go up. He igored the fact that when I told him that the equity buyers built up can be a cushion for price decrease. Going back to my own case when I bought my property in 2005 with high interest rate of 5.625%, I would have more money than I put down as down payment 6 years ago. It was based on the assumption that the selling price is 13% or $130K lower than my purchase price. It seems to be a loss on paper. However, if I am going to pay the same amount on rent on a comparable property as my mortgage anyway for shelter, I am having a gain. You can have a gain for a loss if market rent is high enough. The current low interest rate would certainly help
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Response by vic64
almost 14 years ago
Posts: 351
Member since: Mar 2010
For those who forgot my situation, I began with a $560K mortgage. 6 years later on a 15 years mortgage, I now only owe the bank less than $390K.
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Finance:
I think I understand more of this than you realize. I don't call myself a finance guy, but I am a CFA charter holder so I am not a total novice. The only reason I use a nominal estimated increase in prices is to come up with the holding time that would be necessary to overcome transaction costs. I don't view assuming prices will increase at estimated inflation as assuming capital gains, even if they are according to the tax code. If I buy a zero coupon bond, the final payment is really a return of capital and realization of interest payments. Even if the payment is treated as a capital gain for tax purposes, it isn't really the same thing as assuming real appreciation in the asset. Hey, agree to disagree on that point I guess. In many financial models you assume an exit price. You can derive that price many many different ways (price multiples, etc). I chose to derive it by assuming real estate would have no increase or decrease in value on a real basis (increase at inflation and then subtract depreciation). Using inflation simplifies everything since if eliminates the need to model wage and rent increases, just that real estate will maintain its real value over time. If you think that is a bubble assumption then agree to disagree. In the end it doesn't really even need to be included. If I were to assume that I would never sell, and I were to discount my down payment on a real inflation adjusted basis the analysis would not change.
I understand that coming up with a discount rate is a very tricky thing as every investment has different risks, and using opportunity costs is not the best method for coming up with a discount rate. A discount rate should be tailored to the uncertainty and or volatility of future cash flows. In the end I find that most people (even most financial professionals) just pull discount rates out of thin air so using opportunity cost is an improvement on that. I would point out that historically real estate has a much lower volatility (of returns/cash flows) than many other investment classes including equities and bonds. I think a reasonable argument can be made that real estate investments require a lower discount rate than stocks or bonds require (my 3% opportunity cost). I did not put that argument in my original analysis because I figured it would send people into a tizzy about recent market volatility, but if you look at real estate volatility over a reasonable time period, the cash flows are quite stable, and isn't that that basis for coming up with a discount rate? Of course if you start with the premise that we are in a bubble, than a much higher discount rate would need to be used to justify a purchase.
I understand that value as defined by most financial models is just some form of present value of future cash flows. I get that. I didn't start with the premise that we are or are not in a bubble. I started with the premise that as a resident of NYC you have to make a choice between renting and buying. Here are two options, which one is better given current financing and investing choices?
I disagree with your point that "In your case, the current buyer is fairly clearly paying more than the present value of X using any reasonable discount rate. " I just don't see that. I think rents (future cash flows) do justify purchasing in some cases. That is the whole point of my post. Yes, there are many market segments that do not justify purchasing, but just because the condo market has a +-2.5% rental yield does not mean it is stupid to buy a unit that implies a 5-7% rental yield (I say implies because I am aware that a buyer cannot easily rent out a co-op). Inonada seems to just say, well I can rent at a 2.5% yield so therefore your comps must be incorrect. Well I disagree. I think the market is more segmented than that. I get his point that he is getting some form of relative value, and a lot better value if you want to live in that type of building. Many people want to live in the buildings I highlighted, and for many reasons (schools, etc). Inonada has different tastes and preferences than I or other have. I fail to see the value in paying 10K a month for a 2br/2ba in the TWC, even if the owner is asking 4M. The view just isn't worth it to me at 10K a month or 4MM. Hey to each his own.
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Finance:
I did not explicitly assume rents increasing, but I concede that for real estate to maintain its real value (pre depreciation) rents would have to increase at the same rate as inflation. I think this is better than trying to have a crystal ball and assume wages increase at x, rents at y, and real estate at z.
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Finance:
Sorry for the very long, and rapid fire posts, but let me ask this. What is the proper value...X... of a unit that currently rents for $4,100, and $1700 maint fee? You can assume any rental increases or decreases you want, just disclose the assumption.
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Response by vic64
almost 14 years ago
Posts: 351
Member since: Mar 2010
The benefit of living in your own house/ or rent out the house is like collecting dividend from a stock. It is like buying a $100 stock with 6% dividend rate in a low interest rate margin account that allows you to have 4 times leverage. Is it a benefit to you 6 years later after collecting $36 dollars in dividend and spending $19 on interest rate, while you sold the stock for $87. This additional benefit for owning the house is that the "$36 dividend" you collected is totally tax free.
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Response by w67thstreet
almost 14 years ago
Posts: 9003
Member since: Dec 2008
Vic you fking moron. Take your $2 dividends while your $2000 stock drops to $20 per share. When I buy in, I'll be earning 10% yield.
You, you just missed your opportunity to sell pets.com at $100/share. And your fking $2 div loos great on 0% savings yield, looks like shit when free Chking accts give 4% yield.
Omfg. Just make sure to scent every corner of your 'abode' by peeing on it.
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Response by w67thstreet
almost 14 years ago
Posts: 9003
Member since: Dec 2008
Pre paid renters! Unite around the thong of Lawrence YUN. That dude is smart!
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Response by huntersburg
almost 14 years ago
Posts: 11329
Member since: Nov 2010
Can you live in a pets.com? Can you rent a pets.com instead of buying a pets.com?
"the standard way to do a fundamental analysis is to ignore capital gains". Yeah right. like it doesn't exist. capital gains (nominal as defined by the tax code) HAVE to be included in your decision making process to buy. of course.that is THE source of the net worth of middle class americans.
Buying a house to live in cannot be subject to discount to the present value of imputed cash flow, even using inflation as a discount rate: there is no cash flow, just an imputed rent, no depreciation.it is a liability.renting is also a necessary liability: u just choose between the 2.
the market has already bottomed as the graphs show.
Ignoring inflation in the models is a serious mistake:a 1mil loan at 5% inflation is a 50k tax free gain/year (interest payment are already included).It does not appear on any financial statement (not in any model), yet is a real benefit of real estate investing.I use it as a long term put on the currency.
And it is tax free.
"condos sell at a premium to coop because they are subject to bubble speculation". you sometimes have to just laugh.
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Response by inonada
almost 14 years ago
Posts: 7952
Member since: Oct 2008
"Many people want to live in the buildings I highlighted, and for many reasons (schools, etc). Inonada has different tastes and preferences than I or other have."
Dude, you posted a post-war 6th-floor unit with 3 windows facing 3rd Ave. I put up a pre-war 27th-floor unit with 7 windows facing Central Park, better neighborhood. Same size, same cost. You really think your coop posting is preferable? The sales market says mine is preferable by a factor of 2.5x.
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Response by w67thstreet
almost 14 years ago
Posts: 9003
Member since: Dec 2008
Let me.....
midtowner, bf you go defending the third reich... can we at least agree the holocaust happened.
Well WHY ARGUE WITH FKTARDS that cant' admit to the existence of the greatest NYC RE bubble in modern history...
@ inonada... it's the reason certain women stay in destructive relationships.... "he said I was pretty.... 10yrs ago"
SO SO sad
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Inonada
Without going too much into the problems with your comp re: short term lease and condition (they didnt show a pic of the apt for a reason)...
The two apts are zoned for ps 158 vs ps 191. Ranked #9 vs #93 on one list I looked at. I understand that a 1 BR renter is typically not in the k-12 market, but I hope you can understand that there is more involved than what floor you are on or the number of windows. As I said, people want different things.
I admit, I did not scour the rental market to find the best deal out there. I just know a friend that rented in that building at that price, and I thought...wow rents are much higher than I thought, why don't people buy. I think the psychology of the market is completely flipped from 2005-2007 when everyone told me it was foolish to rent, and you might as well buy at any price because it will never go down. I think people now think...you are a fool for ever buying anything because it is cheaper to rent and you are sure to lose your entire down payment. I think that type of mentality is necessary for things to bottom and for opportunities to present themselves.
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Response by jhochle
almost 14 years ago
Posts: 257
Member since: Mar 2009
Inonada:
Buying the place at 1.8 or whatever price comes with the option of improving it to the point where you would want to live there (yes I think that is over priced). Renting it for 4200 does not come with that option, and requires living in a potentially estate condition apartment with someone's furniture, and maybe having to move again in 1 YR. I don't see the value in that.
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Response by inonada
almost 14 years ago
Posts: 7952
Member since: Oct 2008
jhochle, the unit's prior listings going back to at least 2006 and "one year plus OK" demonstrate that this is not a short-term listing. Prior listings show pics of a pretty nice interior done with built-ins. Not exactly my sort of thing, but much better than the bland interior on the one you had up:
On schools, this is a 1BR. Let's get real. Besides, who'd want to subject a child to living on the 6th floor facing 3rd Ave? You know about the link between air pollution and childhood athsma?
I can understand that different people have different wants, but soon you'll be comparing 1BRs in Long Island in good school districts.
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Response by inonada
almost 14 years ago
Posts: 7952
Member since: Oct 2008
Jhochle, I'll grant you that rent v buy looks best for buying with 3rd-tier properties. I've said this before. However, you take your example to an extreme. Less than 10% of 1BRs on the UES are listed for more than $4K on SE. The rental market is well-known for having all the best listings being taken out in days while leaving the crap to sit. Nevertheless, you use $4100 as a reference point against a coop overlooking 3rd Ave. If that is where you think the market is for 3rd-tier 1BR apts on the 6th floor facing 3rd Ave and have a desire to live there for the next decade, then by all means buy. I happen to think you can do much better and shake my head at people who fool themselves with such justifications.
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Response by financeguy
almost 14 years ago
Posts: 711
Member since: May 2009
Jhochle:
Please show me how an investor could make an acceptable return at 5% gross without assuming capital gains that come from someone else being willing to make less than 5%. 4-5% gross was the standard for the entire bubble, when investors expected to make returns of 10% on capital gains and so didn't care about fundamental returns.
Alternatively, show me how to calculate a 7% gross return on the comps you posted. At 7%, I might be inclined to look a little more closely at what the actual net after interest is. Even though that seems very low, if the unit had unusually low projected expenses and was in a neighborhood with a good chance of above average rent increases, 7% might be within the discussion range.
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Response by w67thstreet
almost 14 years ago
Posts: 9003
Member since: Dec 2008
jhochle... just rent a studio for 1 yr in the PS 199 or whatever floats your boat... get your kid in. Siblings have priority even if you move from PS 199 zone.
AND, I DON'T MEAN FOR YOU TO MOVE INTO THE STUDIO.....think of it as a gift of the bubble ninnies. Take a portion of the $1MM you saved by not buying at peak and renting..... and use some of that "capital" gain for your kid's education..... I mean your kid's education and financial well being at your utmost concern, right?
YOUR GOAL in life isn't to scream to a crowd "I'M a PREPAID RENTER!!!!!"
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Response by maklo1421
almost 14 years ago
Posts: 126
Member since: Dec 2010
Jochle, while I largely agree with your approach, a couple of your assumptions are too aggressive and maybe that takes away from your conclusion (that buying makes sense in certain sub-markets). But the bigger picture is that if you dial those particular assumptions back, you can still arrive at the same conclusion.
$4,100 is quite high and you get there by using extreme comparables. Inonada rightly latches on to this and argues convincingly that it is just not the appropriate level. But $3,000 to $3,300 does not sound far off and does not directionally change the conclusion (that buying is cheaper than renting)
Your 3% cost of capital assumption is probably too low too. Again bumping it up a couple percentage points will not directionally change the conclusion, though it makes it look less like a slam dunk.
Lastly, FG's logic that you should ignore capital gains is flawed. You cannot ignore capital gains. I guess he does not realize that he is just making the assumption that capital gains are zero (which completely ignores investment time horizon), which is an assumption the same as assuming the property appreciates at inflation - which seems quite reasonable.
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Wow, you can't argue will really sounds logic like that. By assuming prices will go up the same rate as inflation, you are assuming a growing bubble. By not assuming any rent increases, you in fact assuming that rents will go up 5%. By assuming you can borrow at a rate quoted to you by a bank you are assuming you can borrow at 2% negative interest rates. By comparing which is cheaper, to rent an apartment, or to buy a similar one, you are assuming annual rates of return on your investment. By looking at buying in a co-op, you are buying into the condo bubble. By finding an apartment that does seem to be cheaper to buy than to rent, you are a retarded bubble buyer. Do I have that all correct?
yes
jh:
It was Midtowner who took your mistakes and ran with them, but you made the basic one: you used your assumption that you will be able to sell for a price disconnected from fundamentals as the rationale for paying a price disconnected from fundamentals. That's the perpetual motion bubble machine.
Once you assume that quality-adjusted prices can continue to go up faster than rents for the indefinite future, which implies that investors will accept ever lower rates of return and developers do not respond to potential profits, nothing else in the analysis matters.
By the way, here is an actual argument for believing that rental prices might not be too out of whack with condo prices. For the bears -- explain this:
1. Developers are building both condos and rentals. Indeed, in the last couple of years, a number of developers switched buildings from condo to rental. Why would they do that if, as the numbers suggest, condos are far more profitable?
2. Does it matter that usually developers reduce the quality when they switch plans to rental?
3. Given that coops are a very sensible way of reducing the credit constraints on middle class buyers (upper middle class in NYC), and are less amenable to bubble speculators, why didn't developers respond to the supposed credit-crunch and end of the bubble by switching to coops?
4. Condos sell at a higher price than coops (after adjusting for the underlying coop mortgage and any tax subsidies) largely because they are easily vehicles for bubble speculation. So they ought to go down faster than coops post-bubble. They haven't. Why is that?
Sorry about the misunderstanding.
jhochle:
Without snark, this time.
The standard way to do a fundamental analysis is to ignore capital gains, for the simple reason that what you are buying (and later selling) is a single stream of future rent payments (or housing services/imputed rent, if you live there).
Those rents/housing services have a value, say X, if you live there until the house collapses. X is the same regardless of whether the house has one owner for its entire existence or thousands. You can't increase X by transferring the property -- some buyers (those who sell into a bubble) may make more than their proportional share of X, but that gain will be exactly balanced out by other buyers (who buy in the bubble).
So the first thing to do is to figure out what X would be.
Your calculation of X depends on what you think future rents are going to do.
But it is unaffected by future capital gains.
Once you have a guess about X, you can see whether you are paying more or less than X, by converting the future stream of rent/housing into a single number. You do that by guessing what a reasonable investor would pay right now in a lump sum for X (the future rents/imputed rent). That's why W67 calls owners "prepaid renters."
When the price is exactly equal to the present value of the future X, that's the breakeven point you claim to be looking for.
In your case, the current buyer is fairly clearly paying more than the present value of X using any reasonable discount rate.
That discount rate, by the way, should be based on the risk of this investment and the risk that you've mis-estimated X, not on your alternative investments, which are irrelevant. A reasonable investor is going to pay for X based on what X is worth, not based on what alternatives you have. Your 3% number for your downpayment is not so much wrong as irrelevant.
Since at current prices a buyer is almost certainly paying more than X, that means that to make money, that buyer needs to sell to someone who will pay even more than X. That's possible, of course. But to simply assume such a buyer will appear at the right moment -- as you did by assuming a capital gain -- is to assume both market failure and perpetual motion.
Once you correct these basic errors, we can discuss whether inonada, who knows, is right that you've overestimated current market rents and whether you've included enough paint jobs and repairs in your budget to keep your imputed rents in line with the market.
You will notice that you assume that the next buyer will pay more for X than the current one, even though you also assume that X will in fact be a smaller number (you assume no rent increase, and time will have passed).
By the way, here is an actual argument for believing that rental prices might not be too out of whack with condo prices. For the bears -- explain this:
1. Developers are building both condos and rentals. Indeed, in the last couple of years, a number of developers switched buildings from condo to rental. Why would they do that if, as the numbers suggest, condos are far more profitable?
That is exactly why buying is more feasible for the small guys. For those developer who decided to go rental. The investment return for developer selling the unit out now is not as favorable than renting the unit out. This is like they bought their own unit as investment properties but without the transaction costs.
Fanancdguy kept pounding that people cannot make assumption that property value would go up. He igored the fact that when I told him that the equity buyers built up can be a cushion for price decrease. Going back to my own case when I bought my property in 2005 with high interest rate of 5.625%, I would have more money than I put down as down payment 6 years ago. It was based on the assumption that the selling price is 13% or $130K lower than my purchase price. It seems to be a loss on paper. However, if I am going to pay the same amount on rent on a comparable property as my mortgage anyway for shelter, I am having a gain. You can have a gain for a loss if market rent is high enough. The current low interest rate would certainly help
For those who forgot my situation, I began with a $560K mortgage. 6 years later on a 15 years mortgage, I now only owe the bank less than $390K.
Finance:
I think I understand more of this than you realize. I don't call myself a finance guy, but I am a CFA charter holder so I am not a total novice. The only reason I use a nominal estimated increase in prices is to come up with the holding time that would be necessary to overcome transaction costs. I don't view assuming prices will increase at estimated inflation as assuming capital gains, even if they are according to the tax code. If I buy a zero coupon bond, the final payment is really a return of capital and realization of interest payments. Even if the payment is treated as a capital gain for tax purposes, it isn't really the same thing as assuming real appreciation in the asset. Hey, agree to disagree on that point I guess. In many financial models you assume an exit price. You can derive that price many many different ways (price multiples, etc). I chose to derive it by assuming real estate would have no increase or decrease in value on a real basis (increase at inflation and then subtract depreciation). Using inflation simplifies everything since if eliminates the need to model wage and rent increases, just that real estate will maintain its real value over time. If you think that is a bubble assumption then agree to disagree. In the end it doesn't really even need to be included. If I were to assume that I would never sell, and I were to discount my down payment on a real inflation adjusted basis the analysis would not change.
I understand that coming up with a discount rate is a very tricky thing as every investment has different risks, and using opportunity costs is not the best method for coming up with a discount rate. A discount rate should be tailored to the uncertainty and or volatility of future cash flows. In the end I find that most people (even most financial professionals) just pull discount rates out of thin air so using opportunity cost is an improvement on that. I would point out that historically real estate has a much lower volatility (of returns/cash flows) than many other investment classes including equities and bonds. I think a reasonable argument can be made that real estate investments require a lower discount rate than stocks or bonds require (my 3% opportunity cost). I did not put that argument in my original analysis because I figured it would send people into a tizzy about recent market volatility, but if you look at real estate volatility over a reasonable time period, the cash flows are quite stable, and isn't that that basis for coming up with a discount rate? Of course if you start with the premise that we are in a bubble, than a much higher discount rate would need to be used to justify a purchase.
I understand that value as defined by most financial models is just some form of present value of future cash flows. I get that. I didn't start with the premise that we are or are not in a bubble. I started with the premise that as a resident of NYC you have to make a choice between renting and buying. Here are two options, which one is better given current financing and investing choices?
I disagree with your point that "In your case, the current buyer is fairly clearly paying more than the present value of X using any reasonable discount rate. " I just don't see that. I think rents (future cash flows) do justify purchasing in some cases. That is the whole point of my post. Yes, there are many market segments that do not justify purchasing, but just because the condo market has a +-2.5% rental yield does not mean it is stupid to buy a unit that implies a 5-7% rental yield (I say implies because I am aware that a buyer cannot easily rent out a co-op). Inonada seems to just say, well I can rent at a 2.5% yield so therefore your comps must be incorrect. Well I disagree. I think the market is more segmented than that. I get his point that he is getting some form of relative value, and a lot better value if you want to live in that type of building. Many people want to live in the buildings I highlighted, and for many reasons (schools, etc). Inonada has different tastes and preferences than I or other have. I fail to see the value in paying 10K a month for a 2br/2ba in the TWC, even if the owner is asking 4M. The view just isn't worth it to me at 10K a month or 4MM. Hey to each his own.
Finance:
I did not explicitly assume rents increasing, but I concede that for real estate to maintain its real value (pre depreciation) rents would have to increase at the same rate as inflation. I think this is better than trying to have a crystal ball and assume wages increase at x, rents at y, and real estate at z.
Finance:
Sorry for the very long, and rapid fire posts, but let me ask this. What is the proper value...X... of a unit that currently rents for $4,100, and $1700 maint fee? You can assume any rental increases or decreases you want, just disclose the assumption.
The benefit of living in your own house/ or rent out the house is like collecting dividend from a stock. It is like buying a $100 stock with 6% dividend rate in a low interest rate margin account that allows you to have 4 times leverage. Is it a benefit to you 6 years later after collecting $36 dollars in dividend and spending $19 on interest rate, while you sold the stock for $87. This additional benefit for owning the house is that the "$36 dividend" you collected is totally tax free.
Vic you fking moron. Take your $2 dividends while your $2000 stock drops to $20 per share. When I buy in, I'll be earning 10% yield.
You, you just missed your opportunity to sell pets.com at $100/share. And your fking $2 div loos great on 0% savings yield, looks like shit when free Chking accts give 4% yield.
Omfg. Just make sure to scent every corner of your 'abode' by peeing on it.
Pre paid renters! Unite around the thong of Lawrence YUN. That dude is smart!
Can you live in a pets.com? Can you rent a pets.com instead of buying a pets.com?
http://www.jparsons.net/housingbubble/united_states.png
http://www.jparsons.net/housingbubble/us_home_prices_vs_rents.png
"the standard way to do a fundamental analysis is to ignore capital gains". Yeah right. like it doesn't exist. capital gains (nominal as defined by the tax code) HAVE to be included in your decision making process to buy. of course.that is THE source of the net worth of middle class americans.
Buying a house to live in cannot be subject to discount to the present value of imputed cash flow, even using inflation as a discount rate: there is no cash flow, just an imputed rent, no depreciation.it is a liability.renting is also a necessary liability: u just choose between the 2.
the market has already bottomed as the graphs show.
Ignoring inflation in the models is a serious mistake:a 1mil loan at 5% inflation is a 50k tax free gain/year (interest payment are already included).It does not appear on any financial statement (not in any model), yet is a real benefit of real estate investing.I use it as a long term put on the currency.
And it is tax free.
"condos sell at a premium to coop because they are subject to bubble speculation". you sometimes have to just laugh.
"Many people want to live in the buildings I highlighted, and for many reasons (schools, etc). Inonada has different tastes and preferences than I or other have."
Dude, you posted a post-war 6th-floor unit with 3 windows facing 3rd Ave. I put up a pre-war 27th-floor unit with 7 windows facing Central Park, better neighborhood. Same size, same cost. You really think your coop posting is preferable? The sales market says mine is preferable by a factor of 2.5x.
Let me.....
midtowner, bf you go defending the third reich... can we at least agree the holocaust happened.
Well WHY ARGUE WITH FKTARDS that cant' admit to the existence of the greatest NYC RE bubble in modern history...
@ inonada... it's the reason certain women stay in destructive relationships.... "he said I was pretty.... 10yrs ago"
SO SO sad
Inonada
Without going too much into the problems with your comp re: short term lease and condition (they didnt show a pic of the apt for a reason)...
The two apts are zoned for ps 158 vs ps 191. Ranked #9 vs #93 on one list I looked at. I understand that a 1 BR renter is typically not in the k-12 market, but I hope you can understand that there is more involved than what floor you are on or the number of windows. As I said, people want different things.
I admit, I did not scour the rental market to find the best deal out there. I just know a friend that rented in that building at that price, and I thought...wow rents are much higher than I thought, why don't people buy. I think the psychology of the market is completely flipped from 2005-2007 when everyone told me it was foolish to rent, and you might as well buy at any price because it will never go down. I think people now think...you are a fool for ever buying anything because it is cheaper to rent and you are sure to lose your entire down payment. I think that type of mentality is necessary for things to bottom and for opportunities to present themselves.
Inonada:
Buying the place at 1.8 or whatever price comes with the option of improving it to the point where you would want to live there (yes I think that is over priced). Renting it for 4200 does not come with that option, and requires living in a potentially estate condition apartment with someone's furniture, and maybe having to move again in 1 YR. I don't see the value in that.
jhochle, the unit's prior listings going back to at least 2006 and "one year plus OK" demonstrate that this is not a short-term listing. Prior listings show pics of a pretty nice interior done with built-ins. Not exactly my sort of thing, but much better than the bland interior on the one you had up:
http://streeteasy.com/nyc/rental/697385-rental-25-central-park-west-lincoln-square-new-york
http://streeteasy.com/nyc/rental/501311-rental-25-central-park-west-lincoln-square-new-york
http://streeteasy.com/nyc/rental/7470-25-central-park-west-lincoln-square-new-york
On schools, this is a 1BR. Let's get real. Besides, who'd want to subject a child to living on the 6th floor facing 3rd Ave? You know about the link between air pollution and childhood athsma?
I can understand that different people have different wants, but soon you'll be comparing 1BRs in Long Island in good school districts.
Jhochle, I'll grant you that rent v buy looks best for buying with 3rd-tier properties. I've said this before. However, you take your example to an extreme. Less than 10% of 1BRs on the UES are listed for more than $4K on SE. The rental market is well-known for having all the best listings being taken out in days while leaving the crap to sit. Nevertheless, you use $4100 as a reference point against a coop overlooking 3rd Ave. If that is where you think the market is for 3rd-tier 1BR apts on the 6th floor facing 3rd Ave and have a desire to live there for the next decade, then by all means buy. I happen to think you can do much better and shake my head at people who fool themselves with such justifications.
Jhochle:
Please show me how an investor could make an acceptable return at 5% gross without assuming capital gains that come from someone else being willing to make less than 5%. 4-5% gross was the standard for the entire bubble, when investors expected to make returns of 10% on capital gains and so didn't care about fundamental returns.
Alternatively, show me how to calculate a 7% gross return on the comps you posted. At 7%, I might be inclined to look a little more closely at what the actual net after interest is. Even though that seems very low, if the unit had unusually low projected expenses and was in a neighborhood with a good chance of above average rent increases, 7% might be within the discussion range.
jhochle... just rent a studio for 1 yr in the PS 199 or whatever floats your boat... get your kid in. Siblings have priority even if you move from PS 199 zone.
AND, I DON'T MEAN FOR YOU TO MOVE INTO THE STUDIO.....think of it as a gift of the bubble ninnies. Take a portion of the $1MM you saved by not buying at peak and renting..... and use some of that "capital" gain for your kid's education..... I mean your kid's education and financial well being at your utmost concern, right?
YOUR GOAL in life isn't to scream to a crowd "I'M a PREPAID RENTER!!!!!"
Jochle, while I largely agree with your approach, a couple of your assumptions are too aggressive and maybe that takes away from your conclusion (that buying makes sense in certain sub-markets). But the bigger picture is that if you dial those particular assumptions back, you can still arrive at the same conclusion.
$4,100 is quite high and you get there by using extreme comparables. Inonada rightly latches on to this and argues convincingly that it is just not the appropriate level. But $3,000 to $3,300 does not sound far off and does not directionally change the conclusion (that buying is cheaper than renting)
Your 3% cost of capital assumption is probably too low too. Again bumping it up a couple percentage points will not directionally change the conclusion, though it makes it look less like a slam dunk.
Lastly, FG's logic that you should ignore capital gains is flawed. You cannot ignore capital gains. I guess he does not realize that he is just making the assumption that capital gains are zero (which completely ignores investment time horizon), which is an assumption the same as assuming the property appreciates at inflation - which seems quite reasonable.