NYTimes Buy vs Rent Calculator

When I want to buy an Audi r8 that's well priced for an 09 with $145k list price and $20k in mods. I stfu and buy it quietly.

The Times calculator is very good. Here's another one, from the Cleveland Fed, that uses Monte Carlo simulations to produce the range of potential outcomes with associated probabilities:

http://www.clevelandfed.org/research/data/rentvsbuy/index.cfm

Obviously an observer of NYC rather than a resident ... you seriously want to live at One Brooklyn Bridge Park?

Eric_14: CLEVELAND FED!!!!! Awesome. Thanks for the link,

"There is a 0.0% chance that you will gain financially from homeownership"

I have found ny times calculator to be the best. tax rate needs to be 28% due to amt.

What seems conservative may actually not be...
Try appreciation of 3%, 3% increase in rent, 10% return on investments

Having rent increase 1-2% more than price appreciation would skew towards buying.

"tax rate needs to be 28% due to amt."

What about state/city taxes?

The tax rate of 28% due to AMT could be underestimating the tax benefit.
In the case of without a mortgage, a big mortgage, one may not have enough itemized deduction to push the bracket down to 28%, and would be paying at a higher tax bracket. One would be paying tax with a higher base at a higher than 28% rate.

The Times calculator is conceptually confused. It asks you to guesstimate future appreciation. But that's the most important number in the whole calculation, and it isn't random.

Future appreciation depends on (1) current prices, (2) future rents, (3) future costs of building/renovating/converting, (4) the returns that investors demand for tying their capital up in a highly illiquid, difficult to diversify, and hard to manage investment. That gets you so-called "fundamental value" -- what a rational investor would pay if it planned to hold the asset for its entire life.

Then you need to add speculative value: (5) whether future investors will be willing to pay more than fundamental value because they expect to be able to sell to a further-in-the-future investor that will overpay even more (i.e., bubble profits), or be afraid to pay fundamental value because they fear that their buyer will not be willing to pay fundamental value (i.e., panic losses).

So a proper calculator would start with current rents, and costs, risk free returns and some guess about an appropriate risk premium. That will give you current fundamental value -- what a buy-and-hold-forever investor would be willing to pay now, given current expected returns. Current prices in nearly all cases, and certainly at OBBP, are far above fundamental value.

You could then guess how much you think costs and rents are going to go up. That'll give you future fundamental value. Current prices are far above future fundamental value unless you think that the retail RE market for some reason expects far higher inflation than the landlord RE market or any market measure of general inflation.

Then you need to think about (5) -- speculative value, bubbles and panics. Future prices are likely to differ from fundamental value, because the market price always also includes guesses about (5) and because many buyers are not investors.

But prices are unlikely to stray too far from fundamental value indefinitely, because when prices depart from fundamental value for any reason, they create extraordinary profit opportunities for investors. If, as is the case now, prices are above the cost of building or renovating, for example, investors will build and convert rentals for sale, thus increasing supply and tending to press prices down.

So if you are guessing future prices at some indeterminate date, your best bet is to use fundamental value. It's like guessing the position of the earth on a unspecified future day: your best bet is to guess "in the sun" -- even though you know that is wrong. Any other guess would be more wrong: at an unknown date in the future, the earth is equally likely to be on one side or the other of the sun. Most important, it is highly unlikely to continue forever in the the direction it is heading today.

CALCULATING expected future appreciation instead of just making it up it will show you that assuming 0% appreciation from now is extremely foolhardy, not conservative at all. You are, in effect, assuming that current prices reflect fundamental value, not the bubble.

Current prices mean that a long-term-buy-and-hold investor loses money and that builders/converters can make extraordinary returns creating new units to sell to owner-occupants. That means we are barely past the Winter Solstice of this cycle -- the tail end of a bubble. Prices are not going to continue to move further away from the sun forever.

Sooner or later, the price incentives will have effects: investors will create new supply of owner-occupied units will rise until prices drop. Then the speculative demand created by (5) will drop as well. Even if non-investor buyers would be delighted to pay a massive premium to own, they won't have to, because investors will be happy to sell to them at the investment price. The days get longer in the spring even in neighborhoods filled with night-owls.

The only way to get 0% appreciation is for the bubble to last until you sell, or extremely high rent and building cost inflation accompanied by a tremendous increase in NYC demand (jobs, salaries).

Its not that complicated. Over the long, rents and home prices go up at the same rate. You should have the same rate for both in such calculators. The average, since the 1890s per Case-Schiller, is about 5%. Nominal, per year.

In terms of what you could have invested in instead of paying the down payment, you should use the geometric average return (CAGR) for bonds & stocks from 1928-2011. The S&P total return has averaged 9.2%, short terms USTs 3.6%, and long-term USTs 5.1%. This is TOTAL return, look up the term if you don't know what it means. But anyway, depending on your age, your non-real estate return should be some average of these three, depending on how you would actually invest.

And for NONE of these should you factor in inflation. Or you should for ALL of these. But you can't do it for some and not others. Its easier to just not.

The Times calculator is a great tool to use to justifying your buy vs. rent decision AFTER you already made up your mind.

you might want to look at this calc. it's for investment property, so allows for rents in multifam, if someones buying in brooklyn many many houses have rental income. the ny calc is great but dosen't allow for that, not everyones getting a condo. it is not a rent vs. buy calc, but I found it more useful.

http://www.goodmortgage.com/Calculators/Investment_Property.html

Jason -- the problem with doing it your way is the same as the problem with the NYT calculator in the first place.

You, and the NYT, are assuming that current prices reflect fundamentals. They don't. We had a bubble and it hasn't corrected yet.

There is nothing is Case-Shiller that suggests that prices are going to go up at the same rate as rents from here on out.

C-S establish pretty clearly that on average both rents and prices reflect costs of production, as you'd expect. So they go up with building cost inflation, which is such a large component of CPI that they go up pretty much with CPI. (Incidentally, that CPI has averaged 5% in the past is not a good reason to expect 5% nominal increases going forward; the market expects CPI to go up much less than that, and the gold nuts expect hyperinflation.)

But now is not average for NYC prices. In the last decade, they went up far faster than rents (which have behaved pretty normally). So C-S's historical work suggests that in the next decade they are going to go up far slower than rents. Which is what the theory would suggest anyway.

"Incidentally, that CPI has averaged 5% in the past is not a good reason to expect 5% nominal increases going forward; the market expects CPI to go up much less than that, and the gold nuts expect hyperinflation."

So many misunderstandings. CPI has averaged 3.1% for the past century of so. I was referring to nominal GDP, which not coincidentally is the average home price appreciation in the US going back to 1890. Again, source = Case Shiller. So I wonder why you bother citing them with a bunch of mumbo jumbo when in fact they give a precise figure. Anyway - That means merely 2 % per year real appreciation - about half what I was calculating for what I could have invested the down payment in.

The Cleveland Fed calculator is much more conservative than the NYT calculator, and says I would likely loose money for any home ownership period less than 15 years. The NYT puts my break-even at 5 years. So clearly you are mistaken in saying they are just the same.

The biggest flaw in home price calculators is that they don't account for the (larger than usually assumed) volatility of home price returns. Look at the history of the Case-Shiller New York City Index. It fell by 11.5% from 1987 - 1991, then increased by 186.0% from 1992 through 2006, then fell 23.7% from 2007 - 2011. That is the difference between losing your entire down payment and swimming in pools of money like Scrooge McDuck all based on timing the market.

I know that this is a housing index and not a condo index, but the return have been much more volatile than a simple plug number in the calculator gives credit for and I would expect that individual sub markets would be even more volatile. The average annual return since the index inception in 1987 has been 3.05% with a 7.6% annual standard deviation. Setting a two standard deviation range and a seven year investment horizon, a quant would expect annual home price appreciation to be -2.7% to 8.8% over any given seven years. That is a huge range and the levered nature of home purchases makes this dominate the buy/rent decision.

financeguy,

Case Shiller is a resale housing price index. It says nothing about the fundamental determinants of housing prices or rents. Shiller often opines, but that is an entirely separate matter, and he would never say that they largely reflect the costs of production, since they largely reflect land values (location, location,...).

Your problem with the NYT calculator seems to be that it won't let you incorporate a short-term price adjustment. It's really easy to add one on your own and I'll leave it to your financeguy skills to do so. If you want some help, the Cleveland Fed calculator allows different expectations for short-term (1-3 year) prices movements and price changes after that.

I didn't say anything about the Cleveland calculator, which I haven't looked at.

I misunderstood what you wrote about C-S, because you have, I think, misunderstood their findings.

They say that prices rise with GDP because quality rises. As we get richer, we buy bigger and fancier houses.

Of course, your house isn't going to get bigger or better. It's going to get older and crummier unless you spend more money on it. So that 5% number is definitely the wrong one to use in any calculator.

On a quality-adjusted basis -- i.e., for the same house -- C-S's basic claim is that real prices are flat over long periods of time -- hundreds of years in their longest series. Nominal prices track CPI quite closely over time frames long enough to cover full bubble/panic cycles. Their long term US data show prices rising slightly faster than CPI, but they explain that they believe this is because they are not fully accounting for renovations and other quality improvements to existing houses, and because the end of the series is distorted by the bubble.

Incidentally, 2%/yr real appreciation with no improvements over a century is far too high to pass the sniff test. How could that possibly happen without landlords ending up owning the whole country?

Eric -- My recollection differs. IIRC, the articles quite definitely do explain the results by looking to standard economic models. Shiller's point was exactly that land value doesn't have as much impact as people expect, because land can be used more intensively and rival cities can develop.

@financeguy

I don't think I follow what you mean by:

"CALCULATING expected future appreciation instead of just making it up it will show you that assuming 0% appreciation from now is extremely foolhardy, not conservative at all."

I realize there will be fluctuations and it may even drop in the short-term, but say I purchase for $500k today, are you saying in 30 years that it is highly likely that the price will be below $500k? I haven't done any math on this, but just thinking about inflation, it seems like $500k will be peanuts 30 years from now.

30 years from now...
over the hill and far away...

Jason, where are you getting your info from? In particular the 5% nominal & 2% real home price appreciation.

Here's Shiller's data from his own site:

http://www.econ.yale.edu/~shiller/data/Fig2-1.xls

He has inflation since 1890 at 2.8%, nominal home price appreciation at 2.9%, and real home price appreciation at 0.1%.

Shiller's data is bout to be more accurate, proffesionals really on his theories

I stand corrected, I must have been thinking of a different souce, which as said above, did NOT correct for improvements to the properties.

Well anyway, that probably explains why the Cleveland Fed calculator makes home buying so much worse than the NYT one.

Who is the junior banker that plugged in 5% instead of 3% for terminal value?

You fing ninny. We overbid for pets.com by a factor of ten!

nyc-observer:

It is highly likely that the REAL value will be far lower than today even in 30 years: that's what it means to have been in a bubble.

Nominal prices are harder to predict. Historically, the most common bubble exit is a long period of flat nominal prices at low volume until costs increase to match. See, e.g., NYC, SF, LA after the much smaller 1983-87 bubble. But inflation has rarely been this low in the historical examples, so it is plausible that we won't follow the usual route.

So, yes, fluctuations are likely. But in real terms, the number around which the fluctuations are likely is about half current prices.

What finance guy is sayingz iz almost any asset will outperform nyc re as the other asset classes have not had a bubble that needs to be overcome. Like if I took $1mm and bought 20 manual ferarris and assorted Porsches that have taken their normal 80% depreciation and warehoused them in Nevada for 30 yrs. I'd be rich versus overpaying for a $1mm studio on west 42nd street. Flmaozzzz