Real Estate is a Bad Investment

And this is why verain was wrong:

Lesson One:
Stock price times number of shares = equity value.
Equity value plus debt = the value of the corporation.

Equity value in finance is what I said - value of shares + options.
Equity value in accounting is somewhat what verain said: it is operating assets minus debt.

Now do you see the stupidity of verain's "Wharton Business School" post? His equity value (price x # of shares) could not in any way be related to debt. That's why I said what he said was nonsense, and why it caused confusion.

However, since you caught half of what he was trying to say, I give you credit because I would not have thought of that. I caught the other half. My experience is as an auditor with Price Waterhouse and Bank of America. Yours is as a portfolio manager. That's why we came to different answers.

This is interesting - I read the whole thread and then all of he sudden apology by SteveJHX. Yes I am in the market to buy an apartment.

I found SteveJHX's backtrack a bit interesting and over-apologetic to EVillager, someone who has attacked him, in relation to trying to support SteveJHX's claim that Verain, the "Wharton Business School" guy is incorrect ... (by the way, I actually know that "Wharton Business School" not the proper name and "Wharton School" is correct). Why so apologetic - I looked at what Verain said, the definitions are right except that people use market value and equity value interchangeably. Shareholders equity is not interchangable with equity value but is interchangable with book value.

I also didn't see Verain say "Equity value in accounting is somewhat what verain said: it is operating assets minus debt."

EnterHome, despite my reputation, I always apologize if I misunderstand something or make a mistake. I was not over-apologetic to evillager. I told the truth. The wiki article is poorly written, but I give him credit for identifying an equity value definition that I would not have thought of when I read what he wrote.

I will say it again: when verain made his first post "equity value" I thought he was discussing shareholders equity, since I was discussing accounting. He gave two definitions: the first was for market capitalization, which is what I said it was. It is NOT equity value. The second definition he gave was for the accounting concept known as value of equity, which is what I saw when I reread it, but he only kind of got it right: value of equity is operating assets minus debt.

Here's what verain said:

a) Stock price times number of shares = equity value.

That's not true; that's market capitalization. Equity value includes the value of options.

b) Equity value plus debt = the value of the corporation.

The way he wrote that technically means book value / shareholders equity: equity + debt = equity + liabilities = assets = book value. Though some people exclude goodwill and other intangibles from book value: see below.

That's what I thought he meant when I made my first post. evillager - to his credit - made me look again and I realized that verain meant value of equity, which is operating assets - debt. "Equity value plus debt" is essentially book value - intangibles, as above.

What is not possible is to confuse two different meanings of equity value:

Stock price times number of shares = equity value
Equity value plus debt = the value of the corporation.

Equity value as a market term is COMPLETELY unrelated to DEBT of any sort, yet that is what verain said. No Wharton graduate would ever say that (if he passed). Those are two different concepts entirely, even if they share the same name.

I don't take back what I said, but I do give evillager credit for looking at it in a different way.

But I stand by what I said - since we've deviated: REAL ESTATE IS ALWAYS A BAD INVESTMENT. ;0

Actually, what verain said was 100% correct

"the value of the corporation" is what is commonly referred to as "enterprise value" = equity value plus net debt

so when you look at multiples, you look at either equity value over net income (same as price over earnings), since the net earnings are what equity holders have a claim on

or:

enterprise value over EBITDA (or EBIT, of unlevered FCF, or whatever metric you choose before interest expense is paid) because these are cash flows that both equity and debtholders have a claim on

you know steve, you are reminding me of my days when I was a corporate finance TA while getting my MBA at an Ivy Leage school (not Wharton)...you are just like the 40 year old EMBA students with no financial background that, no matter how hard they try, just never seem to "get it" and have no chance of getting a wall street job

this is pretty standard stuff, wall st 101 or 1st week of corp fin class

I repeat - you are 100% exposed as someone who is talking out their ass, and anyone who listens to you is a fool

You said "a) Stock price times number of shares = equity value.
That's not true; that's market capitalization. Equity value includes the value of options."

I think your ultra literal definition is too nuanced to be able to make a claim that Veran's statement was "untrue", especially since you acknowledge how you were way off base yourself. Options aren't a big component of public company's valuation and I don't think Veran was giving all footnoted lessons and every last minute detail. And you are relying a bit too much on Wikipedia to assist you in splitting the difference between those defintions. I think you should know that no one calls equity value based on accounting statement numbers, and you do yourself even talk about "technically" or technicalities to call him wrong which you stated emphatically. "Technically" and "book" pretty much sum themselves up and state their limited usability by anyone using valuations practically.

Also you just said that equity value plus debt is essentially book value minus intangibles. Debt is not intangible. Book value, which is just accounting or technical definitions is book assets minus debt. And no one said that equity value is related to debt. Veran didn't. He said that equity value plus debt is equal to the value of the company. Which would be analogous to the value of the home, or the price it sells for, is equal to the amount of mortgage debt on the home plus the amount of cash that the seller sticks into his pocket (equity).

Steve, come on. Do better. Seriously. People come here and maybe they are swayed one way or the other based on what they read, so you give your opinion and then back it up with all sorts of statistics and education and academics, and then to be so "book" oriented, ipmractical, and just wrong just isn't fair to the readers. Please.

Thanks

You said "a) Stock price times number of shares = equity value.
That's not true; that's market capitalization. Equity value includes the value of options."

I think your ultra literal definition is too nuanced to be able to make a claim that Veran's statement was "untrue", especially since you acknowledge how you were way off base yourself. Options aren't a big component of public company's valuation and I don't think Veran was giving all footnoted lessons and every last minute detail. And you are relying a bit too much on Wikipedia to assist you in splitting the difference between those defintions. I think you should know that no one calls equity value based on accounting statement numbers, and you do yourself even talk about "technically" or technicalities to call him wrong which you stated emphatically. "Technically" and "book" pretty much sum themselves up and state their limited usability by anyone using valuations practically.

Also you just said that equity value plus debt is essentially book value minus intangibles. Debt is not intangible. Book value, which is just accounting or technical definitions is book assets minus debt. And no one said that equity value is related to debt. Veran didn't. He said that equity value plus debt is equal to the value of the company. Which would be analogous to the value of the home, or the price it sells for, is equal to the amount of mortgage debt on the home plus the amount of cash that the seller sticks into his pocket (equity).

Steve, come on. Do better. Seriously. People come here and maybe they are swayed one way or the other based on what they read, so you give your opinion and then back it up with all sorts of statistics and education and academics, and then to be so "book" oriented, ipmractical, and just wrong just isn't fair to the readers. Please.

Thanks

enterhome - he's not even "technically" correct. market cap and equity value and interchangable, because options have to be counted, since they are claims on that future cash flow (and dilute the ownership interest of owners of oustanding shares)

also, your analogy of value of a corporation to the total price paid for a house is 100% correct

but why listen to me? just "more crap" from someone who has "risked his future" on real estate, right?

dudes, enough! I stand by what I said. He did not say "enterprise value," and if he had, it's more complex than that: market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

evillager, you can't even say, "market cap and equity value are interchangable, because options have to be counted," because the options aren't in the market.

So stop - you're talking out your ass.

Market capitalization is not the same as equity value, it is not interchangeable. Market capitalization is the total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The value of options varies, and it can, in fact, have a huge effect on diluted earnings per share, especially in the case of ESOP's: they can HUGELY dilute the per-share value of of a company. That's why there's an FASB about it, and that's what the poorly written wiki article was about.

I actually wrote an ESOP accounting system back in the day, when I worked at Arthur Young.

So stop - you're talking out your ass.

"I think you should know that no one calls equity value based on accounting statement numbers."

That's dumb. You need to know the net value of your operating assets to see what return you're actually getting on them. If your return on your operating assets is less than the cost of owning them, then you're in dire trouble. And you can only know your cost of owning them by knowing your debt.

"He said that equity value plus debt is equal to the value of the company." No, I said the value of shareholders equity plus liabilities equals assets. evillager then tried to add in "enterprise value," earnings before interest, taxes, depreciation and amortiation (EBITDA), and all sorts of other completely unrelated nonsense.

I did not say that debt is intangible. I said that some people for some purposes do not include intangibles in book value.

"also, your analogy of value of a corporation to the total price paid for a house is 100% correct."

Wow! The total value of a corporation is the same as the total price paid for a house? You've got to be kidding. The total value of a corporation is calculated using the discounted cash-flow method. I defy you to apply a discounted cash-flow method to the price of owning a home, since there is no cash flow.

UNLESS - you use imputed rents for market rate rentals. Which is, in fact, the true value of a home: the price you would pay to rent it.

EnterHome, I was not way off base. What's happening here is obfuscation. I repeat - you are 100% exposed as someone who is talking out their ass, and anyone who listens to you is a fool.

So, let us stick to the premise, boys. Rather than (futilely) trying to prove me an idiot - deucescracked tried that with probability and failed - stick to the point. When you're heavily invested in real estate and prices are about to plummet - and are plummeting - you resort to the time-honored Karl Rove technique of smearing the messenger.

Won't work. Go back to the original post: since you're so smart, REFUTE THAT rather than trying to divert what the thread is about to things you claim I don't know about but do.

Real estate prices are constrained by incomes and leverage. 40x/28%. There is no way around it. Those ratios give you a p/e ratio on real estate of 12. There is no way around it.

But it's not going to work.

Dudes, you're WAY out of your leagues.

Just one last note about "enterprise value" before going back to work, if in fact verain was talking about "enterprise value" (which he wasn't), he forgot a whole big part of it: cash and cash equivalents. You can't count the debt without counting the cash.

In a takeover, which is what enterprise value is for, you need to know how much cash there is to pay off the debts.

Sorry new to the topic, could you please walk me through 40x/28% and the implied real estate p/e of 12? I have seen that concept a number of times so wanted some rigor around the definition of the 40x and 28%.

In my case, I have roughly returned an avereage annual ROR of 13.4% after costs (in most cases I've gone FSBO when I've sold, reducing the biggest bite) on my real estate investments over the past 20 year period. In addition, please remember I've only had to put 20% down, and that other renters have paid my mortgae and maintenance/tax costs from the purchase point forward and bought these places for me in essence, plus put positive cash flow in my pocket each and every month in addition - which doesn't figure into the ROR calculation! Furthermore, on my primary residences (all of which I've lived in for two years or more to take advantage of the cap gains), the first $500,000 (recently) of sale price has been completely TAX FREE earnings which I've put back into my pocket and reinvested.

I think if you doing rent vs. buy calcs it's very hard to justify buying a place. It's an emotional thing (and that can be good and/or bad, depending). But do not tell me real estate is a bad investment. If you know what you're doing, I find it to be FAR more expedient than other equities, commodities, or art. It's the only investment I know where can put 20%, leverage the entire value, and have someone else pay the balance for you PLUS out money in your pocket monthly - and at the end of 15 years, you own the investment free and clear!

Sure, lorenzonyc. If you buy you're limited to monthly housing expenses is 28%. If you rent you're constrained to 40x monthly rent. The 12x ratio of home prices to annual rents exists because of the ratio of prices to income. If you make $100,000, you can you can rent a property that cost you $2,500 ($100,000 / 40). You can buy a property that will cost you $2,333.33 in total cost ($100,000 * 28%).

Let's just use rents vs. mortgages to make it easy. At 6% interest, you can afford a $400,000 mortgage, giving you payments of $2,389.20 You can afford annual rent of $30,000. $400,000 / $30,000 = 13.3. But when you add in other costs - taxes, maintenance - you really can't afford that $400,000 mortgage, lowering that 13.3x ratio to around 12x.

malraux, you are correct for INVESTMENT PROPERTIES. The economics are entirely different, and I'm not discussing that. The $500,000 tax exemption saves you at most $75,000 (15% * $500,000) but it also could make you subject to AMT, which you can't control, and whose rate is 26%.

Unfortunately - and this is my entire point - if you buy right now and try to rent the place out, for the most part it your carrying costs will be twice your investment income. That is the problem. Historically, when you first buy a place, you start by breaking even on a cash-flow basis.

(sigh)

ok steve, you win. not the argument, but you have tired me out and I'm done with rebutting you. but rest assured - your statements have made anyone who has any basic level of fimiliarity with financial statement analysis and corporate finance know that you have no idea what you are talking about.

and no, I am not "talking out my ass" - that is what you are doing, since you are spouting off about a subject which you know nothing about, trying to make yourself seem like a big shot. I am actually speaking from my experience, which includes an ivy league education, 3 years of investment banking experience, an MBA (from another ivy league school), and 3 years as a an analyst and portfolio manager at an investment firm. if you have some advice on fixing my laptop, I'm all ears - but you have no credibility on finance or investing.

evillager - I said and someone else did on different boards here, that coming to these boards is like coming into a room with a vicious pale blob banging on his pan with a stick, 24/7. PLEASE stop engaging the blob (STEVEJHX) and let's go back to coherent communication. Hopefully he's wane on his own. If not, that's one more proof that he's not normal.Let him type away. His 18 paragraphs of drivel can be ignored.

inquirer, you are totally right. unfortunately, I will probably stop posting altogether. which is too bad - I found some of these boards pretty helpful leading up to my condo purchase, and now can probably be helpful to some others. not in taking or giving an opinion of whether it's a good or bad time to buy (and who would really take advice from an anonymous message board about a multimillion dollar investment?), just in navigating the whole complex process of buying a place in new york city. as long as steve keeps taking over these boards, people will actually be less informed about the process. quite a shame.

Steve- I attended one of the top business schools in the country. I have been doing mergers for more than a dozen years. Public company transactions. I write fairness opinions wihch expose my firm to heavy liability if we are wrong, and include those opinions in merger documents with the Securities and Exchange Commission (which then become public). That includes going private transactions where every element of analysis is replicated and subject to review by government accountants, investment bankers on the other side of the tranaction, and shareholders including institutions and hedge fund managers. I also lecture at Columbia Business School once a semester for a friend who is a corporate finance professor there.

ok ... so now, Steve, I don't know who you are, you may be a good guy, but you don't understand any of these corporate finance concepts and are making this a less than interesting discussion - its like you first learned the terms today, and instead of being taught by an educator or in a training class, you use Wikipedia and parse if for every last details. I'm sure that Verain and Evillager understand completely that when they say debt, they are talking about net debt (debt minus cash), and they also know that in Wall Street parlance, Equity Value, Market Value, Market Value of Equity, etc. are all interchangable, as are Enterprise Value, Firm Value, Unlevered Market Value, or "value of the corporation." Similarly, Book Value and Shareholders' Equity are the same, but no one would ever confuse Shareholdes' Equity (an accounting term) with Equity Value (a market term). Yes, you can look at Book Value vs. Tangible Book Value. These used to be more relevant in the days of Pooling of Interests accounting which was gone back around 2001. I rode the elevator with Bernie Ebbers in 1998 up 51 stories when he told his investment banker (it was a weekend) that he would pay X for MCI if he could get Pooling account and Y for Purchase Accounting (more if Pooling). And Yes, if you want an academic definition you could say that Market Cap doesn't account for in the money options vs. Market Value (or whatever), but no one thinks about it that way, and I think the example first given above just wasn't going through the nuance of options math because that wasn't the simple lesson that was trying to be taught to give effect trying to set you straight in your assumptions about equity as a levered asset (look up capital asset pricing models) and real estate prices being an unlevered asset and a different market.

What's your problem? If you don't understand something, the mark of a smart man is to be quiet and listen and learn.

evillager, 6 whole years of experience, ha? Well, that's very impressive.

You've never seen a down market, that's your problem. You don't have enough experience in the real world. You try to obfuscate market realities by throwing in non sequiturs about terms whose value is debated.

I've seen 3 - yes three, not counting this one - severe corrections in the real estate market. In the late 80's in NY, in the early 90's in London, in recent years in Miami.

I remember Black Monday very clearly. I remember the evisceration of Bank of America when it was where Citigroup is today. I remember the dismantling of large parts of Price Waterhouse when the market collapsed in London and Madrid. I've seen it at my clients'.

You say bizarre things like "I think you should know that no one calls equity value based on accounting statement numbers." That's arrogant, and ignorant. You don't have enough experience in the world, haven't seen how these things operate in the real world.

There is no way to get around the 40x/28% income constraints on property prices, which leads to housing prices fluctuating around 12x annual rent. It is inexorable. You've yet to come up with anything to dispute that. You've yet to come up with anything that disproves that over long periods of time the S&P 500 ALWAYS outperforms housing as an "investment." No one anywhere debates that but you. You are even so bold as to spew that equity value is the same as market capitalization, and that stock options are immaterial to per-share price dilution.

It's nonsense.

I also have an Ivy League education, and I've also worked in some 25 countries. I've designed and written the very computer systems that you rely on to do your work. I've audited and consulted for most of the major investment and commercial banks around the world, and clearing and settlement systems. I'm involved on a daily basis in litigation on the very things you're talking about, as well as rights issues, takeovers, CDO's, you name it.

And I can probably fix your laptop. Get your thumb out of your mouth, study what is a down market. You're cocky, and you have a lot to learn.

Like 40x/28%.

First of all, MARat, I wasn't discussing the terms - others added them in. It's not what we're discussing on this board. They throw it in to obfuscate.

You say, "I'm sure that Verain and Evillager understand completely that when they say debt...." Yet when I say something, it comes from wiki. I do the wiki thing so people reading can have a reference, that's all. I don't always understand thing and when I don't I'm the first to admit it.

You rode the elevator with Bernie Ebbers in 1998 up 51 stories. Wow. Once I was sitting at the table eating lunch next to Paul Volcker. I'm on my way to the Fed.

Very helpful. Where do the numbers 40 and 28 come from? Why are those the right metrics to plug into your calculation? Is that just convention for each constraint and how strong is that convention (ie, why isn't it at the discretion of the mortgage co or leasing agent)?

lorenzony, the numbers come from the market. The usual rule for renting is that you must earn at least 40x the monthly rent, else they won't rent to you. The usual rule for mortgages is that no more than 28% of your total income can be allocated to housing expenses. As shown above, they're virtually the same number.

They can change, and if they do the structure of the market will change. But they've held pretty constant over time, because one default can wipe out the profit on many compliant transactions. If I have a $100,000 loan and default on it, and the bank loses, say, $10,000, it will never recover that amount, and it wipes out the profit on many other loans.

Ditto lending: if I default, it can take a year to kick me out during which the lessor makes no money, and he then has to pay to get me out. That is very expensive.

"What's your problem? If you don't understand something, the mark of a smart man is to be quiet and listen and learn."

MARat, an excellent point. What you don't understand is that steve was a PWC auditor, document translator, and IT guy and that background makes him an expert in absolutely everything.

And, MARat, your Bernie Ebbers story proves my point. It takes a lot more than accounting or finance to know the value of a business. Ebbers did a really great job with that takeover, didn't he? Like capitalizing expenses so they could be amortized when they weren't capitalized expenses.

I (and others) were very concerned when we had MCI Internet service in the late 90's and they kept on sending us bills for services we didn't have, or had canceled. It smelled of fraud.

Ditto Enron. I was deeply involved with litigation surrounding that company, and I knew something was out of control, because they were paying me 40% more than market rates to do their work. It came as no surprise.

And elsewhere I have told the story of why I left Price Waterhouse - Banesto wouldn't give me data to check loan amortizations. I wouldn't certify their systems, I was overruled, I left and formed my own company. One month later, the entire Board of Directors was thrown in jail.

When I was at Price Waterhouse I also told Reuters that their Globex system (not today's Globex system) wouldn't work. I had the project halted once, but I was overruled the second time. Read this from 1992:

A pivotal test of the GLOBEX 24-hour trading system was postponed almost immediately after it began in early March due to what some sources call "a minor glitch." The failed test is not expected to cause further delays to the project's launch, currently planned for July. The 250 trading station (dubbed "keystation") test, conducted March 3 in New York, London, Chicago and Paris, ended abruptly "due to a software bug which Reuters believes can be quickly corrected," says Gary Ginter, the managing director of the GLOBEX project.

http://findarticles.com/p/articles/mi_hb3104/is_/ai_n7763436

I know a hell of a lot more than you idiots give me credit for.

I don't know "everything," JuiceMan, but I do know that when instead of discussing the merits you attack me personally, I'm onto something.

That Globex was eventually abandoned.

First of all, MARat, I wasn't discussing the terms - others added them in. It's not what we're discussing on this board. They throw it in to obfuscate.

I think Verain was trying to give a simple lesson, it was you who pulled in the extra terms as if they were mutually exclusive and proved he was wrong and didnt know accounting.

I don't know if he went to Wharton, his lesson could have been taught at any basic course on valuation or markets. Which means you could take one too.

I tried to go through the whole discussion but there is way too much on definition of enterprise value etc.

Stevejhx, from your first post, how did you address the criticism that the 8% is a nominal value and the 0.7% is real? Also, that 8% is an equity value (so the p of p/e) and the 0.7% is the e. I would bet the primary driver of the growth you describe, especially for data series including any part of 1980-2000, has been the expansion of the p/e ratio. There have been a lot of good, durable reasons for that expansion, many of which would translate to housing prices growing relative to imputed rents (think about the increased access to mortgages, notwithstanding the last few months). So if I were doing a contrast of stock returns to housing returns, I think you really need to compare housing prices to stock prices. Now you might argue housing prices are in/coming out of a bubble, but I don't think that is too different from stock prices (so as the OFHEO indexes or Case-Schiller go down, so has the equity market, in fact more so, for lots of the same reasons).

I am not saying housing is a great investment, or that stocks are, on an absolute basis, and I think your posts on housing values are at least provocative even if I don't totally agree. I do however think the analysis of why the S&P beats housing is not complete in the first post of this thread. Also, I own stocks and am about to own a house. I will get much more hedonic value out of the house than the stocks, (that means happiness), so if the S&P and housing returned similar financial returns, I would go with the house.

Steve:

Phew, nice to see we are on the same page now. So let's make thing simpler and look at NOMINAL returns for both S&P500 (8.0% + inflation) vs. real estate (0.7% + inflation).

You said assume 80/20 mortgage vs. renting and investing the difference in the S&P500. The 5x leverage on real estate gives 3.5% + 5*inflation.

So which is higher, 3.5% + 5*inflation (real estate), or 8.0% + inflation (S&P 500)?

You could argue that S&P500 investors can lever up, but in reality most retail investors lack the discipline, risk tolerance, or sophistication to use options or margin debit such that they come out ahead.

I will concede one point to you Steve, which is that the S&P500 investor could spend the extra time working on a Web 2.0 startup or putting up a blog and getting some Google Ad revenue, while the real estate investor will need to become a landlord eventually to keep up the 5x leverage.

How about agree both real estate and stocks are important chunks of asset allocation in our net worth portfolios?

Lorenzo, the P/E ratio is also tied to interest rates - the higher the rate, the lower the P/E and vice versa. Rates are way lower now than in the early 1980s, hence the P/E multiple expansion, since your hurdle rate is lower. In fact, you can think of the inverse of P/E as earnings yield. If it's true for stocks, it should be true for real estate.

John Bogle has written/spoken extensively about this, and he argues that you should expect earnings growth (5%) plus dividend yield (2%) out of the market long term, assuming P/Es remain constant. So 7% return - and on a nominal basis, not real. Which is pretty close to the 7.7% (3.7% treasury yield plus 4% risk premium) I mentioned before.

I also continue to be skeptical about this 0.7% increase...what is the data for housing prices and rents in manhattan? How does that compare to the S&P?

I actually don't think I am cocky. I have never made any predictions on the market going up or down wildly. I have my opinions, but know that I have a margin for error in buying my apartment, which I will be very happy living in for the next 5-6 years. And yes, I think I will make a profit on it, but if I don't, who cares? That means the townhouse I want to buy eventually will just be cheaper then.

isn't Bernie Ebbers in prison?

Name dropping Bernie Ebbers in the heat of his M&A battles ... that was the largest deal of the time ... was to show that I've been there, done that, for a long time now. If someone wants to take advice on corporate finance from a guy who is an information technology auditor, then so be it.

Evillager, I think the point that began this corporate finance mess was that you can't look at appreciation in the real estate markets and compare that to returns on equity. One is levered, one isn't. (as you point out the risk premium over treasury). The point made was that you have to create leverage on top of the real estate purchase to get a proxy for what "investing in real estate" returns, and then compare that to investing in equities. One thing that Verain missed out on is that equity market returns are not only driven by the leverage built into the equity instrument themselves, but margin allowable in the markets is also present and a driver of superior market equity returns, ultimately driven by supply and demand.

Other factors making real estate INVESTING and equity investing incomparable is the relative illiquidity of real estate (especially homes) compared to the liquidity in the equity markets.

Also, the original point regarding the ratio of income to home ownership is interesting, but can only be applied on a macro level to draw the conclusions that were intended to be drawn. Manhattan will truly be different because as we know, there is a widening disparaty between high income earners and low income earners. We also know that since high income industries are disproportionate to Manhattan (or Manhattan is more attractive to high income earners because of the availability of all of the luxury ammenities here - Bloomberg cites Manhattan as a premium product) that the high income earners will live here and so if the equation that the original poster put forth is correct, Manhattan real estate would appreciate significantly faster than other real estate markets in line with the appreciation of wealth and income... perhaps in general markets you could do the proper math to show that the original point is correct, but I think we'll have to wait for another IT auditor to help us with the more complete and correct analysis.

weasel boy, when you go to the trouble of initially naming your thread "Real Estate is a Bad Investment," and then infer it's only a bad investment in certain cases when you state: "malraux, you are correct for INVESTMENT PROPERTIES. The economics are entirely different, and I'm not discussing that," it just sounds like so much backpedaling.

Now you're suggesting that real estate can be a GOOD investment right now, as I described in my post above, under certain conditions, and that my personal returns speak for themselves. So what you're REALLY saying, if I understand you, is that buying one piece of real estate as your primary residence right now is probably a bad investment, but not that ALL methodologies to Manhattan residential real estate investment are currently a bad investment.

Furthmore you state that "Unfortunately - AND THIS IS MY ENTIRE POINT - if you buy right now and try to rent the place out, for the most part it your carrying costs will be twice your investment income. That is the problem." Ummmmm, not true at all, again, IF you are experienced, and know how, when, and where to recognize opportunity (yes, wb, even in the current market there are good opportunities, and there will be moreso as people begin to get panicy in the short term near future).

As I've always said in my posts (including the infamous 'idiot thread' I started), it's SWEEPING GENERALIZATIONS that annoy me. Be more specific, wb!

who is weasel boy? I should get off this board as quickly as I got on it.

I can't believe I am wading into an argument like this.

I was very curious about Steve's arguments so I decided to replicate some of his work. I built an Excel spreadsheet using the assumptions that he included in his original post, and I got the same answer.

But then I stress tested it and the answers were surprising. The model was exquisitely sensitive to the rate of real property appreciation and rental growth (which I kept the same). If you assume 0.94% growth in both instead of 0.7%, renting and buying according to the original assumptions are equal. If that number is 2.00%, buying beats renting by a lot. I'm sure my model has some minor differences from Steve's, so he might get a slightly different result (I'm protecting myself in advance here). I also used housemath and Nytimes calculators to sanity-check this result and it generally held.

I think the example that he gave is pretty artificial but the point is valid: you can't just blithely assume that buying an apartment is a better use of cash than investing that cash elsewhere. This should be clear to all participants.

Similarly, I think his overall theme from his multiple postings is fair: you run substantial risk when you buy into an overvalued asset class. According to his analysis, Manhattan real estate is an overvalued asset class based on multiple metrics. I think he's probably right on this - 24x annual rent is pretty excessive. I will add that some high quality Brooklyn real estate I have looked at recently is going for about 15x.

What's my point? I think my point is twofold: 1) saying that renting is ALWAYS better than buying is predicated on some very specific assumptions that may or may not hold true; but 2) real estate is an asset like most others and as such participants need to be price sensitive.

What were your mortgage assumptions? Rates? Amortization?

The title of this thread and similar others makes me think of the Big Lie -- keep repeating things enough and people start believing you. Mr. jhx seems to be a man on a mission.

Before even reading his OP, just from reading all the crap steve's been posting, I could tell he didn't even factor in the tax benefits of holding a mortgage.

Have held my tongue long enough. You guys are pathetic - a novel has been written here. Meet up over coffee or a meal and hash it out there.

lorenzonyc, 8% S&P return is not nominal, it's real. The nominal rate on a rolling-average basis (eliminating the effect of choosing arbitrary start and stop dates) is 12%.

There have been "good reasons" for the increase in housing prices. In Manhattan the median property price is highly correlated to Wall Street bonuses: that's where the money went. Wall Street bonuses = income, and - as I've always said - property prices are tied to income, and leverage.

It remains a fact: if you are market-constrained at 40x/28% of income, BY DEFINITION housing prices are constrained by income, and it is those relative constraints that set the 12x "p/e"ratio.

Leverage is an issue, but only on the margin. The first person to use a lot of leverage gets a good deal. Every next person gets less and less, because property prices rise to offset the leverage.

In Manhattan we were in a long real decline in property prices until 1998. The population then started to rise, Wall Street bonuses rose, leverage rose through new mortgage products. My point is that though the population continues to rise, incomes are falling b/c of the Wall Street effect, leverage has been greatly reduced, and new construction more than offsets the growth in the population.

Robert Shiller proved that over 350 years, land constraints do not make property prices more expensive. Property prices increase along with incomes.

"If I were doing a contrast of stock returns to housing returns, I think you really need to compare housing prices to stock prices."

The problem with that is that housing prices are uncorrelated to stock prices. They are correlated to household income.

evillager, again: "the P/E ratio is also tied to interest rates - the higher the rate, the lower the P/E and vice versa."

That is true only because it affects your cost of capital. But there is no market constraint on corporate earnings - they can be whatever they are. For residential real estate that is not true; for residential real estate the constraint is an income-driven constraint. Therefore, if you have incomes fixed in the short-term and interest rates fixed in the short-term, the only thing that can change to get you to reach the 40x/28% constraint is the price of the property.

"Rates are way lower now than in the early 1980s, hence the P/E multiple expansion, since your hurdle rate is lower. In fact, you can think of the inverse of P/E as earnings yield. If it's true for stocks, it should be true for real estate."

That is true for investment real estate, not residential real estate. The value of residential real estate is its output value: market rents. The value of investment real estate is its discounted cash flow. And if you take the discounted cash flow of investment real estate right now, I believe you will find it negative in the long term, because market rents - what you could get for renting a property - are 50% below owners' carrying costs. If - as is happening - market rents decline, and incomes return to a normal level of growth, you'll never be able to make money.

MARat, I am weasel boy, and I wear the label proudly. Your last significant post is accurate. There is an income skew in Manhattan that affects the median price of property. I think the point I've been making is that incomes are falling, and we're not talking about the very high or very low ends: we're talking about well-off people who still have to work to make ends meet. For them - which includes me - the income ratio holds true.

Sometimes IT auditors limit themselves to looking at computer operations. Other times they help build sophisticated trading platforms, settlement systems (like Visa) and payment systems (like SWIFT). You just have to know whom you're talking to.

malraux, I never suggested that any particular property was under- or overpriced. I said the market was overpriced. You can make as much (or more) money in a falling stock market as a rising one, if you know how to do it. That's not what I'm talking about.

I'm not talking about investment properties; I'm talking about residential properties.

nlo, your post is accurate. Minor differences can have huge effects over time. Chaos theory, which please don't start to discuss b/c I know very little about it. K?

My original post was meant to get people to change the way they look at real estate. I'm glad you did.

Popomobile, mortgage rates don't matter but the type of mortgage does. The analysis works with a standard 80/20 30-year mortgage, because that's the depreciation schedule for real estate: 27 1/2 years less the land portion. Mortgage rates don't matter because prices rise and fall in value to compensate for interest rates.

ba294, you don't know what you're talking about. The 28% constraint does not include tax benefits: it is 28% out-of-pocket housing expenses of income. Moreover, the value of residential real estate is by definition its output value: not paying market rents. Market rents include the tax effect because landlords get that same deduction and more: they can defer capital gains tax indefinitely, which homeowners cannot.

cough cough .... hairball just came up.

"...I'm not talking about investment properties; I'm talking about residential properties...I never suggested that any particular property was under- or overpriced. I said the market was overpriced."

Interestingly, I'm talking about BOTH - residential investment property - and that's not necessarily overpriced. Listen, you're the one who named the thread "Real Estate is a Bad Investment." I'm saying this is not true in all cases, even now, but your post heading reads and suggest otherwise. Next time, try "Residential Real Estate Is A Bad Place To Invest In General Terms," and avoid the sweeping generalizations.

malraux, that was my original title, but i thought it was too long.

(sigh again)

ok, last post

corporate earnings are tied to GDP growth. corporations can grow earnings a little more than GDP, but not much. hence my 5% earnings assumption vs 3-4% GDP growth (again, nominal).

the inverse of P/E is earnings yield. for instance, if you have a P/E of 10, that is a 10% earnings yield. P/E of 20 = 5% yield. you can compare this to yields on other asset classes - e.g. corporate bonds (which also carry some risk), treasuries (which have no repayment risk, but do have duration risk if rates change), or anything else.

So basically your comparison is a risky asset (equities) vs a risk-free asset (treasuries). To compensate for that risk, investors demand a premium, typically about 4%. 10-year treasuries are currently at under 4%, so your expected return should be a little undert 8%. again, this is nominal.

so even if you believe your 0.7% growth rate for rents and property values (which I don't), you should be using more like 4% return for the S&P 500 as your alternative investment, since inflation is currently running at 3-4%.

final point - inflation, which is increasing, benefits real estate owners (if you have a fixed rate mortgage), since your mortgage amount and monthly payments are fixed. this is why I think it makes far more sense to just compare nominal to nominal - and I don't think the data for manhattan would show 0.7% annual increases in property values or rents for the last 20 years.

leelin, in actuality your "inflation effect" only works if the nominal rate of inflation is above the nominal interest rate. Otherwise, what you're really doing is not paying the principal back with devalued currency, but rather paying a lower real interest rate for the property, this because mortgage rates are pegged to long-term bond rates; long-term bond rates take expectations of future inflation into account. Therefore, the interest rate you pay is a real rate + expected rate of inflation, discounting the cash flows to current prices. If the market is efficient, what you think you're doing - paying back with deflated currency - is actually taken into account by the portion of the nominal interest rate that takes future inflation expectations into account.

While your analysis is true to some degree, I believe you have to look at it in a broader context.

Ooops, let's try that again:

"but rather paying a lower real interest rate for the property"

should say, "but rather paying a higher nominal interest rate for the property" (to take inflation into account).

I'm a crappy editor.

evaillager: corporate earnings are tied to GDP growth. corporations can grow earnings a little more than GDP, but not much.

True. And property prices are tied to incomes and can grow a little bit more than incomes, but not much.

What you're saying about the risk premium for the S&P 500 is true, but you're not accounting for the risk in real estate.

See my answer to leelin regarding inflation accounting. Assuming a perfect market, inflation is already accounted for in the mortgage rate (as it's tied to long-term bond yields), to arrive at a desired real rate.

Another point to note is that it's not just "inflation": there are many ways to account for inflation, and the behavior of each inflation component is important. Right now inflation is rising because market rents - which make up 41% of the CPI - have been rising (though that's stopped). Housing prices ARE NOT calculated into inflation; IMPUTED RENTS are the measurement of inflation in the CPI. Rents are rising because - overall - because housing has become unaffordable (for reasons already discussed). Perversely, however, housing PRICES are falling. So we are seeing massive deflation of an entire asset class that - oddly - causes inflation to rise.

This is because up until 2000, imputed rents were correlated to housing prices. Then with subprime and exotic mortgage products, that correlation was lost. Imputed rents were much lower than owners' carrying costs, which they never were in the past. Housing prices skyrocketed, owners' carrying costs skyrocketed, and market rents fell.

That is not normal behavior. Inflation has been understated over the last few years, and it is now being overstated. That's why the Fed isn't all too worried about inflation: as property prices become more affordable the demand for rental housing will fall, causing deflation.

Thus, you're not looking at inflation in imputed rents, you're looking at deflation in property prices, which does not in any way benefit property owners.

The problem with inflation is in how the numbers are calculated.

To be even clearer, what I said was, "But there is no market constraint on corporate earnings - they can be whatever they are."

What you said was - sigh! - "corporate earnings are tied to GDP growth."

GDP growth - sigh! - is not a market constraint on corporate earnings. Sigh. Corporate earnings are PART of GDP. Therefore, corporate earnings are a constraint of GDP growth, not the other way around.

Sigh.

The only market limit on corporate earnings is the size of the market, because no firm can hold more than 100% of it. But that's a short-term limit, because the closer you get to controlling 100% of a market, the greater pricing power you have. The constraint on that is demand elasticity of supply - you can only charge so much for a product before people stop buying it, unless you have a monopoly on a necessity, like water or electricity, when the government will not let you control prices, but will limit price increases to a percentage of input costs.

It's about the only time that input costs determine prices; output values determine prices. The former is what makes regulated monopolies highly inefficient; the latter is why the value of residential real estate is the cost of renting it.

While I do appreciate your Ivy League MBA, you missed the class on economics.

and i meant "Price Elasticity of Demand". Sorry. Tired.

Why is this so challenging? Blue-chip companies have earnings yields of ~6% right now with an earnings growth outlook that is stable and possibly improving. NYC residential real estate has an earnings yield of ~3% based on my math (could argue anywhere from 2-4%). Further, the outlook for earnings (rents) has to be negative b/c they are 1) already falling, 2) tied to Wall St. bonuses that are about to take a dive. Certainly anything can happen, but I just don't see any logical argument for buying NYC real estate at 2x the valuation with lower growth prospects.

The culprit is simple, we are coming off a long bull market in real estate. It took us 8 years to once again believe that real estate was an attractive asset (and that stocks could become overly risky) and it will probably take us another 8 years to unlearn that as valuations have completely reversed. I fully expect at some point in the next 3-5 years conventional wisdom will swing to the point that family & friends actively dissaude you from buying as "everyone knows renting makes more sense." At that point, real estate will probably have higher yields than equities and improving earnings growth prospects and it will be time to buy.

What's the argument that a NYC apartment (essentially an investment in the investment banking industry) is worth 2x the valuation of a company like Cisco (tied to global growth, etc)?

mbz, Warren Buffett said the same thing about residential real estate. It doesn't produce income, so why is it so expensive?

Unfortunately, you have all the hotshot finance types who seem to believe that they are, in fact, Masters of the Universe, that they know everything, that they can't make a mistake (let alone admit one), that everything always goes up. Especially the young ones like evillager who has all of six years' experience and has never seen a down market in his life, and so his only reference point for sensing a down market is to look at what his MBA textbooks said when he was a TA, which is of very little use in the real world.

This argument we've been having here has basically come down to an argument about CAPM valuations and value-investing valuations. Read from the top of the page - all the fancy ratios and this that and the other thing is basically CAPM, and it suffers from all the defects of CAPM and modern portfolio theory.

Value investing isn't quite so testosterone oriented as CAPM, and doesn't excite these finance guys because you not only have to look at numbers, but you have to feel it. You have to know the intrinsic value of things, and not rely on fancy statistics and models and myths.

The value of things is measured by the value of their output. The output of residential housing is what it would cost you to rent it. What it would cost you to rent it is tied to household income. Leverage * household income = price. Total housing expenses are market-constrained at 40x/28%. That gives an inexorable p/e ratio of 12x annual rent = home price.

All of these fancy CAPM people versus me, the lonely IT auditor and translator. But if I'm not mistaken, it was all of these fancy CAPM people who got us here in the first place, and 75% of actively managed mutual funds underperform their indices. I don't think they're so smart, and if you read evillager's most recent post, it pretty much proves it.

Here is a fun anecdote: I am looking at an apartment (to rent). It is in a nice, brand new building. The asking rent is ~$7000 (I'm sure I'll be able to get it down) and the broker was nice enough to inform me that it is also for sale for ~$2.4m. The monthly costs to buy are ~$14-15k vs $7k to rent. How an entire population ignores such simple math is beyond me. Such are bubbles, I suppose.

mbz, BRAVO! I have been making that argument for months. My rent is $4,500 per month, buying a nearly identical apartment across the street would be about $1.2 million, giving the same ratio.

You see, these CAPM people have made their models so incredible complex by including things like the potential tax effects and risk premiums and enterprise value and all sorts of very complicated things, when what is required is simplicity.

It seems amazing to me that so many obviously very intelligent people could be making such a complex argument about something that is so easy to understand. All you need to do is be able to add, subtract, multiple and divide. You need to be able to determine the value of something, and in the case of residential property, the value of it is what it costs you to rent it. Period, case closed. "Imputed rent." Imputed rent = market rent, so how in God's holy name can someone say that there is 100% inherent added value to owning?

The only way they can do it by coming up with complex valuations that give them the number they want, by correlating uncorrelated things, and by counting things, like the supposed "tax benefits" to having a mortgage that are already factored into the price of market rentals.

It's true that in the past property has been expensive in Manhattan. That's because the people who live here make a lot of money. Property prices have risen in line with their incomes, and in line with rents.

Until recently.

Now you really are cracking me up...I've met Warren Buffett, and work for a billionaire (that's with a b) disciple of his. I also took classes for other value investors who are worth anywhere from a few hundred million to $1 billion+.

Yes, I am young. 30 years old and made over $1m last year. I try to learn from those who are older, wiser and wealthier than me. I have a feeling you are just older, so I'll pass on your words of wisdom.

As for the rest - if you want to listen to Steve, please go ahead. Best of luck to you.

evillager, you are cracking me up. You met Warren Buffett? Did you ever ride in an elevator with Bernie Ebbers?

Oh - when you sat down and pow-wowed with Warren, did you ask him about his thoughts - or Charlie Munger's - on real estate?

On the real estate bubble:

Buffett: "What we see in our residential brokerage business [HomeServices of America, the nation's second-largest realtor] is a slowdown everyplace, most dramatically in the formerly hottest markets. [Buffett singled out Dade and Broward counties in Florida as an area that has experienced a rise in unsold inventory and a stagnation in price.] The day traders of the Internet moved into trading condos, and that kind a speculation can produce a market that can move in a big way. You can get real discontinuities. We've had a real bubble to some degree. I would be surprised if there aren't some significant downward adjustments, especially in the higher end of the housing market."

On mortgage financing:

Munger: "There is a lot of ridiculous credit being extended in the U.S. housing sector."

Buffett: "Dumb lending always has its consequences. It's like a disease that doesn't manifest itself for a few weeks, like an epidemic that doesn't show up until it's too late to stop it Any developer will build anything he can borrow against. If you look at the 10Ks that are getting filed [by banks] and compare them just against last year's 10Ks, and look at their balances of 'interest accrued but not paid,' you'll see some very interesting statistics [implying that many homeowners are no longer able to service their current debt]."

http://money.cnn.com/2006/05/05/news/newsmakers/buffett_050606/index.htm

That's what I mean by cocky. You are really arrogant and full of yourself. You met Warren Buffett and you work for a billionaire. What does that make you?

Very different from Warren Buffett who is very humble. You are Wall Street cocky.

I took classes too, and alas, and I have an Ivy League degree, but I didn't make $1 million last year. A mere $750,000. So you beat me. But I've been making lots of money year after year without ever incurring a significant loss.

That's the trick. Ask Bear Stearns. Or Merrill Lynch. Or Citigroup.

Sometimes I work for Goldman Sachs. That doesn't make me a trader, let alone a good one. Sometimes I work for Proskauer Rose. That doesn't make me a lawyer, let along a good one.

If you can give me one good reason why real estate is valued at twice its historic price / income ratio, and why it will stay there, then you might continue to make a million dollars a year for a long time to come. But you can't because there isn't one, so you will likely be caught in every asset bubble that ever occurs in the future.

You don't even know what you don't know.

You should "pass on my words of wisdom," but not the way you mean it. Pass them on to others.

You are the one who likened home prices to the value of a company.

Sigh.

"...Very different from Warren Buffett who is very humble. You are Wall Street cocky..."

weasel-boy, a word to the wise - regardless of the validity of your or evillager's arguments above, I would be EXTREMELY CAREFUL if I were you of accusing OTHERS of being cocky, arrogant, of full of themselves.

V-E-R-Y.....

C-A-R-E-F-U-L.....

evillage, are you suggesting a value investor would buy instead of rent in the current market? i find that very, very hard to believe.

mbz: I am a value investor of higher-end (in terms of price, location, and overall quality) one and two bedroom Manhattan properties. I would definitely buy the right investment property today and add it to my portfolios, rent it out, and produce positive cash flow. I would agree it's difficult at the moment. But opportunities are definitely out there. It's certainly not impossible.

malraux, every unit i have been able to do the buy/rent comparison on suggests the price would have to come downn 30-50% to generate positive cash flow (unless perhaps using some financial gimmick with an artificially low intro rate, etc). Is the market just that inefficient at times or are there certain niches where this is not the case?

thanks for your concern malraux. you're often right. and the way you write you probably are a value investor of higher-end properties - as long as you see it in positive cash-flow terms, that's good enough for me.

but that's for investment properties, not residential real estate.

i also never claimed that the time i sat next to paul volcker for lunch - he was at the next table over - that any of his wisdom rubbed off on me, like the bernie ebbers (please don't rub me, bernie!) in the elevator story or the i met warren buffett so therefore i know story.

mbz, if you read all the things that evillager has said and how he tries to switch topics, you will see that if what he is saying as his job and income is true, he's highly overpaid. he talks like someone who just got a fancy degree and likes to spew out words yet says:

to enterhome: "your analogy of value of a corporation to the total price paid for a house is 100% correct."

and to me that corporate earnings are constrained by GDP growth when in fact corporate earnings form part of GDP, and so limit GDP, which is not a constraint in the economic sense.

so of course, mbz: value investors are all out there now looking to pay twice as much to own an apartment as to rent it. Yup, that's what they're doing.

Actually I'm at work right now, thesupertrooperwerd. This is an entertaining break.

How am I wrong and always will be? Property prices are not constrained by incomes? Is that what you claim?

mbz:

I would suggest a couple of thoughts, for what they're worth.

First off, high end properties in very desirable locations that have excellent amenities are rarer than one might think. It's not a matter of just being another glass box new build condo. I mean truly great layouts, light, views, floors, appliances/fixtures, ceiling height, room size, central A/C, with terraces (wrap only), fireplaces, usually on the top floor, that are very quiet in buildings with all the bells and whistles that really mean something (not bowling alleys, etc., which in general add nothing).

Secondly, even in the midst of a financial downturn, these properties tend to rent out with little or no problem to stable, long term, high quality tenants who pay on time with a minimum amount of fuss.

Third, whether in a market downturn or ascendancy, these types of units rent for FAR more than what you think the market might/should bear - and MUCH more than you can imagine.

But, as I said, these types of units are rarer than one might imagine, and it demands a good deal of effort to track specific properties in specific areas on a regular basis, to schlep through hundreds (thousands over 20-25 years?) of open houses, to contiually review and have front loaded access to all the new developments being built so that you can not only get in early, but have pick of the litter as it applies to your investment methodology. Seriously, I probably have purchased between 2-3% of all the properties I've looked at in one form or another over the past 20-25 years.

malraux, this makes some sense. What you are saying is 1) you work exceptionally hard and therefore can perhaps find the occasional mis-priced property, and 2) you may have identified a niche that offers abnormal returns. I believe that is possible however it doesn't change my view that the market as a whole is overvalued.

I do wonder if the abnormal returns offered in this "niche" represent a market inefficency or compensation for above-average macroeconomic risk. In a true economic crisis (not the mild recessions accompanied by low interest rates that we have become accustomed to) I wonder if high-end properties would have the most to lose. However, that's not a question we could answer unless we had a severe crisis.

As an equity investor I have no choice but to agree that if you work hard enough something is always mispriced (although I have the luxury of hedging out the macro risk).

mbz:

While we all hope to find the occasional mis-priced property and capitalize on the inefficiency, in general, that is not my methodology, because Manhattan (specifically at the high end) is a pretty efficient market, in my past experience.

I would agree with you, however, that this niche offers abnormal returns (but one, of course, still has to be very prudent about due diligence), and that this niche indeed compensates for above-average macroeconomic risk.

As for your thoughts/comment regarding past economic crises, I can only say that I started doing this in 1985-6, and having been through the zeniths and nadirs of the Manhattan "high-end" rental residential real estate market before, I feel pretty comfortable with my situation and position. There's no guarantees, of course, but I'm sanguine about my risk level.

But this is not a situation relating to finding mispriced high-end properties. It just doesn't happen - in my experience.

malraux, sounds very interesting. Can you give me an example of a property that you have purchased in the past so I can get a better idea of what you are saying? I am trying to get stevejhx out of my head.

Well, here's a recent one that everybody on these boards is aware of because I have discussed it before. So I apologize in advance to those of you in advace who have heard me talk about it in the past.

Bought 15 CPW 2 bed/2-1/2 bath, closed 2-3 months ago, roughly $3.5MM/20% down/6.375% 30 year fixed/maintenance + taxes about $2,200 per month. Total monthly nut around $21,000. This unit is rented on a three year contract to an excellent for $26K/month, going up to $27K in year 2, and $28K in year 3. In addition, I should add that I could sell this unit right now (yes - in today's shitshow of a market) for $6.5MM - $7MM with little or no effort.

Bought penthouse wrap terraced condo w/fireplace in GV, 2 bed/2-1/2 bath, closed 8/07, for about $3MM/20% down/6.5% 30 year fixed/maintenance + taxes about $2,000 per month. Total monthly outlay about $17,500. Rented on a two year lease to a great tenant at $21K/month. The builder/sponsor called me about a month ago and offered me $1MM more than I paid for the unit if I'd sell (said no, of course).

stevejhx, that 0.7% growth in real income stat - that is wages or includes financial asset income?

I really don't have the time to read all steve's post but I agree with some of the post.
If you can rent for $7000/month vs $2.4M, it does not make any sense to buy in this volatile market. But on numbers are about right. I am no way near his property cash flow, but 2 of my properties which I closed within the year are netting me $$$.

where are these 1 mil apts that you can rent for 2000 per month or 2.4M apts you can rent for 7,000 per month. Who comes up we these numbers?

This is becoming an intelligent thread. Even peeps I normally disagree w/ are coming up with intelligent numbers.

I'm glad.

Steve:

If we focus on your original post and assumptions, you claim 8.0% real S&P500 returns beat 0.7% real returns on real estate.

I've successfully convinced you that you need to compare 8.0% + inflation for S&P500 vs. 3.5% + 5*inflation for real estate. Inflation has usually been higher than 2%, often much higher, so that puts real estate ahead under your own assumptions (even if we use the cashflow benefit you claim from renting).

You said "my inflation effect only works if the nominal interest rate is higher than the nominal rate of inflation." Not true. Even if inflation and interest rates stay constant and all markets efficient, if you get a mortgage such that you only downpay 20%, then for every percent the house appreciates (via inflation or otherwise), you get 5 times that percent return on your investment.

Actually, leelin, you didn't "convince" me that I need to compare nominal rates rather than real rates, but that's a different matter. What I said was the what you said was true in one regard, but not on the whole. On the whole, mortgage rates are tied to long-term bond yields, which factor in expected future inflation. Therefore, where the "inflation money" comes from is the mortgage interest.

Except in cases of extremely high inflation, or where nominal inflation is above nominal interest rates, the effect is negligible, because inflation is necessary for the economy to grow.

In countries with high inflation they "correct" nominal values for year-on-year comparisons. We don't do that here.

Moreover, your leverage rate for a 20% down payment is 4, not 5: 20/80 = 1/4.

spunky, the $2.4m apartment that can be rented for $7k is absolutely a real apartment - I have looked at it. It is in a new building. Maybe the $2.4m ask is way inflated, but then again, maybe the $7k ask is as well.

mbz, I showed the spunkster a similar unit at 99 Jane, asking rent $8,000, lowered to $7,000, raised again to $8,000 (under a "new" listing) and on the market for something like $2.4 million.

Rockrose rented a similar apartment at 100 Jane - albeit not as nice - for $5,000.

It's in another thread from March. And I did the same analysis for nearly identical apartments to rent and buy at Chelsea Vanguard and Chelsea Stratus, across the street from each other. The exact same ratio.

mbz-

1) saying "would a value investor buy in this market" is like saying would a value investor buy a stock in 1998-2000 (and that's assuming we are in such a dramatic bubble). I am not buying an index of manhattan real estate, I am buying an apartment to live in. I do know that one of my former professors, who is most certainly a value investor, bought an apt on park ave for about $30m last summer

2) In my neighborhood, the east village/LES, there are 2 new rental buildings: avalon bowery and the ludlow. both have 1 brs starting at $4k and 2 brs starting at $6500. The 1 brs are about 650 sq ft, 2 brs probably 1000. there is no disconnect between those prices and after tax all-in monthly costs of ownership of a comparable new condo building. I could probably rent my condo out and breakeven right now, although rent will increase while my mortgage payment is fixed. I'm not saying I don't believe you about your $7k / $2.4 mil apt, I'm just saying I don't think that is the norm across the city

3) my issue with steve is 2 things - 1, I think he's a blowhard who is generally talking out his ass (and making up info about himself, evident from self-contradictory posts about where he is currently investing), and 2, I think his math is flawed in his "model" (comparing real returns to nominal, using different time periods for stock market and real estate retruns, and having a ridiculous assumption for stock market returns going forward)

I mean, do you really want to take advice from some 50 year old who posts here all day long and lives in a 1-br in chelsea? There are a few people on this board who seem to have great experience with real estate and are worth listening to, but steve isn't one of them.

evillager:

1) value investors look at lots of things, but the the stock market bubble you referred to would have never bought a stock in a company with an infinite p/e because there was never any e.

If you have $30 million to spend, then this analysis does not apply to you. Already stated.

2) As usual, you count the tax benefit without calculating the opportunity cost. Your tax benefit amortizes; your opportunity cost accretes.

The "model" is not "mine": it is the definition of "imputed rent" extrapolated over time using real historic data. The 40x/28% constraints are widely accepted market constraints.

Nothing is "ridiculous" about the stock market returns: they're based on a 50 year rolling average of returns on the S&P. Documented.

I NEVER compared nominal and real interest rates.

I have repeatedly prove that the 24x ratio is constant across the city. I don't care if you "believe it": it's not to be believed or disbelieved. It simply is true.

Regarding your insults, first I'm not 50, second I live in a 2-bedroom apartment, 3rd I have a vacation home that I own, 4th I have a Lexus SC430, so I'm not hurting. And I've also made a ton of money in real estate over the years, both here and in South Beach.

None of my posts has been self-contradictory; I've always said I've invested in the same thing: Brazil.

But those aren't reasons to listen to what I say. Do the math and the research yourself. Calling somebody a blowhard when you make all the amazing statements that you do seems rather odd.

Then of course....

steve - Brazil sounds interesting, maybe we should talk offline? i would love to pick your brains on investment in Brazil.

Off topic, but the best way to make money is using direxion funds and profunds. Pick a bull or bear direction, and let the magic of index options do the work.

best and biggest alternative energy producer in the world (sugarcane ethanol) and soon to be the country with the third largest proven oil reserves in the world. The North Sea did miracles for Mrs. Thatcher. A population large enough to support its own industry, potential trading partners with a (maybe someday) revived Argentina. And a pro-business left-wing government. What could be better?

evillager, i understand buying because you want to live in your apartment. However, we are debating the merits of real estate as an investment. A Ferrari is also a poor investment but may well be a good purchase. As an investment, I think the case is clear. You are buying an asset (on leverage) with a very low earnings yield which is hyper-correlated to the health of Wall St. during the 3rd inning (?) of a credit crunch & deleveraging cycle. I'm pretty sure Ben Graham would roll over in his grave at the thought that value investors are claiming NYC real estate is a good investment.

"A population large enough to support its own industry, potential trading partners with a (maybe someday) revived Argentina. What could be better?"

hmmm... a revived Argentina?
One thing interesting about Argentina... there're practically no mortgages as of yet. All cash. You go into a bank room, sign papers, and exchange cash for keys.

mbz:

Based on your most recent comment to evillager, did you read my reply to your query above?

johnknyc, Hope Springs Eternal!

evillager can buy if he wants and can afford it - just know the downside risk if he's forced to sell in the short- to medium-term. Eventually, the market will recover, but right now for the most part owners want twice as much to sell an apartment as to rent the same one, so how long can that last?

mbz, here's to Columbia, my alma mater!

Mbz, we are debating whether it makes financial sense to rent vs. buy. As I point out above, there are very few rental options that are appealing to me (I cited Avalon Bowery and the Ludlow, but don't even want to live in those places) and for the ones that are, the cost of ownership is not much different than the cost of renting. So I glad to buy, be happy in the place I live, and have my monthly costs be largely fixed going forward.

Ben Graham owned a place in Manhattan, La Jolla, and in the south of France. He also wrote plays and could have been a professor in classics as easily as finance. So I think he would have understood the "intangible" value of buying a place that is your own. I do, however, think he would roll over in his grave if he hard value investors say they can expect a 12% nominal return from the market going forward, and using that as their hurdle rate vs. other investments.

I don't think most people are coming to streeteasy for help with their decision to buy an apartment to immediately rent out, they are debating buying a home. But if that is your objective, it seems to me that malraux is trying to do the real estate equivalent of what Warren Buffet did with Coke and Geico - buy a great asset at a good price, as opposed to the "cigar butt" investing he did earlier in his life (buying an asset of low or declining value at a rock bottom price). Both ways can make you money, but he found buying great companies to ultimately be more satisfying and profitable. I don't know if those opportunities exist right now, but he seems to think they do. And the real point is that he doesn't have to be right about every apartment - just the ones he buys. That's what Buffett would call staying in your "circle of competence".

Steve said: "Moreover, your leverage rate for a 20% down payment is 4, not 5: 20/80 = 1/4."

Where I'm from they call that 5x leverage, because for every 1% that the underlying rises, you gain 5%.

Downpay $20K for a $100K house. It goes up 1% to $101K. You now sell the house and pay off your loan to get $21K back. Did you just gain 4% or 5% on your investment of 20K?

I think once you fully understand that example, you can finally see that my point doesn't depend on changing inflation or inefficient mortgage rates.

All you need was ~1.2% inflation to beat investing in the S&P500 under YOUR OWN numbers, because you compare 8% + inflation with the S&P500 vs. 3.5% + 5x inflation in real estate. Don't pretend that you need 10% inflation for real estate to win, and you won't be able to argue that mortgage interest rates are necessarily sky high under 1.2% inflation.

evillager said "Mbz, we are debating whether it makes financial sense to rent vs. buy"

NOPE. Sorry. This lavel of this thread is "Real Estate is a Bad Investment".

Rent implies living in the unit/home. What does that have to do with an Investment? That is not what we are debating about. You don't live in and S&P index or a commodity ETF or some Private Equity Partnership.

What we ARE debating is whether or not Real Estate is a Good Investment (Asset Class) or not, compared to other Asset Classes. Not compared to rent. That one has been infinitely beaten to death... soooo last year.

Let's at least get that straight young grasshopper.

MMAfia, actually steve said "I'm not talking about investment properties; I'm talking about residential properties"

And he started the thread by saying "No matter how you slice it, renting is ALWAYS financially more beneficial over time than owning" and then ran through his (flawed) numbers of an indiviual renting vs buying a place.

Um, how is this not debating whether it makes financial sense to rent vs. buy?

MARat, Verain and Evillager I noticed that you slowed/stopped posting? Please don’t be dissuaded from steve's comments. Your viewpoints are well taken and appreciated.

Just don’t get pulled into an argument (I’m sad to say I did once but will not again).

So here is a question in the spirit of this thread. Granted they are not exact comparables, what is a good approximation for stock returns and property returns in Manhattan?

As someone earlier pointed out, the most sensitive assumption in any comparable model will be the appreciation rate – by far. The best data I can find is from millersamuel.com but it only goes back to ’89.

From that data for all of Manhattan, median price in 89 is $240K, in 2001 $430K so about 5% annually. I picked 2001 as it seems people agree that is before the run up.

I’m not in favor of doing this type of analysis because it is too sensitive to appreciation assumptions, but if you assume a 5% appreciation on real estate, and 10% on the market, you’ll break even in about 5 years (assuming 30% tax bracket and married) and be way better off when you stop paying your mortgage after you retire. Dont forget that if you assume you pay rent of 3K/mo now, in 30 years at 4% inflation that will be about $9K/mo which means you need about $1.5 MM when you retire, earning 6%, to pay your rent until you die 15yrs later. Owners do not have to worry about that.

With those assumptions, you should buy as soon as you can!

Not that I’m advocating that, just that the results can be skewed either way based on the assumed appreciation rates, so we should be focused on them in this discussion

mschlee said: "if you assume a 5% appreciation on real estate, and 10% on the market, you’ll break even in about 5 years"

If you get an 80% mortgage and downpay 20%, then with a 5% appreciation on real estate, you are earning 25% on your downpayment.

The trick then is tapping the equity without paying 6% to a real estate broker, while keeping close to 5x leverage. You'd probably need to become a landlord. Sadly 5% a year for real estate might be gone for a while...

mschlee, I'm not dissuaded, just busy with work and a bit bored with the online "argument"

but yes, I think you hit the nail on the head...your assumptions for future appreciation on real estate and returns from your alternative investment (in this case the s&p) will drive whether buying an apartment is a good investment vs. the alternatives for your cash

and as verain and leein pointed out, the other aspect that was missing was the effect of leverage. even if you don't use margin, an investment in equities is partially leveraged, since most companies have debt. you can "juice" your returns with margin, but you can also be called on that margin, so it's dangerous. with homes, you can lever at 4 to 1, and you get to buy and sell when you want to - no margin call.

the final piece missing is the tax advantage. steve may disagree, but yes, you need to take into account the tax deduction on interest payments when comparing to renting costs.

now, note that I'm not advocating going out and buying an apartment. it all depends on the situation - seems like mbz found a place much cheaper to rent than buy. but for me, the numbers for ownership work, and I'm very happy with my place. I'm certainly no real estate expert, but I do know about finance and investing, and I know my neighborhood (east village and LES) very, very well.

you nailed it evillager.
I was also able find 2 properties with positive cash flow.
It's hard to find a place much cheaper to rent than buy, but mbz did and more power to ya!

stevejhx: where in brazil are you investing?

myself, i went buenos aires. moved back to NYC - renting one to locals, the other to tourists.
hoping everything holds together and tourism maintains in south america. otherwise, it's an exit strategy

thoughts on hydrogen anyone?

leelin, please. If you have $20 and I lend you $80, I am lending you 4x your money. That is $4 for every $1 of yours, not $5. Your argument is wrong because you're attributing your gain entirely to the $80 you borrowed, not the $20 you put down yourself.

If you have $20 and I lend you $80, and you make 10%, you will wind up with $110. But only $8 of those dollars are attributed to leverage, the other $2 are attributable to your own money. Therefore, you argument is fatally flawed.

As is your inflation argument, not only because inflation is factored into mortgage rates, but because a low level of inflation is a necessary part of economic growth. If inflation falls too low - as if it rises too high - the economy is in trouble. To follow your silly argument to its silly conclusion, every bank would wind up losing money on every mortgage it ever made if there were even moderate inflation. As I repeated, the only time inflation matters is when nominal inflation rates exceed nominal interest rates, because it then eats into the real interest rate, which has factored long-term inflation in.

Argument over.

MMafia is correct, we're discussing the economics of residential real estate. Evillager, read what I wrote: the economics of this argument do not work for investment real estate. My point is that you should not look at residential real estate as if it were an investment, because it's not a good one over time.

Investment real estate - what malraux is talking about - is entirely different. It may seem the same to some but it's not, because there is value-added in what the landlord does, and he gets paid to do it, which you don't if you rent to live in. You don't get paid, there is no cash flow. And as malraux stated, he breaks even on a cash-flow basis from the get go. If you can find a property like that - one that costs you on a cash-flow basis the same to buy as to rent - then it is properly priced, because, AS I HAVE REPEATED SO OFTEN to you financial types, it is decided economic theory that in a free market, goods and services are valued at their OUTPUT VALUE, not their input value. The OUTPUT VALUE of owning a property is what it would cost you to rent it, because that's the sole benefit you get from it: the right not to pay rent.

With malraux's investment properties, he does in fact take advantage of someone else paying his mortgage and taxes and expenses. Therefore, that's a profit for him. For the owner-occupier, that is an expense, not income, and the only thing that renting does is give him the right not to pay that expense.

If I grow an orange and eat it, the value of that orange is exactly what it would cost me to buy it in a store. If I grow an orange and sell it to someone, I profit the difference between the marginal cost of growing the orange and the price I get for it. If I grow an orange and sell it to a wholesaler, who sells it to a retailer, and I go to the store and buy that orange back...

I'm a fool.

Yet that is essentially the argument you are making. Malraux is in the retail orange business - he buys the orange and sells it at a profit. He makes money. If I take that same orange that I sold to malraux and eat it, I don't make any money. The only thing I've done is save the cost between what I sold the orange to malraux for, and what it will cost me to buy it back from malraux.

That is why a) there is a fundamental difference between investment and owner-occupier real estate; and b) the benefit of owning as an owner-occupier is precisely the right not to have to pay rent. The only benefit I get from growing oranges to eat them myself is the right not to buy them in a store. No profit. The benefit I get from growing oranges to sell them to someone else is the difference between the marginal cost of production and what I get when I sell them. Profit.

That is also why you can't include the tax effects alone, because they are factored into market prices. I pay tax on my profit from selling the orange. Malraux pays tax on selling my orange retail at a profit. We count those deductions when we set our prices.

Malraux sets his retail orange price. That's what oranges are worth, taxes included. If I buy it, the tax is factored in. It's already in the retail price.

Just as it's already in the retail price of market rents. If you buy a place to live in and it costs more than it would cost you to rent it, it's like me selling malraux an orange, malraux putting the orange for sale, and me going back and buying the very orange that I had sold to malraux. Not only do I pay the tax on growing the orange, but I reimburse malraux for his taxes, and even pay him a profit for the honor of doing so.

Guys, this is first-year microeconomic theory. I don't see what's so difficult for all you modern portfolio theory types to understand. Imputed rent = market rent. Not only is that how the CPI is calculated, it's how property taxes are calculated for apartments in NYC.

evillager: "I do, however, think he would roll over in his grave if he hard value investors say they can expect a 12% nominal return from the market going forward, and using that as their hurdle rate vs. other investments."

That is the historic return on the S&P 500 on a rolling basis over 50 years. It is not useful to forecast future behavior. It is, however - since it behaves that way over long periods of time and always has - useful to compare long-term gains. In fact, it's all we have.

Who is discussing "hurdle rates"? You really, really need to drop your text books now. First, we're not discussing investment real estate and what return you would need to choose to allocate your money there versus elsewhere. What I am saying is precisely that that analysis does not apply - owner-occupied real estate is NOT an investment. It merely substitutes one expense for another. In essence, it's a capitalized expense, and that's how it should be treated.

If I'm a bank and buy an ATM, I capitalize the cost of the ATM and depreciate it over its useful life. That is what I do with owner-occupied real real estate. If I'm Diebold, I make money selling them.

mschlee, I think you owe me some 14 apologies for the stupid things you said on one of my prior threads.

Nonetheless, "if you assume a 5% appreciation on real estate, and 10% on the market, you’ll break even in about 5 years (assuming 30% tax bracket and married) and be way better off when you stop paying your mortgage after you retire."

First, residential real estate can only increase as fast as incomes. Incomes went up considerably on Wall Street over the years, and you will see that median Manhattan sale prices correlate almost 100% to Wall Street bonuses. Your assumption is that they will continue; mine is that they will not.

"Dont forget that if you assume you pay rent of 3K/mo now, in 30 years at 4% inflation that will be about $9K/mo which means you need about $1.5 MM when you retire, earning 6%, to pay your rent until you die 15yrs later. Owners do not have to worry about that."

First of all, increases in rent cannot long exceed increases in incomes. If incomes continue to rise, landlords can raise rents. But second of all, if you take the numbers that I started this thread with and extrapolate them beyond 30 years, you will see that at 30 years an owner-occupier will have lower tenancy costs but no income-generating assets. The investor will have to pay slightly more per month out-of-pocket but that will soon be erased with the compounding of the investment assets. Plus the investor will have a lot more assets.

5% appreciation on real estate
10% on the market
4% rents.

Those are all historically flawed assumptions. Real estate and rents increase at the same rate over time, with leverage the "fudge factor." 12% is the historic nominal rate of return on the S&P 500. Unless you can come up with documentation to prove your numbers, as I did mine.

So, finance people, I hope you go back and retake Econ 101. Because you don't know what you're talking about.

Erratum: It is not useful to forecast future behavior

should be

It is useful to forecast future behavior, just not in the short-term

Just a quick comment regarding the discussion between investing in real estate vs equities. i generally agree with steve that equities are the better investment, however, had you invested started in 1999, and invested in equities, you would be flat. Had you invested in re starting in 1999--you might actually be up, dependent upon the geographical location. I think the finance community generally agrees that equity returns will not be what they were in the last 100 years. I would say that a 7-8% nominal return is more accurate-so approximately a 4-5% real return, dependent upon your inflation rate. This country as a whole has risen as a huge world power, succeeded in several wars and as a result has seen equity prices soar. This is less likely to happen in future decades. There was a joke yesterday or the day before about buying manhattan. If you were the one to buy manhattan, you would have realized annualized returns of roughly 10%--a decent return, but about the same as the sp500.

Glad to see that Steve is moving past NYC real estate and into new markets. That's much more productive than endless rumination/arguing that was going on.

I would love to participate in conversations/debates about buying opportunities in the world.

Renting is always a better investment than buying except for:

1 - if you are the landlord
2 - if you bought anytime over the last 10 years
3 - if you bought anytime over the past 40 years in ares like coastal north east, any major urban area, most prime suburbs, etc
4 - if you dont calculate the $250/500K exemption
5 - etc, etc, etc, etc

Renting is not the path to wealth, it is not even the path to a good credit score.

petrfitz, read the orange example. It's all factored in.

1 - what?
2 - true for the last 10 years, but not the 10 years prior to that, and not compared to the S&P500
3 - not remotely true: Dallas, Houston, Denver, New Haven, etc.
4 - it's factored into rents: read the orange example
5 - stocks have historically always been a better "investment" than owner-occupied real estate.

To buy owner-occupied real estate is to capitalize an expense. You are extrapolating from a short-term past without looking at current market conditions.

petrfitz, just to add: your example implies that no matter what the current price of real estate is, it's always a good time to buy. "New Economy" talk.

As opposed to your "its always a good time to buy stock????"

1 - being a landlord is always better than being a renter.
2 - BS
3 - BS
4 - BS
5 - BS

Also - for the past year the market is down how much?

BUT - The Northeast experienced a rise in median prices, which were up 4.6 percent compared with a year ago.

HMMM?