Manhattan RE a bad investment?

Case-Shuler has been saying this for many years. The behavioural psychology of home ownership is fascinating. How many times have you heard a seller say that they doubled or tripled their money when they failed to consider the costs of maintenance, financing and in particular capital improvements. Few people even know how to perform an accurate rent vs. buy analysis. Home buyers invest a high percent (I think probably too high) of their net worth in homes without consulting a qualified professional financial advisor.

We have been conditioned over many generations to prize home ownership as the American Dream but many people lost everything in the Great Recession and had to start all over again because they did not understand the risks and responsibilities of home ownership.

Well, if the median apartment price is only up 1.8% annualized from the apartment price ten years ago, then my apartment that I bought nine years ago must not be worth much more than paid for it -- and yet it is! How to square?

For starters, let's say median apartment price to median apartment price isn't apples to apples, since no one bought "the" median apartment. To make this case properly, you'd have to look at resales of individual apartments over the timeframe. And indeed, most people who have anecdata about single-property resales have seen decent growth.

Better than the stock market? ... probably not, and inonada can chip in here if he's around. But not terrible. And that doesn't even count the idea that some of those purchases generated tax advantages for their owners.

And then there's the case of people who bought in "prime" areas on sale -- some of them did wonderfully in terms of appreciation.

IMHO, the lackluster annualized return of "median to median" more likely shows lackluster wage growth over the decade, which I think we knew about already...

ali r.
{upstairs realty}

From the article: "But leveraging a home only delivers greater returns than an all-cash purchase if the home value grows at a faster rate than the mortgage interest rate being paid."

I'm not sure that I agree with this statement as it does not take into account the return on other investments that can be made with the capital not needed to purchase the home.

Anyway, it's a rare buyer that can choose between using debt or paying all-cash. But to the extent that a buyer has some flexibility, I agree that it may not make a lot of sense to max out on leverage.

Its Finance 101. Higher leverage = higher risk. Especially when personal recourse is included.

incredibly misleading sensationalist article surprisingly featured on The Real Deal. Real Deal shame on you. Median? Please you have to look at resales of individual apartments to see what the price appreciation was. A midtown east condo studio bought in 2003 for 275k recently was appraised for 630k. The investor who purchased it basically broke even with the rent but paid down his mortgage 105k. He did home improvement of 5k so net of 100k. His net equity is 630-175 = 455k so over 15 years comes to a return of 11% on leveraged(borrowed) money. Investor made almost HALF a MILLION in 15 years. Awesome return.

SteveFR, I agree with your disdain for The Real Deal who often take articles from others and condenses them down for their audience. And while I think using a 2008 start date for their 1.8% average return conclusion says little about the current market, it is an interesting 10 year lookback that reflects a period when many people purchased apartments. Of course, if they purchased in say 2011 or 2012, the analysis and conclusion would be entirely different. It all depends on one's perspective.

It also depends on what type of property and when it was bought and sold so your example of a condo studio has its own set of built-in biases most notably your start date of 2003 and presumed sale date of 2018.

Regardless, I worry about a few assumptions in your analysis. An appraised value of $630,000 would imply a net sales proceeds after closing costs and capital gains tax of say 25 or 30% lower. Also, when you say the investor "basically broke even", I wonder if this was after all operating expenses including federal and state income tax, brokerage fees, and vacancy/collection loss.

But you make a good point about market timing and the positive benefits of a long-term hold.

I think the article, however flawed, should remind us that investing in Manhattan residential property is risky. Strong returns require near ideal circumstances. For the average buyer, my advice is to only invest what you can reasonably afford assuming some stress in the event of an unpredictable but eventually certain housing slump at some future point.

Currently, there is still a lot of "stupid" money that continues to pour into the market.

I agree that the premise of using median apartment price to median apartment price is a Fool's errand. I also agree with ximon that most people don't do a proper analysis. For example they are quick to include all the tax advantages of ownership, but rarely include the negative of added tax due to depreciation recapture.

Someone most definitely bought "the" median apartment in 2008. Someone also definitely sold "the"median apartment in 2017. The problem is that it wasn't the same apartment.

Correct 30. To the extent that it makes any sense at all, it still only tells you something about 2008 vs. 2017. If you did not buy your apt. in 2008, who cares?

Streeteasy condo index hit a peak in mid 2008 (before recent one) as the recorded sale lag 3 months at least. It is hard to make a lot of money as an investor if you bought at the previous peak. Naturally, there are several other issues with the assumptions in the article but the main point "if you bought in 2008 local market peak as an investor and sold it recently you did not make much money after transaction cost" is not too far from the truth.

With much money being low/mid single digit returns per annum after two way transaction costs and using leverage.

To me, the only way to make real money in resi is to 1) hold long-term or 2) find bargains in up-and-coming neighborhoods or, more realistically, 3) invest in fixer-uppers or distressed assets.

Ximon, 2 is hard to do but #3 exists in any market.

Yes, 300. #3 is always available and a decent way to make a living either renting or flipping.

Speaking from personal experience, in our building prices peaked in 2008 then went down and up over the next six years and re-peaked in 2014. Prices have pretty much stagnated since then.

Luckily we bought over 20 years ago at a price of $150 a sqft., prices now are over $900 a sqft. Most importantly we like where we live.

RealEstateNY, using my trusty HP-12C financial calculator, I calculate that your buy-sell scenario produces a compounded average return of about 9%, just under the long-term average for the stock market of about 10% so that's quite decent performance.

But assuming closing costs, capital gains taxes, real estate taxes and capital improvements as the article suggests, your return would be lower, maybe quite a bit lower.

Although I think this article is poorly written as it cherrypicks a particular time period with significant periods of market stagnation, it also raises good points about the blinders many home buyers wear when considering a purchase. A home is not strictly speaking an investment but when so many people are spending so much money on homes, it starts to make more and more sense to look at it like an investment.

According to Nobel Prize winner Robert Shiller, for the period 1890-2005, inflation-adjusted home prices rose just 103 percent, or less than 1 percent a year. Maybe there have been fundamental changes in residential real estate since 2005 and New York City may certainly be the exception to the rule. I just ordered Shiller's book "Irrational Exuberance" so I hope to learn a lot more about this issue.

Of course cap gains would be applicable to stock market investments as well. Plus, capital improvements could be deducted during a RE sale. So when all that is calculated in, there might be parity between these two types of investments, depending on market conditions. And don't forget the added benefit that you've been able to live in your home...

Good points, Squid although stock market transactions do have lower transaction costs in general. When you say capital improvements are deducted, you mean for capital gains?

And historic stock market returns do not typically include the return earned from reinvestment of dividends which could add 2-4% to your yield.

Yes, the biggest difference between owning a home and owning stocks is that home investments have the added non-economic benefit of providing a roof over our head and a bed to sleep in. Not sure how yet to value that non-economic benefit but I think economists like Shiller would simply capitalize the savings from not having to pay rent but that really doesn't work IMO.

Of course, you only have that roof over your head as long as you don't lose that home to foreclosure due to a bad investment decision or a severe market crash.

>>When you say capital improvements are deducted, you mean for capital gains?<<

Yes.

And you are correct about the added value re: dividend yield.

I think an apartment to live in and an apartment to rent out are very different calculations. If you are living on a tight budget, renting is probably the best. If you are comfortable or rich, in my mind, there is a premium to be paid over rent for an ability to customize the place you live in to your liking (just like a custom suit), and not having to move. For me this premium is at least 10-15% over a comparable rental. Most Manhattan buyers increasingly fall in second category as more and more wealthier people like to live in the cities rather than suburbs. Also, if use a broker with rebate and buy a coop, you can get in at zero cost or less as there is no mortgage tax or title insurance.

A fourth way to make money is to buy anything in a post crash environment. Anyone who bought anything in 1991-1993 made money at any future point.

In Manhattan like many wealthy areas, the most luxurious places to live (other than hotels maybe) are owned homes. So whether economic decisions or not, the wealthy will prefer to own vs. rent.

In addition to the ability to renovate to your heart's content, there are other non-economic factors at play such as pride of ownership (bragging rights), the desire to control one's destiny, and what I would call the myth of affordability - that belief that because one can afford to own a home today, they will always be able to afford it.

One of the many valid criticisms of government policy leading up to the Great Recession were policies that encouraged higher rates of home ownership which led to so many mortgage defaults and personal bankruptcies not to mention the collapse of our entire economy.

One of the problems is that in overheated markets The Lending tap is open too wide and Banks give loans on "junk". Then post crash the tap is too closed add based are there foreclosure experience (which often occurs on loans they never should have made in the first place) policies get enacted like refusing to loan on places smaller than 600 square feet, or "Pro rata share of underlying mortgage" (where if you got a really good deal on an apartment they wouldn't lend, but if you were severely overpaying they would).

Yes, 30. An interesting phenomenon in the market leading up to downturn is the lack of adequate premiums for quality homes or quality locations. But after the market collapses, there is a strong "flight to quality". This seems to happen in every cycle. Financing criteria is a big part of it but also over-building in marginal locations.

30, I like the 4th way a lot but if equities are down at the same time, they bounce back first. Ideally, you would buy some real estate as well as equities if you have the money sitting in cash. It is very hard to time the market top and bottom. In 2009, one may have put in the money into equities at 1000 spx level thinking that it is the bottom and stopped themselves out at 850. In that sense, it is easier to pick the bottom in real estate as it a slower moving market but you have to have cash sitting aside. I was fortunate to do this trade in 2011 for the apt we live in.

ximon,
Take a look at the prices in the new Essex Crossing buildings and tell me it doesn't fit that scenario.

Yes, 30. Essex Crossing prices are scary indeed. The problem with these marginal properties is that, even if you are bullish on the market outlook, you will still have to assume a longer hold period in order to protect your equity in even a mild recession. But is that the type of buyer in LES?

I agree with everything you said on equities. Also, that taking advantage of a market downturn requires a lot of cash.