“spend” of purchase price

I remember when cheeseburgers at Mcdonald's were 30 cents.

I'm not sure you've defined a useful metric, especially if it doesn't include financing costs.

In my spreadsheet, I calculate 3 metrics:
* total cost of ownership, including opportunity costs
* monthly out-of-pocket costs in year 1
* cap rate sans financing

TCO is the main barometer. It lets me put every apartment on the market (whether rental, new construction, resale, or co-op) on equal footing, taking into account everything from purchase price to renovations to inflation on utility bills to flip taxes on exit.

The other two metrics are mainly sanity checks to make sure I haven't overlooked a hidden dog or diamond, and to forecast a household budget.

To be clear, I add rows not only for apartments I'm interested in, but also for the apartment I'm currently renting, as well as several rows of "generic $XXXX rental". Then I can see how any particular unit on the market compares to staying put and/or to renting at other well-known price points.

Nada, Not sure if this is a teaser question to another bearish thread. But I think of the spend as rent on a substantially similar apartment. This keeps it simple.

And extra money spent, if any, (ex principal payments) over eqt rental is partially “freedom premium” to customize the way you like, not having to move etc (rich generally like to pay higher premium perhaps 15-20 percent over renting for some) and the remaining investment loss if there is price decline or no appreciation. Of course some people just park dirty money.

RB, you da man. What does your magic spreadsheet say when you bump the price of a property by $100K, keeping everything else the same, in terms of monthly cost? Does do something different than doubling the cost if you bumping it by $200K?

300, I’m more asking what you think is being spent, on a monthly basis, if we increment the cost of an apt by (say) $100K.

I’m more asking about what one should expect that they are spending monthly, in expectation (on rent plus ownership premium/discount, if you will). I.e., if an apt is priced at $1M, should I think of buying that as (separate from monthlies for maint/tax) spending $1K/mo, $2K/mo, $3K/mo, $4K/mo?

Most non spreadsheet experts will just think of that maintenance/cc/taxes plus mortgage payments Plus insurance.

They are not far off as they are ignoring assessments/routine upkeep/periodic maintenance to keep the property in the same condition/transaction costs, but including principal payment makes up for it in a crude manner.

And each apartment is different - maintenance/cc/taxes/price point/ultra luxury.

So no sure you will get a linear function in per $mm.

I can’t help making Inonada’s head explode: In my “spend” calculation that governs how I actually act, I ignore completely opportunity cost on capital invested. The equity invested is “spent” up front and completely ignored thereafter, so it is in the “spent” past tense calculation, but as a sunk cost. If it comes back to me down the road, so much the better. If it doesn’t, I’ll survive. I spend no time torturing myself on how much more money I would have today if I behaved differently in a myriad of ways in my life. However, I have found perverse fun in torturing those skilled in finance. :)

P.S. - Also, to be clear, I do not have oodles of money such that it does not matter to me at all; again, but for living by my husband's side, I would fall squarely in the "mass affluent." It drives my husband nuts that I don't think of the money he makes as "ours" because we paired when he had none, BUT, were I to think of the money he makes as "ours," he takes spending to another level that I cannot understand; for example, he has been known to give away more than I make in an entire year to what I would label as "lost causes." He spends nothing on himself, but if you are running for dog catcher on a progressive platform in the reddist district in the land, he's your guy!

I’ll keep that in mind for my next career, MCR. If Mr. MCR would support me, I know it’s gold!

MCR, so would you say that you are relatively indifferent between “spending” by paying cash upfront vs taking out a mortgage and “spending” on interest+principal over upcoming years? Or so you think you are “spending” more vs less if you did one vs the other?

300, by the measure you suggest from spreadsheet experts, naively that would the more money you put into a down payment the less you have spent. Are you suggesting that metric with a fixed level of down payment, or with any level of down payment?

That is why I anchor with as simple method of rental eqt which has no mortgage assumption and it will give very close to your average spend.

For buying cost method (cash flow/ affordability), usually 25% down in Manhattan if you want to look at it from actual cash flow point of view. All this works fairly well for non ultra-luxury.

I think most buyers in Manhattan use both even though the calculations may not be that precise and have a bias depending on whether you want to buy or rent.

I don’t like to borrow money, so I feel like I would be spending more were I to take a mortgage because it would entail psychological cost as well as whatever more sophisticated financial costs or benefits the mortgage would entail.

My rule of thumb / mental model is to just look at the monthly expenses - maintenance, taxes, interest, insurance. Add those up, compare them to an equivalent rent, and make sure it's a comfortable amount to be spending on housing.

This leaves out the purchase price, sale price, and principal payments, the theory being that they all cancel each other out, assuming that you sell for the same price.

Thanks for the deets, everyone. I have a follow-up question for each of you.

300, on the first metric of “rent” you suggested people use, the following doesn’t make sense to me. Suppose an apt rents for $4000 and someone buys it for $1M, the amount the person “spends” by buying it is $4000/mo. If they buy it for $10M, they spend $4000/mo. If they buy it for $100M, they spend $4000/mo. That seems strange. Perhaps they receive the same benefit / value, but I would have thought they spent different amounts. Is that indeed what you are saying?

MCR, in your “spent it all at purchase, anything left is a gravy” view, is there an effective lifetime on your purchase? I.e., is it that you consider whatever is left after (say) 30 years is gravy? Or are you thinking you’ve bought a place, you plan to sell it in a year, and anything left after a year is gravy?

Bryantpark, is the interest on a typical amount of down payment percentage? Or is it invariant? I.e., if a person has a choice between buying a $1M for cash vs buying it with a 100% mortgage at 3%, are you saying in the former case they are spending $0 vs in the latter case they are spending $30K/yr. In other words, if you buy with cash, you are spending nothing? Or no matter whether or not you finance, you are spending interest on (say) 80% of purchase price?

Leaving aside ultra-luxury and temporary dislocations in the market, a $4000 per month apartment is unlikely to have a big range in price at a particular time in the market. Prices reflect carrying cost etc and what you can rent for within say 10/20 percent. This is one metric for “spend“ which has less room for fudging. Second metric is cash flow metric which includes financing element and how good a deal you got in price or financing (mortgage rates even for the same maturity vary by 50 bps depending on the customer; then there is mortgage maturity question) or unknown about future price growth. Most people think of both even though their calculations may not be precise. Super rich do not care about either just like when they buy a dog sculpture.

But I think you are too smart not to know this. What is the real question or point you want to make?

I usually compare the rent to the monthlies plus the amount of interest which would be payable on the full purchase price if it were financed 100% with an IO loan at the prevailing available 30 year mortgage rate (understanding that the mortage would not be 100% and not interest only).

This assumes that the cost of the equity risk is exactly offset by the expected property value growth. It also doesn't account for the liquidity needed to purchase which I don't assume as a constraint. These are absurd assumptions, I know. But if you try to build assumed principal growth into a model you find that it dominates the buy vs. rent decision.

I am trying to sell my Queens coop right now and at the current ask price (well below my realtor's recommendation) we essentially lived here for free the past five years - which no reasonable assumptions would assume.

300, I just want to know what different people think the “spend” is, really. I know what I think, interesting to hear how other people view it. Sometimes, I gain insights into why mispricings (in my apparent view, anyways) occur, and that can help me formulate my own path more confidently.

FWIW, I get your second metric and think it’s sound, but the first metric seems like a self-fulfilling prophecy of sorts. “It’s a good metric because it should be a good metric and tends to be, but when it isn’t we can’t tell, and BTW in market X the metric is wrong because Y.” That sort of thinking can lead to a lot of potential for mispricing. E.g., the “spend” of an ultra-lux apt is nothing more than rent, so if the price is high that means the “invest” portion of price reflects high expected appreciation. Therefore, paying the high price is fine: you’ll make it up in appreciation.

I am generally fascinated by the range of responses. So far, we have:

1) Spend is only rent. (Does not vary with price.)
2) Spend is the entire purchase price upfront. (Varies directly with price, no contemplation of spending as anything other than buying a shoe to be thrown out, with whatever you get at a consignment sale as a windfall.)
3) Spend has something to do with typical financing cost. (Varies with price.)
4) Spend depends on what is actually finance, if you haven’t financed it you haven’t spent it. (Not sure if this view is confirmed by anyone yet.)

Some of the discrepancies are kinda interesting. E.g., suppose you buy with cash. #2 says you engaged in spending a huge chunk immediately. #4 says you have / will not have ever spent anything.

" Or are you thinking you’ve bought a place, you plan to sell it in a year, and anything left after a year is gravy?" - I never plan to sell (psychological) any piece of real estate I buy, but in the event circumstances change such that I do sell in a year (or after just six years as was the case with the coop we just sold), yes, anything left over is gravy. I don't go back and calculate the monthly spend in retrospect; I am sure if I were to do that, our recent coop sale would yield a frightening number, but what's done is done, and I prefer not to torture myself.

WoodsidePaul, FWW that’s exactly where I came down in answering my own question. I.e., annual “spend” of purchase is approximately 30-year interest rate on full purchase price. Anything beyond that is “invest”, which one can place an expectation on, but it can (in the end) turn out to be a big negative or positive (as you have had).

I’m still trying to figure out the succinct explanation (for myself, anyways) of why I think 30-year interest rate on full price, at time of purchase, should be a good proxy for what one is signing up for “spending”, regardless of outcome of the “investment” side.

MCR, thanks. Let me translate what you wrote into something I can work with. I’ll take “never” to mean 30 years, which is kinda how long you’ll lhold it in expectation. You might be in good health, but you’re not going to live forever and there’s a chance you’ll sell sooner. So for you, I’ll mark you down as “purchase price divided by 30 years” is spend, anything else is gravy / invest.

FWIW, you probably didn’t “spend” a crapload on that place. Rather, you spent $X and your investment was crap, at least that’s the way I think about it. I’ve certainly had my share of investments that were crap, went to $0. Doesn’t bother me to acknowledge that, just one investment is a larger mix, bound to happen.

Especially now with SALT caps isn't taking a mortgage out the moral equivalent of saying "I can do better with my money"?

Tax issues aside, If you buy mortgage backed securities, that’s pretty much what you get:

https://investor.vanguard.com/mutual-funds/profile/overview/vmbsx

You’ll see that fund has returned 3% per year pre-tax and 2% after-tax over the past decade. So there is a tax drain, but a similar risk / return profile is available elsewhere.

The thing a lot of people forget, and perhaps that is why in the case of “spend” an ARM rate may be better than a 30-year fixed rate, is that when you get a mortgage, you’ve also purchased an option. That option gives you a right to refinance whenever you want, and it accounts for something like 0.5% of the difference between a fixed-rate and an ARM.

@ inonada, like any simplification / rule of thumb, mine has some assumptions built in that reflect my circumstances and experience.

In my case, the assumption is that I buy with 20% down, hold for a while, then sell after 5-10 years when circumstances change. I don't ever plan to pay down the mortgage substantially, so the interest is the main expense, and the opportunity cost for capital tied up in equity is negligible, so it is left out of the model.

If you pay cash, then that obviously completely breaks the model, because now the interest is 0 and the opportunity cost is substantial. Other things that break the model would be buying something in. a new development where there's a premium for being shiny and new that won't be there in 5-10 years, temporary tax abatements, land lease buildings, anything where you can't realistically expect to sell for about the same in 5-10 years.

Going right back to your original post, of course the "spend" depends if you pay cash or finance, because there's always a cost of capital that has to be accounted for. If you finance, it's interest, if you pay cash, it's opportunity cost.

What happens to cc+taxes, allowance for upkeep, and insurance even if you want to keep it very simple with the complexity of the spreadsheet.
“annual “spend” of purchase is approximately 30-year interest rate on full purchase price.“

What happens to cc+taxes, allowance for upkeep, and insurance even if you want to keep it very simple WITHOUT the complexity of the spreadsheet?

“annual “spend” of purchase is approximately 30-year interest rate on full purchase price.“

Sorry, I meant to say (per the OP) the annual “spend” of the purchase price is interest on the full purchase price. So cc/taxes/upkeep/insurance go on top of that for full spend.

Except for the “spend is rent regardless of how much you spent on price” method which you mentioned (but I don’t think are defending), there seems to be a sorts of consensus.

At 3% interest rate, your method (payment with 75% LTV) comes out to 3.8%. Paul & mine, 3.0%. I think bryantpark ends up about the same once the “negligible” 20% capital cost is accounted for. And I even forced MCR into a reluctant 3.3%.

So we’ll call it 3%-ish these days, but used to be 4%-ish a decade ago, and maybe 5-6% in the 2000’s. I’ll decree that as the official StreetEasy consensus.

@inonada - Yes, you have now articulated the “spend” calculation that I was taught, but which I don’t actively use.

P.S. - Except rather than the 30-year mortgage interest rate, I was taught to use the “risk free” rate, and I suspect the assumptions underlying that are outdated.

Current “risk free” rate is 0.68%
I would provide a cite, but I am on a mobile device, so I’ll just borrow the words of Paul10003 and say “just google it.”

You are quoting the ten year treasury bond yield. Not fully risk-free. E.g., markets decide interest should be 1.68% all of a sudden, the value of the bond drops by 10%. A more proper risk-free is the overnight rate, fed funds rate, 1-month t-bills which are more or less 0.

But I imagine back when you were taught it by (say) pops in the 1980’s while you were enjoying an Orange Julius at the mall and being instructed on life, the 2-ish percent spread between 10-year bonds at 8% and mortgage rates at 10% was immaterial on the overall story.

Yes, economists can spend hours discussing “the risk free rate” without ever reaching consensus on appropriate proxy.

The “orange julius in the mall” made me laugh - my father would not be caught dead in a mall, and I don’t know what an Orange Julius is. Off to the Google machine I go!

Nada, Are you really making a claim that non interest expenses are the same percentage of purchase price for say Manhattan Condos? Or how do you get from 3 to 3.8 percent.

@mercer - go back and read nada's post; the differential is based on leverage vs cash purchase.

I have not done the math, but I think even beyond the leverage vs. non-leverage, I think inonada is differentiating between different types of leverage (30yrs fixed, 15 year fixed, various ARMS). Run the numbers with the ARM that is your preferred and see if the numbers work (75%LTV with your preferred ARM vs. 30-year fixed jumbo).

Nada,
I have not paid more that 2.5% interest rate for years in fact for most of last 9 years. My current 10/1 arm I/O less than 2.5% before rates came down. So one can decide what interest rates maturity they want to use - no set standard in the market. If I were to use the method you are leaning towards to determine "spend", I will be at 75%x2.5% plus non-interest cost which vary greatly as a percentage of property value in Manhattan. So it is not possible to have a simple percentage of property price a majority of people would agree upon.

My preference is still rental equivalent while keeping in mind alternate matrix which is cash outflow assuming certain percentage financing.

"But I think of the spend as rent on a substantially similar apartment. This keeps it simple.

And extra money spent, if any, (ex principal payments) over eqt rental is partially “freedom premium” to customize the way you like, not having to move etc (rich generally like to pay higher premium perhaps 15-20 percent over renting for some) and the remaining investment loss if there is price decline or no appreciation. Of course some people just park dirty money."

I hate to agree with 300_mercer, but I need further explanation as well. I have learned that inonada frequently skips steps in this thinking, which, after he articulates them, seem obvious, but I need him to spell it out for me too.

Apologies, don’t mean to be confusing. I am just trying to understand what you are telling me.

300, you had said:

“Most non spreadsheet experts will just think of that maintenance/cc/taxes plus mortgage payments Plus insurance.”

So I took mortgage payments (including principal, per your words) at a 3% interest at 75% LTV. Those work out to 3.8% of price. E.g., monthly payments on $750K of loan at 3.0% is $3162 per month, or $38K per year, or 3.8% of $1M purchase. If you want just interest at 2.5%, happy to take that.

Really, I just want you to tell me what you think. I’m more interested in an actual value. I come to you and ask “Hey, some place is asking I pay $1M (cash or borrowed, in any form I choose), and I want to know what I am effectively spending per month on the $1M portion (to which I’ll add cc+tax+etc). I know there’s an investment component which is uncertain, but can you tell me what I should budget it as for the purposes of spending to see if I can afford it.” I just want a number from you, really, like $3000/mo so I can budget with it. And if it were $10M for that same apt, I want a number on that too, so I can see if I can afford it in my budget.

I think you are saying “No matter what, rent is what you spend. Everything else is investment loss/gain.” Which tells me that if I go buy a $10M place with cc+tax at $10K/mo, and it rents for $4K/mo, then I can comfortably afford living there if I can afford $4K/mo in my budget. Whatever else happens ends up as an investment gain/loss, but I should not think of it as spending. No matter the price for the same apt, I have signed up for $4K/mo in spending as the “certain” component of the purchase, plus some uncertain investment gain/loss.

Is this what you are saying?

To clarify the assumptions, do you agree with the following?
1. maintenance, cc/taxes are not a percentage of market value in Manhattan
2. And we are not talking for ultra-luxury / $3k per sq ft plus apartments

On 1, I mean the same percentage of marker value for all properties.

On (1), yes. On (2), don’t make any assumptions.

Rental eqt does not work with ultra luxury or most new development priced at say more than 20 percent premium to say somewhat comparable 10y old resale condo . Nor does cash flow check.

Just like driving new car out of the lot, value falls immediately after you buy it (percentage varies depending of the price level) despite prices coming down in the last few years. As ultra luxury prices continue to come down, new car effect will get smaller.

That is why I always like to think in terms of rental equivalent as an anchor plus a premium/discount when you compare it to cash outflows (people define it differently depending on their spreadsheet expertise) with 25 percent down. Rental equivalent tells you how much of emotional/freedom premium (rich making $1mm plus will typically pay higher premium than someone making $100k per year) and future price appreciation is built in. No way to separate the two components due to individual differences. Other way to say this is “spend” is much higher in the first year than your cash flow if you over pay for something relative to individual “freedom premium”.

If I were to be analyzing a high-end purchase as an advisor to a wealth family who cared about these calculations, I would say spend has three components:
1. Rental Equivalent
2. How much premium over 1 they are willing to pay for ownership in absence of price appreciation using cash flow approach with 25 percent down? Perhaps 0-25 percent range with most people towards the higher end.
3. Remaining “Froth” at the current market price. This could be 20-30 percent of Price for ultra-luxury in the current market.
The end result may be that they will say, I just do not care. Let me buy.

Thanks, 300. A few questions:

- On #2, what interest rate would you use, and by cash flow should I assume you are including principal payment in that component?

- How do I know what falls into #3? I think you are saying if rent per #1 works out to 1.0 and cash flow per #2 works out to anything up to 1.2, then the amount in #3 is 0. However, if #2 works out to (say) 1.8, then we should put in a consideration for #3. Is that right?

- How do I figure out the spend on #3? Continuing with the example, if #2 works out to 1.8, we should assume “froth” is 50% (1.8/1.2 - 1), meaning you’ve paid 50% too much, and we need to characterize that as spend? How many years should one amortize this “I just do not care” purchase price overpayment across, the expected duration of ownership like (say) 10 years?

A little different.
#2 is just a premium they are willing to pay over 1. If #1 is $1 and “freedom premium” is 20 percent for that family. $1.2. Ken Griffin will probably put 100 percent premium if he thought in these terms.
#3 is actually hypothetical cash flow with 25 percent down and say 10/1 arm I/O plus carry, Insurance upkeep etc (no principal payments included). If that results into $1.4, price reduction which will bring down $1.4 to $1.2 is first year spend.

Btw, I have not done anything fancy above except introducing some quantification of individual preferences in form of “freedom premium” in buy vs rent calcs. Most people will understand it if not necessarily agree with it.

What do you have to say to the non-insignificant number of 220 CPS buyers who pretty obviously bought as investment property?

Got it. So basically, 300 Wealth Advisory Services comes with a special Name Your Own Premium feature. Client can name a premium as they see it per #2 (1.2x, say), but if cashflow per #3 exceeds it (1.4x, say), then 300 calls One Time Spend On the difference (0.2x) . However, if client does not underbid by declaring #2 to match #3, then their monthly spend is effectively #3.

Is that right?

And what do you like to use for insurance & upkeep, as a fraction of purchase price? (If these vary based on what’s being bought, please give guidance on that too.)

How about the coefficient of correctness?

30, As investment property, ultra-luxury never made sense unless they were betting on price appreciation alone. They clearly made a very bad investment choice if they were not planning to live in it.

Nada, Correct. Beyond rental eqt which is definitely spend, remaining hypothetical cash flow split between spend or investment / first year hypothetical write down depends on individual utility. That is all I have to say.

@nada

>> What does your magic spreadsheet say when you bump the price of a property by $100K, keeping everything else the same, in terms of monthly cost? Does do something different than doubling the cost if you bumping it by $200K?

In its current form, my spreadsheet applies the same home appreciation across the board, i.e. it assumes that any bid Richard would actually submit is equally well-priced. Therefore, barring a structural change, I must answer a slightly different question than the one you've asked: it tells you what happens if you bid on a *different* property that is $100K nicer, or another that's $200K nicer.

(Asking it to raise the bid on a given property by 10% would -- incorrectly in my view -- cause it to predict a 10% higher sale price down the line.)

Using my customary assumptions for the post-covid decade:
30yr fixed @ 2.5% with 20% down
0% home appreciation
3% investment return
2% inflation
2% rent increases

Feeding in 3 hypothetical co-ops priced at $1M, $1.1M, and $1.2M, each with $2K maintenance / no reno / 1% flip tax, I get TCOs of $544K, $592K, and $627K. That very roughly corresponds to rentals nominally asking $3500, $3750, and $4000.

I notice no one is calculating in a risk premium being the chance the price of your purchased unit goes down times the probability that will happen.

Under portfolio theory, risk premium is something you earn through diversified exposure to an asset class. Any additional risk you take on via concentration in a single name is risk you shouldn't "expect" to be compensated for. Maybe your investment hypothesis is right, maybe not -- a model can forecast the probabilities of each, but there's no standard formula for predicting who'll be right.

To your point, this is an argument for building-in a margin of safety in case you're wrong. I like to make sure my TCO is at least X% less than a rental I'd otherwise be comfortable with financially, and that the margin of safety successfully guards against various parameters getting tweaked in unexpected ways, but this is all very hand-wavy, in part because there are several underlying risks being conflated.

A cash buyer, for instance, is buying a giant inflation hedge. Opportunity cost -- lack of diversification across other equities -- accounts for most or all of their risk. They are exposed to market risk, yes, but are unlikely to be forced into an inopportune sale.

A highly leveraged buyer (typically a developer or investor) is also hedging against inflation, while taking on interest rate risk. The latter risk IS diversified though -- they can roll their position with any lender, not just the original counterparty -- so I'd expect this strategy to earn a premium for its higher risk, all else being equal.

A more typical homeowner with a fixed mortgage is hedged against both inflation and rates. They'll pay for that safety in the form of lower expected returns, while still taking on the uncompensated risk of a concentrated position, which is why it's advisable not to make it too high a % of their net worth. You could argue they are also exposing themselves to "local job market risk" in a more direct way -- a Broadway actor who rents can trade down in a pandemic, while a Broadway actor who can no longer pay their NYC mortgage is in for a world of hurt.

A renter faces inflation risk head-on. They're not leveraged, so being priced out of a market segment they once enjoyed isn't ruinous to their net worth, but it's still a risk to future budgets and/or lifestyle.

RB, thanks. Seems like you’re coming in around 3% on “spend” as I would define it (accounting for corrections on the margin related to low inflation & return adjustments).

>> I notice no one is calculating in a risk premium being the chance the price of your purchased unit goes down times the probability that will happen.

30, that might be because I intentionally left it out of my question. I’m asking people to separate “spend” (what they consider certain, that for which they are receiving non-investment benefit) from “invest”. Risk premia are more about “invest”, and I would hope that people tying up capital are expecting something beyond the “spend” to make up for that risk.

I’ll also state that implicit in RB’s calcs were:

1) he expects RE to lose money in real terms / be flat in nominal terms over the next ~10 years
2) he expects investment capital to barely outperform inflation over the next ~10 years
3) the risk/uncertainty on 5x leverage on #1 matches the risk on #2

So he has accounted for risk, though in answering my question on “spend” it probably doesn’t much matter.

I don't have strong insight into #1. (that's why I'm kibitzing here, after all) It's more that I want to ensure bids make sense with or without an investment thesis behind them, and pocket any appreciation that does come as pure bonus.

On #2 while I'm neutral to bearish on the absolute return, I'm "optimistic" (terrible I know) that there will be severe corrections along the way that give cash-heavy people like me a chance to make money.

And on Yom Kippur, no less!

This thread hurts my head. I am happy that inonada and richardberg have found each other.