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By astrid Follow Thu, 5 Apr 2007, 9:00am 6,693 views 274 comments
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theotherside
The EXACT calculation of the implied finances in your example $1,000,000 with $800,000 notional mortgage @6.5%, using NAR published averages for closing costs, other costs maintenance & repairs.
Home Purchase Price: $1,000,000
Down Payment: $200,000
Closing Costs: -$50,000
Other Costs: -$10,000
Net amount financed: $860,000
Marginal tax rate 33%
Mortgage Term 30yr, 6.5%APR, fixed, simple, no penalty
State & Local property tax (before fed deductibility): 1.4%
Insurance, maint, repairs 0.5%
10 year CPI expected: 2.5%
Selling costs: 4.00%
Opportunity costs (risk free 10-year T-Bill) 4.50%
Holding Period: 15 years
Rent equivalent = $3,500/mo
Yearly amortized loan & rent comparison:
YEAR 1:
---------
Pmt=$65,857
$9,957 Principal, $55,900 Interest
$14,000 Taxes
$5,000 Insurance
Tax Deduction = $18,447
$66,410 Nominal cost of ownership
$42,000 Nominal alternative rent cost
*** Nominal alternative PV of renting in Year 1 = $48,329
YEAR 15
----------
Pmt=$65,857
$24,044 Principal, $24,044 Interest
$14,000 Taxes {note, taxes would be higher, assuming 0 tax growth}
$5,000 Insurance {note insurance would be higher, assuming 0 ins growth}
Tax Deduction = $13,798
$71,058 Nominal cost of ownership
$59,345 Nominal alternative rent cost
*** Nominal alternative PV of renting in Year 15 = $11,714
---
Note, I have inflated Rent costs, yet not property taxes or insurance, just so those figures can't become red herrings. Even so, the gap between ownership versus rent falls very slowly, due to the fact that even while rent rises, tax deductibility falls.
theotherside is omitting important terms from her equations which level the opportunity costs. Running a sensitivity analysis reveals that the PRICE paid for the home determines about 72% of the result. Tax deductibility is the next highest, at 8% sensitivity.
That means that 72 cents of every dollar are determined by your initial purchase price, while only 8 cents of every dollar are determined by your tax shield.
For this reason, mortgage rates are also very low sensitivity (less than 2%). Because lower mortgage rates also lower tax shield effect, which is an iterative calculation. Also keep in mind the tax shield is front-loaded. Therefore, contrary to theotherside's claims that longer ownership periods yield better results, in fact the opposite is true from a financial perspective. The best results are based upon maximizing leverage + tax shield, usually by moving every 5-7 years.
Of course, I'm not advocating doing that, because a home is not a stock portfolio. And, even while maximizing leverage + tax shield, one is accumulating debt distress risks.
There is no free lunch. There is no easy money. There are no "it's always better to do X" pat answers. Ever.
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Greenpoint doesn't list the Loomis property on its web site. If the owners got a HELOC from another firm, would that show up on the title report as well?
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theotherside Says:
> 1- Let say an owner has a $1,000,000 house with a
> $800,000 mortgage (20% down). After a few years
> you have to sell due to relocation/new-job/divorce
> Scenario 1 (worst case) : RE is DOWN 25% (nominal
> prices)
Good to hear that 25% is “worst case”…
> You need to take $256,250 from your savings (painful)
> but your new mortgage is $600,000 (or exactly $200,000
> less than your previous situation).
For the ~1% of Americans that have over a quarter of a million in cash this may work, but what do you suggest for the ~99% of Americans who don’t have $256K in cash sitting around?
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FAB knows what he's talking about, or so I've heard from theotherside.
I thought he was also going to point out that the marginal value of the tax deductibility declines faster than the nominal deductible interest as a function of income.
Or in plainer language: The lower your tax rate, the less the tax shield helps you. It is a tax DEDUCTION, not a tax CREDIT.
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GC Says:
> FAB, 1/4 mil in addition to the dwelling which is owned outright?
I don't have the exact numbers, but not many (I would take the bet that it is under 1 in 100) Americans have $256K in cash savings...
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FAB: Are you including people who could liquidate portfolios to generate a quarter million in cash? I'm not sure why you'd have that much green sitting around earning nothing.
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Redwood City, CA
tOS's worst case scenario is exactly why I don't want to buy right now. I can squeeze out a 200k downpayment, but I doubt I'll be able to squeeze out another one in 3-5 years.
And really... that scenario implies I've now spend 480k to own 20% of an 800k house. (plus expenses! Not counting opportunity costs!)
Tits to that! Margaritas all around!
I'll agree that buying a different house in the same area code (or larger subset that makes sense) is pretty much a wash regardless of the overall market being up or down.
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I will not ever buy with 20% down because I don’t want a home that expensive.
I nominate this to be considered as The First Koan of Patrick.net !
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GC:
"The only people who benefit from a rising RE market are those who can sell and downsize."
True, but you can also sell and rent.
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HARM's website
So the punch line, which I coincidentally said before, is that you buy when you need a house. Forget about sitting and the anguish that I’ve seen on this board.
Investing in RE is a whole different story. There, one needs to buy low and sell high.
25% drop in RE is no big deal if you intend to live in a house for a long time (15-20 years) and can afford the mortage.
To be frank with you, I sense a fair amount of greed amongst the fence sitters. This I have already pointed out on several occasions.
To be quite frank with you, I think you're either full of shit or baiting us.
Exactly how does recognizing the reality that I --and virtually everyone I know-- can't afford 99% of the housing stock in my state using a conventional (non-toxic) loan somehow make me full of "greed" or "anguish"?
Oh, and for the record, a 25% drop is a *very* "big deal" if it happens to wipe out your entire net worth. Maybe buying right now as a primary residence can make sense IF you can afford conventional loan payments AND intend to stay put for a very long time, sure. But what happens if life suddenly throws you a curveball at exactly the wrong moment and you HAVE to sell long before your "intended" 15-20 year time horizon?
Something like 50% of all marriages end in divorce, and sometimes people get sick. Or, they lose their jobs and can't find another one that pays as well. It sucks, but these things are hardly rare occurrences.
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Hi_there,
Did you cut-and-paste your post from a two-bit real estate investment seminar transcript?
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Allah's website
Something like 50% of all marriages end in divorce, and sometimes people get sick. Or, they lose their jobs and can’t find another one that pays as well. It sucks, but these things are hardly rare occurrences.
...other times there is a big huge colosal bubble is about to explode and you see no point in buying before that happens!
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"25% drop in RE is no big deal if you intend to live in a house for a long time (15-20 years) and can afford the mortage"
What a silly statement. First off we will see a drop and flatness maybe for long time to come. This may take decades. Demographics be damned. Second why pay the premium... buying at the peak is a premium to seller... People are so vain.
At the end you look look like a fool holding Yahoo shares at $350/sh
maybe in 150 years it will be worth $350/shares again. I dont expect to
see NAS getting anywhere near 5000 for many decades...
Thats a bubble folks... Japan RE is a glowing reminder the peaks may never ever come back.
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Allah's website
Allahs three commandments of real estate:
1) Wait for the crash.
2) Buy.
3) Be Merry.
By following these 3 very simple rules, you will survive as a mortal.
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"1- Let say an owner has a $1,000,000 house with a $800,000 mortgage (20% down)."
Many homes listed today at $1M were only worth around $300K or so to beging with... with med income being 85K today those 10 year ago prices remain supported while $1M is unsupported.... that why we call it a bubble.
I dont see the point even discussing financing using $1M when these prices will decline downward by more than 50%.
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Allah's website
Thats a bubble folks… Japan RE is a glowing reminder the peaks may never ever come back.
Even if the peaks come back 20 years from now, that's like stuffing all that money into a mattress for those 20 years. Inflation will make $1M feel like $10K after 20 years, maybe even less!
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TOS (and Randy as an aside),
You keep spewing your calculations, but it misses the forest through the trees. If one doesn't need to immediately buy for utility reasons, why buy now at clearly the top of the cycle? So what if the numbers turn out to not be so bad in the long term? If waiting a year or two gets me a better house for less money, that's worth it to me. So what if GC calls me a greedy fence sitter. So be it!
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You got that right allah!
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Allah's website
I dont see the point even discussing financing using $1M when these prices will decline downward by more than 50%.
TOS wants you to buy her $1M $hitboxes.
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"TOS wants you to buy her $1M $hitboxes. "
BAHAHAHAHAHAH !!!
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Watching CNBC midday... topic...
Why are more expensive employees being fired for cheaper new hires.
All about Circuit City. First off Best Buy was paying less than CC. No news there like Google is overpaying for its employees. one day they will pay the price like SGI did with overspending.
"Hey its cheaper!" Was what one analyst said.
It will take a very long time for salaries to even come close to support todays prices...
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HARM's website
New thread: Refinance = Debt Forgiveness
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Allah's website
It will take a very long time for salaries to even come close to support todays prices…
Today's prices will come down to be supported by those salaries.
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HARM's website
On the other hand trying to time the bottom is hopeless...
Riiight. So exactly how much do you need for those "investment" properties you're trying to unload?
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Allah's website
As I said before…buying now is crazy !!! The cost of waiting 3-5 years is very small…On the other hand trying to time the bottom is hopeless…
Timing the bottom is alot easier than timing the top. When the bottom is hit, it will stay there a while, the hard part is figuring out for sure when it will go back up again.
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Redwood City, CA
You don't need to time the bottom to get a decent deal. Just 'not insane' is all you need to hit if you're really buying a house and not an investment.
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Redwood City, CA
Also... it depends on how you define tops and bottoms. (Ooooh, a straight line for anybody from SF!) If you mean the exact absolute peak and the deepest part of the trough, then yes. Impossible. However, you could argue that we've been at the 'peak' now for about a year and a half to two years, depending on which market you look at.
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HARM's website
SFBB nailed it.
You don't need to time the EXACT bottom, just be able to recognize when the monthly net cost of borrowing is roughly in line with the net cost of renting for an equivalent unit. Which should not to be too hard, even for the severely math challenged.
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@theotherside
As I said before…buying now is crazy !!! The cost of waiting 3-5 years is very small…On the other hand trying to time the bottom is hopeless…
And as I said before, many times before, even specifically to you:
* No one will be able to time the bottom purposefully. Some will accidentally (and delude themselves they were smart and shrewd instead of lucky).
* I personally will buy before the bottom, and probably ahead of most of the people who frequent here, because I have a high utility value to owning.
* Your earlier arguments specifically showed that selling/buying-again right now would be superior financially to waiting a bit. So I'm confused now about your argument. It's crazy to buy now, but it's superior to buy now?? I'm not an investment banker, so please eludicate me.
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@theotherside
I count only property taxes pre federal tax deduction. All others are post deduction. That's the way it works. You don't get to deduct your taxes from your taxes in that particular case. Quite soon you probably won't be able to deduct any state taxes from federal taxes at all, or so I hear.
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Allah's website
I just need to watch for 4 things before I buy.
1) The ownership rate drops back down to 65% or 66% from 70%.
2) Easy money is nowhere to be found.
3) Inventories drop down to 7 months supply.
4) Foreclosures stabilize.
Until all of these things happen, I won't even start looking.
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Because 25% of $1,000,000 is $250,000. Or, as we used to say back in Uhiuh, "a quarter million bucks".
Hmm, a loan for a quarter million more, or a quarter million less? Hmmm. Let me think real hard for a moment. Hmmm. What will the extra interest cost me on a quarter million again, even forgetting all that mysterious financial present value math and stuff?
Oh wait, only 15%. Hmmm. Back where I came from we'd call that "uh hundret an fiftee grand".
By the way, 25% improves affordability by "uh quarter".*
*Actually, 25% decline in nominal prices results in more like 38% improvement in affordability because of the way all that evil math with exponents in the equations works.
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So now GC can tell the future?
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I am "one". I will buy a house that is around .5 larger, splitting the savings rewards with the improved house rewards.
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"Future is still uncertain, as far as I am concerned."
That is why we use tools like financial trends, rations and other matrix.
It is the reason we have financial analysts in major corporations
looking forward looking at various scenerios in their markets.
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"You don’t need to time the EXACT bottom"
Pull up the S&P from 1993-4 to 2002 and slap a straigth ruler and line up the trends from 1992 to the bottom at 2002 after the fall in the market.
Or using simple math.. .start with S&P in 1993 add 7% YoY increase gets you to the fabled bottom of the market after 2000. The 7% comes from Peter Lynch long term index returns he spoke widely about. Second matrix is PE and major trigger when stocks hit net book values.
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Carlsbad, CA
Malcolm's website
I'm going to Roswell NM tomorrow, this is a perfect thread. I can't wait to read it.
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Allah's website
If the mean is 50%, the exact bottom will probably be 55%; So we really don't care too much about the exact bottom.
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"it didn't require any discipline to attain it"
Uh... BOO-YAH!
The article posted yesterday from the OC Register regarding the sale of Warren Buffets Laguna "manse" illumintes this quite clearly. Had he sold at the peak (article dated 10 May 2005) or the "crater" isn't going to make a rounding error on WB's net worth. It's the principle of the thing DAMN'IT!!! :)
Hey Robert!
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Robert Cote' you are my favorite amongst dystopians.