patrick.net

It’s possible overpay for a house, right? Once you agree with that, you start thinking about what the correct value for a house actually is. It is the rental-equivalence price.

Of course you can overpay. But I think I just disagree that the correct value is the rental-equivalent price. That's just a little too simplistic of a model.

what about the deflation hedge?

Nomo, and you tatu are both clueless, as clueless as any 2006 buyer. Seriously, learn something before you bankrupt yourselves!!! $500K price to $2000 rent and you could have 50% rental inflation, and STILL be worse off buying than renting.

I just ran the new york times rent versus buy calculator for $500K price, $2000 rent, and even with 3% rental inflation and 2% home price inflation, at no time in the next 30 years does the owner come out ahead of the renter.

Honestly, if you can't see the problem here, you are too far math challenged to think about real estate.

azrob00 says

Nomo, and you tatu are both clueless, as clueless as any 2006 buyer. Seriously, learn something before you bankrupt yourselves!!! $500K price to $2000 rent and you could have 50% rental inflation, and STILL be worse off buying than renting.

Wow--calm down there sonny. I didn't say anything about that particular house. Of course there are houses that are overpriced and that I wouldn't touch with a ten foot pole. I thought I made that clear in the other post.

ok, calm now! And, of course your point is true: in an inflationary environment, buying even at a higher mortgage-payment to rent makes sense, as what you are really buying is a comparison of multiple years mortgage payments, to increasing rents.

However: right now, rents are very very flat at best, and home prices by every indicator seem set to fall again.

Lets not use the false choice logic of A. buy now, or B. rent forever. There is choice C, rent for a year or two, then buy.

sf ace: First off, the tax right off for interest is not a tax credit. You only get it if you itemize. It is a deduction, and thus only can be counted to the amount that it exceeds a standard deduction, for most married people the standard deduction is something like $13K. Assuming someone put 20% down on this home, and financed the $400K at 6%, of that $24K in interest, only $11K would exceed the standard deduction, and thus the saving is WAY DOWN from your silly example, down to $3300 a year. Your mileage may vary, if you have tons of medical expenses or child care that get to be counted (there are individual hurdles for each one... it isn't as simple as totaling them up) then you might get to count more.

AND, in fact, the NYT rent versus buy takes into account the tax deduction, you can set your marginal tax rate. Still doesn't matter this home is a terrible buy, even with price appreciation and rental appreciation, it misses forever. Invest the difference between renting and buying, and the owner will never catch up.

You know that people who bought $500K homes that would rent this cheap in 2006-8 are the people walking away right?

azrob00 says

Lets not use the false choice logic of A. buy now, or B. rent forever. There is choice C, rent for a year or two, then buy.

Agreed.

Has anyone else observed this disconnect in rental prices and sale prices in Bay area? How is it justified - to get 1800 $ rent on 500k+ property - Is it case of too many smart people living in one area?

We had a disconnect since 1997. and yes we have too many people who flocked here post 2000 thinking they are smart, actually believing prices at $500K, up from half as few years earlier.

Nomograph says

it is almost always much, much cheaper to own in the long run.

Almost always? Any factual basis for that statement?

Nomograph says

I challenge you to prove me wrong by including historical inflation rates and price increases into your Rent vs. Own paradigm.

Just use the NY rent-vs-buy calculator. You can put in whatever house and rent inflation you want. Doesn't makes sense to buy the house I'm in under any reasonable scenario.

Sure, if there is hyperinflation, I lose. It does come down to:

1. monthly cash flow (I know for a fact I'm at least 2x ahead on that one)
2. a bet on inflation

My bet on inflation is low inflation for a long time to come yet, because unemployment is stubbornly high, and because the bond market is not pricing in any significant inflation.

And significant inflation in consumer items may also drive down house prices, if less money is available for mortgages after paying for food, etc.

Nope nomo, my az real estate dreams are fine: sold 4 rentals pre bubble, sitting on half a million dollars... and I'm a tenured professor of mathematics (graduate work in math applied to econometrics at UC Berkeley fyi) . I'll buy at the bottom, and let those less fortunate so to speak, like you, rely on platitudes like "buying is almost always better in the long run..."

All, thanks a lot for your valuable input.
SF Ace - I think cost of owning should be less than renting even without including federal credits because if the owner loses job he should be able to cover his payments through renting it out if he has to move out of area. And I cannot avail fed tax credits if this property converts from my primary residence to rental.
Nomo - I have home(s) in other parts of country and all of them are positive flow even without availing federal tax deductions. I am hoping that those homes will continue to cover for themselves. Example - I have 300k property generating me 1900 $ per month and my dilemma arises when I compare that to 500k in bay area renting for 1700! It just doesn't add up mathematically. I feel lot of Indians and Chinese landed here in bay area and have no idea of potential of rest of USA. But all Asians have lot of money, so where does it go - all become investors and put it in hole in bay area! And unless bay area job bounces back like late 1990's I am not convinced these prices make sense. 1700 rent on 500k property?

Liveconfused,
you said
" I think cost of owning should be less than renting "
That has not been the case in SJ since at least the early 90s. I rented a house for $1800, it was worth about $400k. Interest rates at that time were 8%, so $28k of interest cost. Let's call it $19k after tax deduction. About $350k*1.1% = $3800 property tax. Total = $22.8k. Renting = 12*1800 = $21.6k.

A lot closer than now, but not cheaper to rent, and that was at the trough of a real estate cycle.

Other parts of the country are different for sure. It's interesting and I'm not sure why that's the case. Theories include prop13 reducing the supply of homes, people hoping for further appreciation, Asian immigrants' preferences.

Look at the bright side; renting here is a good deal, so for those who prefer renting can save money and enjoy the flexibility. (although, check out one of the other threads for a renter's tale of woe about the hassle when the landlord decides to sell)

azrob00 says

for most married people the standard deduction is something like $13K. Assuming someone put 20% down on this home, and financed the $400K at 6%, of that $24K in interest, only $11K would exceed the standard deduction, and thus the saving is WAY DOWN from your silly example, down to $3300 a year

SF ace says

A couple earning 160k - 180k would itemize based on state income tax and state sdi and personal property alone. That level of income would avoid the dilution and maximize the tax benefit. It just shows it’s possible, that’s all

Both are great points. I enjoy this thread. When the realtwhores exaggerate the tax advantage they usually ignore to tell you that either you take Standard deduction or you itemize and take the interest deduction. Of course, as SFace points, it might help if you have lot of state tax(buying a car) or medical expense that would help.

Not taking either side(Buy or rent) I can tell that renter has plenty of cash for enjoying a better life style than today's buyer. It'll take several years for today's buyer to come out ahead of renter in living that outside of the home life style. At some point there is a break even point. I just don't know when.

When factoring in the price to rent/own, you also need to factor in the factor that, when you rent, you have higher mobility. This is something that is difficult to quanitfy (as it is more valuable to some than others).
If the cost of ownership of a house is the same as renting after factoring in the tax deductions you get from owning (which may be getting lowered for people with higher incomes, mind you), it generally doesn't make sense to buy. The cost of ownership should be significantly lower than renting. Why buy otherwise? All your buying in that case is the inability to move quickly and a lot of hassle. True, you don't have a landlord to deal with, but that's about it.
Also, with owning, people are quick to forget real estate commissions (you essentially lose 6% when you buy a house), underestimate upkeep, forget the closing costs, forget the piece of mind having that 20% downpayment still in cash may make (with today's super low rates, you basically lock yourself into a 3.5% after tax return, which is still better than money markets, but a low rate for a pretty illquid asset), underestimate extra taxes/hassle/payments made if they decide to sell and end up owning two homes for a period of time, etc.

Nomograph says

Buying is almost always cheaper than renting in the long run, assuming normal market conditions.

Even in abnormal market conditions, (which are relatively short) in THE LONG RUN, buying is almost always cheaper than renting.

I think Nomograph is right that, in general, long-term it's better to buy. If you like your place, and won't move and get an okay price on it, then you'll end up better long-term. At least as long as you're not buying in the middle of an epic bubble like California 2005.

But, over the past 40 years, we've had enormous economic growth in this country, and there was a period of high inflation in the 70's/early 80's, which was raises the price of everything, including houses.

Also, the interests rates are low currently. So if you look at today's long-term interest rates and then look back at the economic growth/inflation we experienced in the 70's-90's, you'd think that long-term, owning is vastly better than renting.

However,I don't think these next 20-30 years will be like the 20-30 years of the past, it may be more like the last ten years. There's a reason interest rates are so low, and it's not just government manipulation. It's because people don't think there's going to be that much economic growth/inflation over the next 30 years. People don't lend at 5% for 30 years if they think there's going to be 10, 8, or even 4% inflation. They think it'll be closer to 1-3%.

If the name of the game is deflation for the next 20 years (like it was in Japan, and we're doing the same shit they're doing in terms of more government, more taxes, more government/less private debt, and lower projected overall growth), then long-term renting isn't as bad, especially if you're more working class and the standard deduction would be as high as the mortgage deduction anyways.

America's savings rate is back to its never-before-seen-until-the-last decade low. For hundreds of years, people saved 6-12% of their income. We're now 3% or less. Government '(both state and federal) has never been as large as it has been in the past as a percentage of GDP (before going into politics, this is the result of both parties). Times are different, and as Japan has illustrated, we should be prepared for something different and not just extrapolate the past into the future.

I disagree, of course.
The whole point of this site is that reasoning like that lead millions to financial doom as “owners” who were then bankrupted by their supposed asset.
It’s possible overpay for a house, right? Once you agree with that, you start thinking about what the correct value for a house actually is. It is the rental-equivalence price.
It’s all about the use of capital. If you waste your capital buying overpriced real estate, you lose.
Price is everything.

Yes, price is everything. It seems too many are missing that point right off.

Nomograph says

Sure. Get the purchase price of a house thirty years ago. Plug in the average monthly rent for a similar house in the same neighborhood, adjusting the rent each year or so to current market value. Now plug in the 20% downpayment, PITI over the same time, plus a reasonable amount for maintenance. Now add in the appreciation over said 30 years, plus the mortgage interest tax deduction. In most areas, say the Bay Area for example, you will see that historically it has been much cheaper to own in the long term.

Historically speaking, when prices go the strasphere, it becomes too expensive to maintain employees, and thus employment/careers/incomes get downsized. There are other variables like this which act on long term trends, forcing prices to correct one way or another. Today we are down to mid 700k workforce form 1.1M workforce in 2000. Interest rates may be low, but you will find employers dont pay attention to those factors.

What a coincidence, more reports / sightings of similar alien investors investing in bay area while working in china :)

http:/s.redfin.com/t5/Bay-Area/One-Example-of-Market-Goofiness/td-p/97668

which blows the level of speculation - 1.3 million home asking 4800 for rent!

And before I could move on I just realized this guy might be even paying close to 13000 $ towards property tax and I doubt he can benefit from tax deduction sitting in china.

So did some ponzi scheme realtor trap the smart investor or is there something to Bay Area which China can see but we fail to see while living here?

E-man you certainly wouldn't want an agent who knows the market then. One who correctly predicted the bubble, wrote about it, and got out of its way. nomoron has called me broke, called me uneducated. I offer a couple of facts that refute those aspersions, and that bothers you for some reason? Sad to be you!+

The links above are now dead, so I went on Craigslist to find one of these 'mispriced' rentals. Here's one at 3154 Trafalgar Road, Fremont, CA that rents for $1,995 per month. It has a Zestimate of $547k. This not rocket science folks; the landlord has a tax basis of $99k and pays less then $1,500 in property tax. He's the one who controls the rental market, and he's about the hand joe landlord (I bought with an ARM for over $500k) his head. Goodbye, thank for playing.

"As ThomasWong likes to think the bay area is tech dominated, it really is not. It has a robust financial industry, tourism, import/export, government and hard/soft (bio)tech. internet, winery. For a law firm, accounting firm, banking firm, SFBA is probablty the second/third most important market. I bet if you draw the income distribution curve, it will the highest standard deviation in the country and explains some of why there is a big difference in price in certain place."

LOL! It was the realtors who were harping the wonders of tech companies and plentiful jobs -- a no lose situation living in Silicon Valley. Then many buyers got stung from tech job losses, and it hurt like a m**********r. So what to the talking heads do? Switch gears and use some other marketing mumbo jumbo!

Yes we do have Chevron and Clorox in the East Bay, been there for a long time.

I bet you do work twice as hard. Robert Reich had a great book about why some jobs pay better and are more fun than others. I think it was this one:

http://www.amazon.com/Work-Nations-Preparing-Ourselves-Capitalism/dp/0679736158/ref=sr_1_4?ie=UTF8&s=books&qid=1271128061&sr=8-4

E: I see where you are coming from.

MY POINT is that in real estate, a field where the majority have a sum total of 100 hours education and a state license granted after an exam a house plant could pass, my having graduate work in mathematics at UCB is not precisely an every day occurrence. Further, having a demonstrated track record of seeing the bubble coming, and acting on it, counts too, in my opinion.

Which would you prefer? an agent who for lack of foresight, bought too much home at the worst time, didn't understand the market, or the economy and has gone into foreclosure? I can point you to hundreds if not thousands, the grand majority of the agents weren't lying when they said, "buy now before you get priced out" they were personally doubling down on houses that made zero sense on a price/rent ratio.

I personally don't feel we are at or even near a bottom. The rapidly increasing number of homes 30/60/90 days late on their mortgages, combined with ever delayed foreclosures has delayed price discovery, but in no way ended it. If you study bubbles, buying very near the bottom is crucial to optimizing your return, selling near a top is not. And, a bottom will form due to fundamentals of value, a top forms when the insanity ends, and that is much much harder to predict. In this forum, a $500K home that rents for

Ptipking222 says

However,I don’t think these next 20-30 years will be like the 20-30 years of the past, it may be more like the last ten years. There’s a reason interest rates are so low, and it’s not just government manipulation. It’s because people don’t think there’s going to be that much economic growth/inflation over the next 30 years. People don’t lend at 5% for 30 years if they think there’s going to be 10, 8, or even 4% inflation. They think it’ll be closer to 1-3%.

Ptipking222 gets it it.

Past performance is not indicative of future results. People like Nomo got lucky and bought into a multi-decade boom cycle, and that is coloring their perception of real estate as an investment. They are also of a generation that lived though the 70's and 80's and understand inflation. Problem is, it's not the 70's or 80's.

As far as I can tell, people that are bulls on housing (e.g. Nomo, SF Ace), don't have any metrics whatsoever on what a fair price to pay for a home is. Patrick has laid out his metrics, so what do the bulls base their pricing decisions on? It seems it's basically "Buying is always better, look at history, end of story."

Nomo saying "Overpaying for a house during a bubble based on anticipated appreciation is another matter entirely." is the closest thing I've seen to conceding that it's possible that renting is better than buying.

I'd love to see Nomo give some more details on how one goes about evaluating when that's the case.

MarkInSF says

Past performance is not indicative of future results. People like Nomo got lucky and bought into a multi-decade boom cycle, and that is coloring their perception of real estate as an investment. They are also of a generation that lived though the 70’s and 80’s and understand inflation. Problem is, it’s not the 70’s or 80’s.

No--not really. It wasn't luck. I suspect that over any 30 year period, buying will be cheaper than renting, as long as you're not buying into a bubble.

MarkInSF says

As far as I can tell, people that are bulls on housing (e.g. Nomo, SF Ace), don’t have any metrics whatsoever on what a fair price to pay for a home is. Patrick has laid out his metrics, so what do the bulls base their pricing decisions on? It seems it’s basically “Buying is always better, look at history, end of story

It's easy. Many of the calculators out there will tell you how long you have to stay in a house before it becomes cheaper to buy. The point is that after 30 years you almost always come out ahead buying.

I'm not a bull on housing. Just pointing out the obvious, really.

dadab says

Not taking either side(Buy or rent) I can tell that renter has plenty of cash for enjoying a better life style than today’s buyer. It’ll take several years for today’s buyer to come out ahead of renter in living that outside of the home life style. At some point there is a break even point. I just don’t know when.

Dont know about renting being the path to wealth. Today's buyers seem to have alot of cash somehow. Could it possibly be at some point they gained proceeds from the sale of a house ? The notion that one would have more wealth by being a renter or buyer is just flawed . You can be poor either way or wealthy either way. For this conversation we wont throw in medical costs - too many wealthy owners went broke because of medical hardships, but I dont have a chart to prove it.

tatupu70 says

MarkInSF says

As far as I can tell, people that are bulls on housing (e.g. Nomo, SF Ace), don’t have any metrics whatsoever on what a fair price to pay for a home is. Patrick has laid out his metrics, so what do the bulls base their pricing decisions on? It seems it’s basically “Buying is always better, look at history, end of story

It’s easy. Many of the calculators out there will tell you how long you have to stay in a house before it becomes cheaper to buy. The point is that after 30 years you almost always come out ahead buying.
I’m not a bull on housing. Just pointing out the obvious, really.

The calculators seem to assume all these things based on 30 year mortgages with x% down. How about those who buy with all-cash at drastically lower prices ? It seems they would come out ahead much sooner, especially if they get enough of a discount.

liveconfused - check out the comments on the PA house:
The owner lives in asia and had planned to move back to the US. But now work is keeping him in Asia and he's looking to rent it out for 2-3 years.

So it looks like he did not intend to buy it as an investment property. One might question his wisdom of buying before the move back to the US was complete, but it seems that we can't question his wisdom of buying a $1.3m investment property because that was not his intention.

Thems buy vs. rent calculators are fine n' dandy, but they assume you are staying in one house for 30 years (or whatever the duration of the mortage is). I know nobody that has stayed in one house long enough to pay off the mortgage.

Fact stands that the first third of a typical mortgage is all interest payments and you spent a good chunk to pay the used home salesman that sold it to you, plus the closing costs, blah blah.

Everyone--no exaggeration--I've known that owned a home ended up selling 10 or less years later. None of these people is rich, nor any closer to having a paid-off home. Sure, that's still just anecdotal and proves nothing, but I'd bet it's pretty close to the general picture of the American home "owner".

Let's see what the NY Times buy vs. rent calculator has to say about my example at 3154 Trafalgar Road, Fremont, CA that rents for $1,995 per month. It has a Zestimate of $547k (similar to the examples liveconfused highlighted). I'm feeling charitable, so instead of using the Zestimate, I'll say an even half million for the sale price (3/2 homes still appear to be going north of this amount, though). With factory defaults, break even is -- well somewhere over the rainbow. Obviously, you can start cranking some knobs and eventually get it to pan out, but not within a reasonable window (7 years). Fundamentals are taking hold, and the old timers are taking business away from the marginal cash flow landlords. How low can you go?

I guess that's why anecdotal evidence is pretty worthless. I know of two couples that sold within a few years after purchasing, and both were to move from a condo/townhouse to a house. Everyone else I know, once they purchased they haven't moved yet. Both sets of parents have been in their houses for more than 30 years.

SF ace said: Now the big elephant here...
I'm convinced the big elephant is the 35%ers. As DinOR used to point out, you deduct your 401k off the top ($33k for two income families). This drops a lot of these individuals/families down 10% for some (or all) of the interest/tax deductions. And zero percent down (give me a break on that one :-). I'll give you this, schools will stratify the different areas, and Fremont may have an attraction to the 35%ers. Appreciation is always the big unknown, and as leverage is involved, you can crank that knob and get results fast. That said, good luck with 2% the next couple of years. Also, my contention for that time period is flat or down on the rents...

If you're a solid 35%, chances are you're looking at something bigger. If you're not, I'd say good for you (you're at a multiple where you could make it on one income if need be). I do agree that at 35% you can move mountains. In Ess Eff, though, that is still condo territory...

When a guy come into the desk, asking 500K loan with no downpayment at 5% rate, I am pretty sure that the financial person will be laugh his rear off.

Not everyone can get that. Just to be little more realistic given the size of the loan, how about 5% DP at 5.5% rate? And the inflation rate for the last couple decades was like 3.5% though, just put that aside for a while and assume all other parameters are the same. What do we get? It will say, renting always is better than buying. If the rent is 2500 instead of 2000, sure, buying is better. So, that's as good as a calculator can get. The result is depending on the perspective of the person who uses it.

It doesn't matter if you're bearish or bullish. People always try to see what they want to believe from any data. Doesn't matter what the data is all about or how is it designed by whom. For instance, the C-S graph is basically telling me that, we're half way thru the recession, and 70% or bubble is still there. What it is telling you may differ. You guys can interpret it anyway you want to see.

As for the standard metric whatever that is... (BTW, is it Patirick's rent.vs.own analogy?)

Patricks analogy, and that old 15X home price vs rent analogy is generally true, and that's the way it should be. However, I have to stay with SF-ace on this matter at least at this moment. For those bubble area where income is relatively high, and presence of housepoors and investors... the place like SF area, part of NY and DC metro, things are not working like other area that already got hammered.

Now, the real question is that, is it possible for those area to get hammered like rest of the US?

I think it should be, but little skeptical about that as long as the government is not letting that happen, and as long as those people already had money from the bubble don't waste it.

SF Ace, and Nomograph, thank you for your long thoughtful posts.