patrick.net

pinnacle says

I still see the same for rent signs I have been seeing for the past six months, only more of them.

I don’t think as many people are paying as used to but the landlords won’t drop the

rent to realistic prices.

I know lots of people who would rent if prices came down but it’s not happening.

Landlords can't drop the rent below the level needed for servicing their debt + some income they need to survive.

It seem that it is 2nd topic where population growth has been discussed.
This is somewhat an off-topic, but each time we head into a downturn, I see how many of my friends start and/or continue families. This downturn was same. At work alone in a group of 20, we had each year 2-3 girls pregnant, and 1-2 guys whose wife's were.
I think much can be attributed to the fact that during downturn it is hard to enjoy vacations, hence people spend more time at home, combine residences, and hence the result...

michaelsch says

Landlords can’t drop the rent below the level needed for servicing their debt + some income they need to survive

rents are determined by supply and demand. What the landlord needs to service his mortgage is completely irrelevant.

If you buy a 1M home and accept $1000/month rent for it, you're better off selling it and putting the money in the bank.

They might have paid it off, but it has to give them better returns than a bank would give them. Hence there is a bottom.

California population is growing, the number of unhappy people leaving vs immigration + people moving here out numbers them. It's a very desirable place to live, regardless of costs. If I'm going to "break even" at the end of the month, I would rather do it in california.

SF Ace is dead on: People don’t make buying/renting decision based on cost alone.

Having said that -
In my house, on a monthly basis, the rent (for an equivalent house) would be less than my interest (minus tax deduction) and property tax (no tax deduction due to AMT) and the opportunity cost of my down payment. And I'm ok with that as I like the house.

But this talk made me curious. So I set up a spreadsheet to look forward to see if the situation would change. For example, 30 years from now, no interest payments, so it could be cheaper then.

I assumed rent goes up with inflation at 3% per year. House price is flat for 5 years, then goes up at inflation + 1%. This is what is cited by case-shiller fans. (more on this later). After tax return on down payment if I rent is 6%. (8% return - 25% tax, actually should probably be a bit less.) Property tax goes up 2% per year, prop 13. Actually this is pessimistic, if the house price is flat for 5 years then prop tax would be flat too. Added something for maintenance and insurance. I used the IINT function to determine the interest per period, minus the tax deduction. (it's true that in some places the tax deduction is irrelevant, but most people looking at $500k+ homes in San Jose makes enough so that they are paying enough CA income tax that they are already itemizing.) Finally, the value of the house is whatever it gets to minus 6% for agent fees on sale.

House is $1.5m, similar ones rent for $4k. 31.25 rent. By Patrick's rule of thumb a $4k rental should cost $800k tops as monthly rental cost should equal ITI immediately.

The result.
At the beginning renting is much better as you might expect.

But, around year 15, the cumulative cost (all the rent minus the investment gains, compared to interest + prop tax + home value gains) is even. And after that, owning is cheaper.

I thought this was pretty interesting. Sure, the assumption of inflation + 1% for house price increase is not set in stone. But if the economy collapses and house prices collapse, then the investment for the down payment probably won't return 6% after tax either.

One final note - I assume that rents go with inflation but house prices are inflation + 1%. House prices being inflation + 1% has some correlation to real incomes growing over time, and people choosing to spend the same proportion of income on owning over time. So it is more than inflation. Perhaps rent should also be inflation + 1% - it would be the same percentage of income, and would maintain the rent vs price ratio. This would also make the owning break-even point happen sooner as the cumulative rent over 10 years would be higher.

How do landlords sevrvice their debt if they have empty apartments for months on end?
Some money is better than no money.

SiO2 says

House is $1.5m, similar ones rent for $4k. 31.25 rent. By Patrick’s rule of thumb a $4k rental should cost $800k tops as monthly rental cost should equal ITI immediately.
The result.

At the beginning renting is much better as you might expect.
But, around year 15, the cumulative cost (all the rent minus the investment gains, compared to interest + prop tax + home value gains) is even. And after that, owning is cheaper.

It's worth noting that rents *should* be higher than owning in the long run. The reason is that a landlord should be able to recoup PITI + maintenance + transaction costs and make a reasonable profit in order to make the property a decent investment property. But investment properties are different from primary residences because you should care about ROI, not about buy vs. rent.

The problem people run into is assuming that owning a primary residence is always better, including during a 5 year or smaller period (e.g. the broken concept of a "starter home"). Given transaction costs, it's often that case that you have to hope for undue appreciation in order to just break even or make a profit on a primary residence with such a short holding time. People did benefit undue appreciation on primary residences during the recent boom, but that was gambling, not investing. In a typical market you will lose money by owning a primary residence for such a short time.

Most people don't live in the same house for 15 years. It should be 6-7 or less imo to make buying make sense.

If it is, in fact, 15 years based on these assumptions, it means the house costs too much and will likely come down. So the 'it will be flat for 5 years, then 4% YOY' is optimistic because that house, in particular, is overpriced.

SiO2 says

SF Ace is dead on: People don’t make buying/renting decision based on cost alone.
Having said that -

In my house, on a monthly basis, the rent (for an equivalent house) would be less than my interest (minus tax deduction) and property tax (no tax deduction due to AMT) and the opportunity cost of my down payment. And I’m ok with that as I like the house.
But this talk made me curious. So I set up a spreadsheet to look forward to see if the situation would change. For example, 30 years from now, no interest payments, so it could be cheaper then.
I assumed rent goes up with inflation at 3% per year. House price is flat for 5 years, then goes up at inflation + 1%. This is what is cited by case-shiller fans. (more on this later). After tax return on down payment if I rent is 6%. (8% return - 25% tax, actually should probably be a bit less.) Property tax goes up 2% per year, prop 13. Actually this is pessimistic, if the house price is flat for 5 years then prop tax would be flat too. Added something for maintenance and insurance. I used the IINT function to determine the interest per period, minus the tax deduction. (it’s true that in some places the tax deduction is irrelevant, but most people looking at $500k+ homes in San Jose makes enough so that they are paying enough CA income tax that they are already itemizing.) Finally, the value of the house is whatever it gets to minus 6% for agent fees on sale.
House is $1.5m, similar ones rent for $4k. 31.25 rent. By Patrick’s rule of thumb a $4k rental should cost $800k tops as monthly rental cost should equal ITI immediately.
The result.

At the beginning renting is much better as you might expect.
But, around year 15, the cumulative cost (all the rent minus the investment gains, compared to interest + prop tax + home value gains) is even. And after that, owning is cheaper.
I thought this was pretty interesting. Sure, the assumption of inflation + 1% for house price increase is not set in stone. But if the economy collapses and house prices collapse, then the investment for the down payment probably won’t return 6% after tax either.
One final note - I assume that rents go with inflation but house prices are inflation + 1%. House prices being inflation + 1% has some correlation to real incomes growing over time, and people choosing to spend the same proportion of income on owning over time. So it is more than inflation. Perhaps rent should also be inflation + 1% - it would be the same percentage of income, and would maintain the rent vs price ratio. This would also make the owning break-even point happen sooner as the cumulative rent over 10 years would be higher.

pinnacle says

How do landlords sevrvice their debt if they have empty apartments for months on end?

Some money is better than no money.

The smart ones keep them full or at least close to capacity.

Just a couple of thoughts here. The economic principle of substitute goods says that when a particular good becomes too expensive (in the view of a consumer) that consumer will seek out a less expensive substitute. The classic example is: beef becomes too expensive because of a shortage to the consumer chooses chicken instead. This applies to everthing including housing. If the house is too expensive to buy people rent. If rent becomes too expensive, there are alot of alternatives: move in with another person or group, move in with relatives, move to a cheaper area, move into a smaller space, buy a motorhome and live in it, live in a campertruck and frequent local homeless shelter(see it all the time near work), actually live at the homeless shelter(again many young working people live there), move out of the area. So in truth people really don't have to pay higher rents ad infinitem.

The second point is so many base their projections based on inflation expectations. Obviously inflation works in favor of asset holder as long as they main their asset properly. But what about economic Deflation? Most of us living have no real idea how prolonged deflation will affect the rental market. First of all most devestating is wage deflation because if you sustantial debt you will default and probably go bk. If you are a highly leveraged re investor and can't sell fast enough you will be wiped out. If you own your asset outright you'll probably be ok although it may take many years to recover to its bubble value(think Japan). This is a legitimate possibility. If we are in this why are the bank so antsy to get re-crap off their books and dump it on the fed, the speculators, foreign investors, gov guarantees, and the like? If they really believed real estate was going to go great guns in the next year of so why not just hold it all till then. There are more being laid off all the time and with our state and local govs hitting budget wall, even more to come. Even the day laborers are disapearing from osh and home depot. 18 months ago there were at least 100 of them waiting for work at osh near my house. Now there are maybe a dozen on any given day. Where'd they all go? People aren't going to be able to remain on unemployment forever. When they get booted off will they be able to find jobs at the payrate they made before? Will there be any jobs for them? I think there will be but for ALOT less and maybe by dislocating higher paid workers. If great numbers of people make alot less in a given area will they be able pay ever increasing rents? Isn't this fundamental to affordability-less demand?

I live/rent in Santa Cruz and while we like where we live (especially the rent, $1700/mo for a 3 bd duplex with yard and garage), I'm always open (hoping?) to move to a house with a larger yard. In the last 6 months, rents for 3 br properties have been around $2200-2500. Just in the last 2 weeks, landlords have specifically been targeting UCSC students, asking $3000+ for 3 br places. I'm very curious to see how the year will progress with increased student fees, cuts to enrollment, grim job outlook, etc., for these landlords.

Betty i think it would behoove anyone looking to rent to make great efforts to find who owns the property, if the place is in some stage of foreclosure or default, or if it is reo. Lots of people scamming out there, like renting out homes they don't own. I don't think I'd rent from anyone who is in default. I really don't want to move every year and I really don't want to put money in the pocket of somebody who's not even paying their mortgage.

If I have a house in San Jose and find a job in Marin, and my brother has a house in Marin and find a job in San Jose, we can trade. We can charge each other $500 or $50000 a month, and the result is the same.

In other words, the people who spend $3000 to rent 700 sq ft houses are the same people who have houses rented out.

No one is stupid enough to work at $10 a hour and pay $3000 a month for a tiny house.

Edit: If Bay Area people are making lots money from the rent, the incomes should be high but they are not.

ptipking -
I agree, if you plan to move in 10 years or less, in current conditions, renting is better (in Fortress). And buying a starter home with plans to move in 5 years is not a good idea. If you like to move frequently, renting is certainly better. And sometimes you get to move involuntarily if you rent.

But, you said: "Most people don’t live in the same house for 15 years. It should be 6-7 or less imo to make buying make sense."

I don't know. Neighbor to my right lived there 20 years. neighbor to my left, 15 with no plans to move. Previous owner of my house, 25. across the street, recently purchased from someone who lived there 30 years. My circle of friends pretty much have lived where they live for 10 years or more with no plans to move. (with one exception, but he lived in the current house for 12 years before moving now).

It really depends on the personal situation. And yes, there is a risk, I could lose my job and all my investments and be wiped out. But then renting and investing is not much better, unless somehow I pick something that survives the catastrophe. Gold guns and goods (canned) are popular in some circles.

John Bailo says

michaelsch says

Landlords can’t drop the rent below the level needed for servicing their debt + some income they need to survive.

Oh, come on. Many of the apartment buildings I see are 20 or 30 years old! They must be paid for. That leaves maintenance and taxes. Take a 3 story suburban townhouse apartment building with two landings and two apartments on each landing. That 3 x 2 x 2 = 12 units. Now these are 1 to 3 bedrooms renting for $700 to $100. Lets average it at $800. So the building…which occupies the same amount of land as a large house is bringing in $9,600 a month.
Now…how big a mansion could you get for a $9,600 a month mortgage?

Even if the building is completely paid for and had no expenses at all, rent would not be free or even close to it. Landlords expect a return on their investment. Otherwise why not sell the building and invest it somewhere where they get a return?

In the end, rent is determined by what renters are willing and able to pay.

@Sio2
Assuming you've lived in a place for 6-7 years, and then lost your jobs, investments, etc, you could probably rent it out, due to inflation without losing anything. It's probably only a major risk of loss for the first couple of years, while rent, taxes, and what not might be substantially higher than the rent.

@xenogear3
College kids are more likely to live together, pull money from parents, pull money from loans, and not fully understand the markets at their age.

@pinnacle
"Some money is better than no money" might seem like a good idea, but might quickly crush you. If you're renting out 12 apartments in a complex, and you have to reduce the rent on one place because no one is taking it from say $1000 to $600, what do you think the other 11 renters are going to want? You went from a $1000 per month loss to nearly $4400 loss potentially! Of course if you own one place, then a little rent might be better than no rent...

justme says

Now, that being said, incomes are dropping, so I would not be surprised to see rents dropping further in the short term.

Actually they WERE dipping. The last report had incomes rising modestly in 1Q 2010.

How is this even a thread?

Ooops, I just added to it.

thomas.wong1986 says

Workforce in 2000, 1.1M down to mid 700s today. Salaries frozen for 3-4 years, unemployment in 2004-05 at 6%, today, unemployment at over 10%. Promotions? dont ask, be glad you have a job. But if you want hard numbers ask your HR departmens lates Rutherford reports. Not pretty!

Thomas--anecdotal evidence really isn't as useful as hard data...

rents are determined by supply and demand. What the landlord needs to service his mortgage is completely irrelevant.
Certainly -- in the long run, as they say, it all works out. I made numerous posts on the Going up thread showing that landlords with the lowest cost basis also have the lowest rents. They cherry pick the good tenants. Landlords who overpaid (with "free" money) eventually go out of business, but they represent a large of amount of friction in the interaction of the supply & demand curves which manifests itself as stickiness in rents (and housing prices). And insanity...

justme says

>>They can’t be insanely high if everyone is paying them.

This is exactly what people used to say about:

1. tulips in the tulip bubble

2. dot-com stocks in 1998

3. houses in 2006

It was wrong them, and it is wrong now.

Nobody rents with the hope of renting for a higher price and making a profit.

MarkInSF says

justme says

>>They can’t be insanely high if everyone is paying them.
This is exactly what people used to say about:
1. tulips in the tulip bubble
2. dot-com stocks in 1998
3. houses in 2006
It was wrong them, and it is wrong now.

Nobody rents with the hope of renting for a higher price and making a profit.

it's possible to have everyone paying ridiculous rent.

were you in the bay area during the dot com bubble?
rents were insane. and everyone was paying.
i had my rent increased from $1200/month to $1600/month in less than year (i moved out of course after the increase).
i just looked on craigslist and the rent for the floor plan i was paying $1600/month in 2000 is $1400/month today.

rents are fairly reasonable today.

mike says

were you in the bay area during the dot com bubble?....i just looked on craigslist and the rent for the floor plan i was paying $1600/month in 2000 is $1400/month today.

I remember very well. Stock options in a tenant's company were granted as part of a office lease contract, and rental applicants were well advised to have references for pets to have any chance of keeping them in their homes. And yep, rents are not a whole lot different in San Francisco than they were 10 years ago.

Thing is the late 90's push was just a side effect of a bubble. There is no economic bubble causing rents to rise right now. Some people though foreclosures would mean a boom in rent prices ("they've got to live somewhere!"), forgetting that people can and will move in with family, or take on roommates and boarders in tough economic times.

This is a good topic. The rent is 3 times more than any other places in US. Also the house is old and small.

Some people claimed that it is easier to find a job or the pay is high. However, the unemployment is 10% and the wage is only 30% more at most based on the economic data.

Just a hypothetical economic model here for your consideration here. The numbers don't matter so much as the percentages and what they may suggest.

Let's say the constants here are a population of 1,000,000, housing units of 250,000, and static incomes.

If at a certain price point, say 1000 per unit, all the units are full and being paid for by their occupants. You could say supply and demand had arrived at equalibrium. Prices were ideal.

Now let's say that prices of these units have risen because owners desire to pad there bottom line profit. Prices have now risen to 1500. Some occupants can absorb these increases but others cannot and search for alternatives. Now 20% of all units are either vacant or are not being paid for by their occupants. Remember the constants, population, housing units, and income. What is the economic solution to insure all units remain occupied and paid for? Demolish housing units? Increase population? Pay people more money? I think it would be wishful thinking that any of those things will happen considering the fragile state of the local economy. In fact just the opposite is happening in this area. More housing units becoming available, population shrinking, and income dropping because of wage cuts and layoffs.

In reality, the amount of housing units not being paid for or occupied is probably pretty darn close to 20%. What's the solution?

Even hypothetically speaking, I think static incomes is probably a pipe dream going ahead for most sectors of the working public.

Of course rents are insanely high here. They have been for a very long time, before the Bush-Greenspan phoney borrowing days, before the dotcom, before Silicon Valley even, the rents have always been insanely high here. IF you think it is too crowded here now, imagine how even more overcrowded and congested it would be here if the rents were not insanely high. The insanely high rents are kind of a relief valve on the pressures of the overcrowding and overtaxing the resources. Some people who are not rich immigrants or don't have high pay jobs, but regardless choose to live here just have to make compromises like living on the financial edge or doubling up or whatever, if they are not comfortable with those compromises then they leave the area. There is a whole lot rest of the USA to move to where the rents are not so insanely high.

save while renting then buy

Austinhousingbubble says

Even hypothetically speaking, I think static incomes is probably a pipe dream going ahead for most sectors of the working public.

that statement makes me laugh... I think you're a little overly pessimistic, even by your own standards.

Anecdotally, I am seeing what looks like long-term reductions in household income in my local community. For example, in one family, the husband lost his job about a year ago and has not been able to find anything that can really replace his income, which was significantly more than his wife's part-time income. She dialed up her hours as much as her company would allow, and he just found a part-time job that will, in the end, pay about 1/6 of what he used to make. They can make it but will gradually have to eat their retirement savings. A neighbor has a similar situation, though he has managed to pick up contract work about half the time, so he is at about 1/2 his previous income. His wife works part-time and has not been able to find full-time work. Again, they are gradually eating their retirement. A third family had a family business which has tanked over the past two years. The wife has taken on babysitting while they wait this out, but, even though they both work for the business and otherwise, they are hitting the savings pretty hard, and the savings is almost gone.

I mention this because I do think that it is relevant to rents. None of the people I mentioned are unemployed at this time--they have jobs, just not the better jobs that they used to have. None of them look as though they are in major financial distress--they still pay their bills and dress like grown-ups. But they are using up savings or possibly moving into debt in order to maintain a relatively modest standard of living, and it is not clear that they will find better employment anytime soon. It only takes one underemployed person in a family to dramatically change what that family can afford with regard to rent in the long-term. So I would suggest that future rents are pretty dependent upon the employment situation going forward, not just how many people have jobs but how good those jobs are. Is the work full-time? Is it an employee or contract relationship? Is the pay at a reasonable professional level, or is the employer getting a discount? Is health insurance paid by the employer, or will the employee need to set aside money to pay for insurance? These things matter, because in the long-term they will change what people are able to pay for rent.

that statement makes me laugh… I think you’re a little overly pessimistic, even by your own standards.

Glad to see you're keeping your snide gland firing.

Clearly, you have done very little reading on the matter of labor.

Austinhousingbubble says

Glad to see you’re keeping your snide gland firing.
Clearly, you have done very little reading on the matter of labor.

I've heard that if you don't use it, then it might stop working--and we wouldn't want that to happen, would we?

I've done little reading? So, if someone disagrees with you--that means that they are uneducated? Who's being a little snide now?

That's not what I meant to imply -- I only meant that I'm incredulous how any reasonable soul could have such a different take-away from well-established data points regarding labor trends/middle class. I didn't think they were that open to interpretation. It's not poetry!

xenogear3 says

I think the problem is NOT “don’t have land”, “too many people move in”, “Too many high pay jobs” or “Unemployment rate is only 3%” in the Bay Area.

It is something to do with the government policy.

Ah, just a taste of whats to come! This is what happens when regular working conservative people are vastly outnumbered by Liberal wackos! Enjoy your fruits and nuts, California! And enjoy your Nazi Governor!

Austinhousingbubble says

That’s not what I meant to imply — I only meant that I’m incredulous how any reasonable soul could have such a different take-away from well-established data points regarding labor trends/middle class. I didn’t think they were that open to interpretation. It’s not poetry!

I'm confused. Please show me the data points/trends showing that incomes are decreasing and will continue to decrease in the future.

Please show me the data points/trends showing that incomes are decreasing and will continue to decrease in the future.

Not much information for 2010 yet, but there's this:

http://www.washingtontimes.com/news/2010/apr/13/personal-income-falls-32-during-obamas-15-months/

And then this brief WSJ article from last Sept which shows changes in household incomes by state:

http://blogs.wsj.com/economics/2009/09/10/lost-decade-for-income-change-for-households-by-state/tab/article/

Of course, median incomes wouldn't even have to technically decrease for the middle class to see diminishing returns if we experience a real inflationary scenario going forward.

Here's one other interesting piece (with chart) I read just recently regarding median incomes:

http://www.epi.org/economic_snapshots/entry/where_has_all_the_income_gone_look_up/

If you want more data, check out some of the essays/lectures (some of which are on Youtube) by noted scholars like Elizabeth Warren, Robert Reich, Mark Barenberg and the recently departed Willard Wirtz.

...as for continued decreases in the future, I fail to see how median wage/salary earners in America are going to regain traction and see any real returns without major reforms when it comes to trade agreements/tariff law/international workers rights, etc. Our exploitation of cheap labor/goods goes hand-in-hand with the erosion of the working middle class here in America - two sides of the same coin.

Austinhousingbubble says

Our exploitation of cheap labor/goods goes hand-in-hand with the erosion of the working middle class here in America - two sides of the same coin.

Ahem... Arizona.

Austinhousingbubble says

…as for continued decreases in the future, I fail to see how median wage/salary earners in America are going to regain traction and see any real returns without major reforms when it comes to trade agreements/tariff law/international workers rights, etc. Our exploitation of cheap labor/goods goes hand-in-hand with the erosion of the working middle class here in America - two sides of the same coin.

OK--now we're getting somewhere. Yes, wages decreased during a bad recession. Of course they did. They always do... They are already starting to rise according to the last data for 2010.

Going forward, you just don't see how they can rise--fair enough. I'll put my money on them increasing--there are problems with the US economy no doubt. But somehow, we always manage to find ways to move forward. This time it might be different, but I'm betting it won't.

Yes, wages decreased during a bad recession. Of course they did. They always do…

Things were exacerbated by the recession, yes, but this doesn't address the real crux; middle class compensation has been steadily whittled away at starting long before the last two recessions thanks to a variety of factors that have only grown in force.

They are already starting to rise according to the last data for 2010.

For which income groups?

Going forward, you just don’t see how they can rise–fair enough.

Adjusted for real inflation, full-time incomes today allow the average employee to command only a fraction of their share of the GDP as it did back in the late seventies. Further exacerbating this phenomena has been our increased trade with China. Economist Robert Scott calculated recently that 2.4 million American jobs were lost between 2001 and 2008 as a result of our trade deals. Granted, the *affluenza* fueled by the housing bubble/HELOC abuse and other forms of easy credit served as a stopgap this last decade, but I think that might be a closed book. Maybe not. In any event, I don't see anything in place in the way of labor or trade reform to reverse the highly erosive forces at work on the working class.

But somehow, we always manage to find ways to move forward.

I only hope our next big gambit isn't just another new & improved shell game.