patrick.net

High end bay area markets are as overpriced...I am frustrated...Let's start the fun again. :)

Wow, sort of written just like a fast-talkin' realiturd. And sort of not. By any chance are you collecting unemployment?

for an asset that drives 30%+ of it’s value from the MID as well as meaningful portion of value attributed to low short term rates

ayup. But one thing to put in the hopper is that rates can stay low for the foreseeable future, or even go lower from here.

The Japanese government is borrowing 10 year money at 1.25% and loaning it out at 2.5% for 35 years.

I think that's a possible future for us, too.

Not certain, though, maybe not even probable. Just possible. 'Course, the Republicans are going to shut down the government completely next week, so there's that.

"I’ll ignore amo as it is effectively zero interest forced savings."

Even though I understand this reasoning, I do not agree that it is forced savings if it is based on an asset that is falling in value. I suppose I'm looking shorter term, though. For instance, if your 1.2 Million dollar mortgage is only worth 1 million after 5 years, (even if you kept a sub 4% interest rate), you will still owe 1.08 million in principal. So how is this any form of savings at all??

The $1 million mortgage looks like this: 5.5% interest plus 1.5% in property taxes = 7% carry or $70k per year, about $5800 per month. I’ll ignore amo as it is effectively zero interest forced savings. Anyone who has any business borrowing $1mm is likely in the 35% marginal tax bracket, so the $70k carry starts to more like $48k (4.8% of mortgage) or $4k per month after tax. This is a huge swing. We’re getting close to rental pricing!

you're not including any principle in your calculation.

there is a very large opportunity cost of having that money sit in a house if the house price depreciates.

^ One just has to assume that the Fed isn't going to allow home prices to fall any further.

The Republicans have taken Treasury's bazooka away, but the Fed is still outside their direct control.

If you have any business taking a million dollar mortgage then the odds are that you won't get the full MID due to the AMT. The AMT reduces the MID by a substantial amount. So this analysis understates the post-tax carry-cost.

Not saying it can't make sense, but when you are talking the 35% tax bracket, all kinds of weird issues come in play.

SF ace says

*AMT tax is a tax credit against regular tax. Let’s say I have to pay 2,000 in AMT in 2010. In 2011, I decide to dispose of stocks and fall back into regular tax, that 2,000 I paid in 2010 is a credit to tax in 2011. Nobody pays AMT forever. Even if I accumulated 100K in AMT tax, it just reduces my future tax by an equal amount when I decide to stop working and fall out of AMT. AMT credit does not expire.

So from that perspective, I suspect eveyone that makes bewteen 200K-300K gross still realize pretty much the full value of MID and people who makes much more may still realize most of the benefit via timing difference.

Wrong. Once you get into AMT, you lose the CA state income tax and property tax deductions.

Assuming you are already paying AMT without a mortgage, with about 200-300K taxable income, your benefit from an 800K loan, (Mort. interest @5% 48K, prop tax @1.125% 9K) is a reduction in state tax of 4K and a reduction state tax of 10K, or 14K in total tax benefits. (Approx. nos, sorry can't be more specific, as this is real data)

14K/57K is about 26%. Far less than 35%.

And no, you cannot get a credit for AMT, except for timing items. (ISO stock or some depreciation cases). Itemized deductions like MID, state, local and property taxes will _never_ create a tax credit for you.

Thanks to all for your thoughtful comments!
Isn't the AMT taxable amount reduced by MID as well as the amount with deductions?

The point that my post is trying to make is that MID has a magnified affect on Bay Area home values. That and borrowers using floating rate money continue to justify a market that is not supported by income. I'm a four year reader of patrick's link's though this is my first post. As a finance guy I buy into the logic that residential real estate doesn't make sense as an investment. Though, i'm coming around the the conclusion that it might make sense as consumption assuming i have a long time horizon and the MID stays in place.

It's really amazing how much the US gov't subsidizes real estate. It's like crack cocaine and I'm not sure how policy makers will ever be able to pull the subsidy, even in the possibility of crazy inflation comes to pass.

SF ace says

cranker. we sound like a bunch of tax geeks getting into AMT,
1) Yes, AMT requires addback of state income tax and state property tax. But this is offset by the fact the for AMT exempts 73K in taxable income. It is impossible to pay AMT without a 150K taxable income. 150K taxable income is a regular tax of $30,243 and AMT tax (150K + 40K state tax addback -73K exemption @ 26% = $30,420. So taxable income of 150K appears to be the infection point where AMT comes into play. (for a family of four but of course individual result may vary)
In other words if I have 270K in gross income, -40K in pretax programs, -75K in itemized deduction -12K in personal exemption for a family of four, my taxable income is 143K, which is still below the infection point of 150K in taxable income to put me into AMT.

No. 150K +40K state tax addback+ 12K personal exemption addback = 212K. Your AMT exemption starts phasing out, and is not 73K anymore, it is now 57K. Your AMT tax is (212-57) @.26 = 40.3K.

There itself you pay $10,000 in AMT.

2) Mortgage interest deduction is a reduction for both regular tax and AMT tax. The value is slightly higher for regular tax than AMT tax at 26%. So 48K @ 26% = 12,480. Yes, I agree once taxable income is at the 200K to 300K level, AMT comes into play. But I just demonstrated above that a gross income of 250K for a family of four with a home will not put them into AMT. That is why I believe the sweetspot for the MID is gross income between 200-280K. That is enough to get a 729K primary and 100K HELOC mortgage.

3) The 26% benefit is for federal tax only. California income tax models after the federal income tax system with adjustments but California has no AMT, so the taxpayer will reduce state income tax by 9.5% paid so total federal and state tax benefit is still around 35%.

Pay 58K in mortgage and prop tax, and get about 16K in tax benefit.

4) AMT is the difference between regular tax and AMT. If the taxpayer is subject to AMT, the AMT is a credit against future regular tax which never expires. The AMT credit is used as a reduction of regular tax claimed on form 8801 on line 76 (tax credit) of the 1040. Unless the taxpayer pays tax based on AMT forever, eventually the credit will be utilized.

This (4) makes me think you have a little knowledge about AMT. There are no AMT credits, except for cases of ISO stock options, or depreciation.

If the reason you are paying AMT is because your regular tax is low (after itemizing state and property tax), you get zero AMT credit for those AMT payments. Zero. Form 8801 gets you zilch.

This is a post out of curiosity rather than an ability to contribute constructively to this thread. So, apologies in advance.
I am sitting on the sidelines looking to buy in the higher end bay area market. I already own a small, old, crappy home with no insulation, no closets etc bought in 1999 which we have outgrown. So, will make a move when prices cool down some more. Schools are important for us, since we do not want to send kids to private schools and it makes sense to buy in an area where the public schools are good. I was of the thought that the increase in mortgage rates would discourage buyers. I have been going to open houses in certain pockets of the bay area for 6 months now (Los Altos Hills, Saratoga, Palo Alto), more as a spectator sport and to get a feel for the local market than to actually buy. But, in recent months, I have seen 2 million and 3 million dollar houses (in the most "desirable" locations) get into bidding wars and disappear out of the market in days. And most of them would need another 500K to refurbish them to bring them up to living standards or in some cases they might have to be torn down and rebuilt in order to match their price tags! I am curious as to who the buyers with this kind of cash are?? Where is the multimillion cash flow coming from? One listing agent told me that she just accepted an "all cash" offer for a run down home in Los ALtos Hills in a desirable lot. I am sure that the yuppy moneyed crowd from Facebook, Twitter etc would not buy these old, crappy homes in "good school districts" because they probably don't care about school fees etc.

bayhousehunter says

This is a post out of curiosity rather than an ability to contribute constructively to this thread. So, apologies in advance.

I am sitting on the sidelines looking to buy in the higher end bay area market. I already own a small, old, crappy home with no insulation, no closets etc bought in 1999 which we have outgrown. So, will make a move when prices cool down some more. Schools are important for us, since we do not want to send kids to private schools and it makes sense to buy in an area where the public schools are good. I was of the thought that the increase in mortgage rates would discourage buyers. I have been going to open houses in certain pockets of the bay area for 6 months now (Los Altos Hills, Saratoga, Palo Alto), more as a spectator sport and to get a feel for the local market than to actually buy. But, in recent months, I have seen 2 million and 3 million dollar houses (in the most “desirable” locations) get into bidding wars and disappear out of the market in days. And most of them would need another 500K to refurbish them to bring them up to living standards or in some cases they might have to be torn down and rebuilt in order to match their price tags! I am curious as to who the buyers with this kind of cash are?? Where is the multimillion cash flow coming from? One listing agent told me that she just accepted an “all cash” offer for a run down home in Los ALtos Hills in a desirable lot. I am sure that the yuppy moneyed crowd from Facebook, Twitter etc would not buy these old, crappy homes in “good school districts” because they probably don’t care about school fees etc.

USA is a big country with a lot of people. No matter how you or anyone think how stupid, senseless, illogical a certain property was sold, I can only conclude there are a lot of crazy people in this country. Take for example the condos at Altaire in PA. Seems like people are living
in a colorful matchbox stack against each other, garages are completely detached from the units, and needless to say, high cost of ownership(HOA alone is $430)

"All cash" doesn't mean "Paid with a suitcase full of money". The term is used very loosely. Often it means no more than "An offer with no financing contingency." Essentially the buyers are betting two things: 1) That the house will appraise and 2) That they can get the loan with no issues.

If you have enough cash to cover nearly any appraisal shortfall, then satisfying 1 is fine, even if you don't have the full payment in cash.

If you have a stellar credit rating, are thoroughly experienced in financing, and have terrific relationship with your lender, then satisfying 2 is also pretty easy.

But, of course, sometimes all cash offers really are satisfied with a wire transfer from a bank account. These people are investment bankers, venture capitalists, CXOs and both dot-com and real-estate bubble surfers who jumped off the wave in time. They do exist, and they want to live in fortress areas.

I agree that there are crazy home buyers out there! But, crazy or not, where are the multiple millions in cash coming from??? Stock market? Overseas? What?

If I was a dot-com player and timed my exit right, then I have millions in cash. If I was an attorney during the dot-com IPO craze, then it didn't take any timing issues at all.

If I started at google any time before about 2003 or 2004, then I have millions, or even billions, in cash. If I had stock options at Apple dated from about the same period, then I have millions in cash. Facebook people are pretty optimistic about their chances and can do no-financing contingency offers these days.

The lawyers for all these companies made killings. Their business planners and venture capitalists did to. They all have money.

Throw in the moguls from the Indian companies where all the outsourcing went since about 2005, and the Chinese manufacturers who are making all your goods but want to send their kids to American universities. It doesn't take very many people with that kind of money sitting around to make all-cash offers in the fortress.

In very round numbers, there are probably less than 1,500 houses sold each year in all the fortress. Of those, maybe 1/3 go all cash. You only need 500 people with that kind of money sitting around to make this kind of thing happen. There are easily that many google millionaires alone.